The cool and sunny weather across much of the US this summer has been perfect for growing corn, which has turned into terrible news for the corn growers.

The bumper crop they’re preparing to harvest is expected to yield a record 165 bushels of grain per acre, with lots of fields poised to produce more than 200 bushels per acre.

As often happens, expectations of a glut have depressed corn prices that were already suffering from a buying moratorium by the Chinese, after a genetically modified strain to which China objects was found in US corn shipments.

As a result, corn is trading at a four-year low below $3.70 a bushel, less than half its price during the drought of 2012.

This is a windfall for ethanol producers, whose costs are largely determined by the price of corn that is their chief input, whereas the ethanol they sell tends to be priced off gasoline. Though ethanol prices have been flat to slightly lower of late, the bear market in corn is crushing bears in ethanol stocks feasting on the widening “crush spread” — the ethanol production margin based on corn prices.

Corn discount in green. Source: Barchart.com

Two weeks ago, when this trend was only slightly less pronounced, we added the West Coast ethanol refiner Pacific Ethanol (NASDAQ: PEIX) to the Aggressive Portfolio, and have already seen a return of nearly 20 percent.

In addition to the sale on corn, ethanol stocks appear to be responding to the prospects for rising demand, since ethanol continues to trade at an attractive discount to gasoline. Also in play may be the growing realization that the favorable margins could stick around for longer than investors have so far dared hope.

This is a story we want more exposure to while the sun shines, literally and figuratively, and today we’re adding a second ethanol name to our basket of aggressive recommendations.

Unlike Pacific Ethanol, Midwest producer Green Plains (NASDAQ: GPRE) has not been seen in the recent past as a default risk, so in its case balance sheet deleveraging is not one of the  attractions. Rather, Green Plains is the producer that has proven better than most rivals at smoothing out the commodity ups and downs, yet its scale and ethanol focus give it plenty of upside exposure to the current favorable fundamentals.


The fourth-largest North American ethanol producer, Green Plains operates 12 plants in Indiana, Iowa, Michigan, Minnesota, Nebraska and Tennessee with an aggregate production capacity of more than a billion gallons of ethanol, 2.9 million tons of the distillers grains byproduct and 250 million pounds of corn oil.

Green Plains also owns four grain elevators that, together with storage facilities at its plants, allow it to store nearly 31 million bushels of grain. Such storage capacity will be at a premium this year. In addition, the company maintains a network of logistical facilities that allow it to market and distribute its ethanol as well as that of a third-party producer. In addition to its railcar fleet and ethanol blending and storage facilities, Green Plains has a commodities trading team pursuing trading gains and not merely trying to maintain its parent’s hedges. Finally, the company owns 60% of an algae biomass development venture.

Green Plains reported a six fold increase in operating income in the first quarter of 2014, earning more than it had during the entirety of the prior year thanks to the acquisition of three plants that boosted ethanol output 35%, even as the cost of corn dropped 39%.

Importantly, the $78 million in operating income reported in April did not include $22 million in deferred profits for ethanol sold but not yet delivered to customers because of widespread rail snags, which will likely help to top up second-quarter results due to be reported July 30.

Adding that deferred stream back in, Green Plains appears capable of generating annual operating income of up to $400 million based on current fundamentals. The company’s enterprise value, adding its manageable, low-cost net debt to market capitalization, is approximately $1.9 billion. Despite rallying 40% over the last two months, GPRE shares still trade at 11.5 times this year’s consensus earnings estimate, which has likely not yet fully reckoned with the corn crash.

Of course, sentiment is likely to remain volatile. If the next few weeks in the Midwest are deemed too dry for optimal corn yields, or if the Chinese were to relent on buying American, the deeply oversold corn market would at least try to bounce and red-hot ethanol stocks could cool off in a hurry.

On the other hand, if corn continues to struggle and ethanol exports keep rising, the trend will extend. More widespread adoption of the E85 gasoline blending standard would also help pour fuel on the fire by expanding the domestic ethanol market.

And if the Environmental Protection Agency decides in the next two months not to rein in legally mandated ethanol use quotas as much as it has indicated it might to cope with a shortage of product and limited gasoline demand, the industry would have another catalyst.

On this score, lower corn prices boost ethanol production and make it harder for refiners to argue that there is not enough biofuel to go around for blending. Cheap corn also makes renewable fuel quotas easier to defend politically both as a needed support for farmers and as a green technology (in truth, the jury’s out on that claim) that does not add too much to food prices.

Two other reasons to like Green Plains are the 20% short interest in the stock, which is embroiled in a pain trade now with the price at record highs, and tax deferred assets that have to this point helped the company minimize its tax outlays and could continue to do so for a little while.

But this is primarily a momentum play on the bear market in corn and the likelihood that the biofuel mandate is here to stay. Buy GPRE below $44.

To continue capitalizing on the strong ethanol fundamentals, we’re also increasing the buy below target on PEIX to $21.