Here's why the Renewable Energy Group should adopt the same principle as renewable diesel

The hits continue to come Renewable energies group (NASDAQ: REGI). After a year of promising activity in 2018, the renewable fuel producer faced a decline in average selling prices and an increase in input costs this year. The political stalemate in Washington has sparked investor hope that a major tax credit will be reinstated as soon as possible. Shares have been cut in half since the beginning of 2019, which has reinforced the negative shame of investing in biofuel stocks.

The well-managed company did its best to overcome the headwinds. Rather than refinance maturing debt, it recently used cash on hand to reduce liabilities and maintain flexibility in the balance sheet. But the renewable energy group came out of June with only $ 61 million in cash. Higher cash outflows will reduce this balance in the second half of 2019.

The return of operational volatility has eroded investor optimism, particularly after the company appeared to overcome the uncertainty of the biofuel markets in 2018. However, there is a potential path to long-term sustainable operations. term: renewable diesel. Renewable Energy Group must just find how to finance the necessary investments.

Biodiesel against renewable diesel

Renewable Energy Group is the largest producer of advanced biofuels in North America, with an effective production capacity of 514 million gallons per year (mmgy) on the continent. About 80% of this commercial footprint is spread over 12 facilities producing biodiesel, the remaining 20% ​​from a single facility producing renewable diesel. There is a subtle but significant difference between the two products.

Biodiesel is considered an advanced biofuel because of the way the regulations have been written. Renewable Energy Group uses low-carbon and non-food raw materials for manufacturing, but is technically a first-generation biofuel. It has a chemical structure different from that of petroleum diesel, which limits the mixing potential and can cause its gelation in cold weather. Although the United States has the capacity to consume much more biodiesel than today, there are more efficient renewable fuels that can replace petroleum-based diesel.

For example, renewable diesel is chemically similar to petroleum-based diesel, which allows for consistent mixing potential and much better performance in cold weather. This value is reflected in the higher average selling prices of renewable diesel versus biodiesel. It also generates 13% more federal compliance credits per gallon (in the form of RINs) than biodiesel and is the lowest-carbon fuel listed in the California Program to Reduce Fuel Consumption. low carbon fuel (LCFS). Vehicles.

All of these benefits have been added to the Renewable Energy Group. While renewable diesel represents only 20% of its total actual production footprint, it has generated more than half of the company's total adjusted EBITDA in 2018. That's why the company must focus on the renewable fuel.

Prioritize renewable diesel is a must

To be fair, the Renewable Energy Group wants to expand its footprint on renewable diesel and better leverage its proprietary production technology, BioSynfining. The company is considering a large-scale expansion of its existing 100mmmy renewable diesel facility in Louisiana and a potential joint venture with Phillips 66 build a 250-mm plant in the state of Washington. The hurdle is financing.

Large expansions will be expensive and would be ideally financed by both cash and debt. With only $ 61 million in cash at the end of June, this is not an option. The joker – and perhaps what management wants – is whether Congress retroactively reinstates the blending tax credit (BTC) for biodiesel producers. If so, Renewable Energy Group will receive a $ 370 million payment from Uncle Sam for production over the last six quarters.

This windfall could allow for a significant expansion of renewable diesel production capacity and position the company for the future. It may also be necessary to remain competitive in the field of renewable diesel, as companies seek to gain market share in the growing list of states and provinces that adhere to California's LCFS program.

Data source: SEC filing.

There are risks in using renewable diesel. In addition to the well-funded counterparts in the table above, a number of petroleum refiners are beginning to explore the possibility of producing co-treated renewable diesel (CPRD) at existing refineries. The CPRD could be the cheapest source of renewable diesel, although it may not benefit from all federal and state incentives. In addition, with the growth of the market and competition, demand for limited raw materials could exceed supply, leading to soaring commodity prices and falling margins.

That said, these risks are similar to what the Renewable Energy Group managed to manage by reaching the peak of the biodiesel market. As the joint venture proposal with Phillips 66 shows, the company is also open to partnering with petroleum refiners by opening up its proprietary production technology. In addition, as the economy limits the future of biodiesel, investors may be willing to accept the competitive risks of renewable diesel.

Management faces tough choices

Renewable Energy Group is in a difficult position. On the one hand, doing nothing is not an option. Biodiesel alone will not be enough to deliver profitable business in a sustainable way, and it must act relatively quickly to avoid fierce competition with greater financial resources.

On the other hand, it must determine how to fund renewable diesel expansion projects in a manner acceptable to shareholders. Its debt is relatively manageable, but it does not make sense to finance expansion only with debt. It could yield more control over the Phillips 66 joint venture or license its BioSynfining technology to other refiners, but it would leave significant value on the table.

Ideally, Congress would retroactively reinstate BTC and hand over a $ 370 million check to the Renewable Energy Group. As the Congress reconvenes this month, investors will know what to watch for, but they will have to consider their expectations.