Is an ethanol bubble brewing?

Aaron Pressman

Andersons Inc. (Symbol: ANDE) of Maumee, Ohio, was for years a sleepy agribusiness that bought and sold grain and ran grain elevators. Five or six years ago, a typical year was about $1 billion in revenue with the company’s total market value (including debt) of about one-third of that. From 1999 until last year, its P/E averaged less than 10. So why in just the past two months is the stock of this corn-fed Ohioan stronger than a country still full of moonshine? It’s the brewing ethanol bubble, I tell you.

Shares of Andersons are up 65% since January 31, the date of President Bush’s State of the Union address. What gives? It seems our friends in Ohio have got themselves a still. Well, an ethanol plant, really. Okay, three plants. And the president has been talking up ethanol like nobody’s business. Since the beginning of 2005, Andersons has invested $36 million for minority ownership in three ethanol plants being built in the Midwest. It will also obtain corn and help run the plants.

There are a couple of reasons to be skeptical about Andersons and the whole ethanol craze. I know, I know President George Bush’s energy plan said we needed to double our usage by 2012 to 7.5 billion gallons but the guy’s track record on predictions isn’t so stellar. More importantly, companies are building ethanol plants like mad. A study by the Renewable Fuels Association issued
in February
(PDF file) found 2.1 billion gallons of new capacity coming online soon and about another 4 billion within the next three years. When I read the study I was reminded of the admittedly much bigger boom in telecom spending that exploded after the 1996 Telecommunications Act. Little that the bill’s proponents expected came to pass, much to investors’ dismay.

Meanwhile in the real world, after a 33% jump in earnings per share last year, Andersons is projecting 2006 per share profits will be about even with 2005. The company also reported something you hate to see last year, increasing net income and EPS while cash flow from operations declined. The company said in its 10-K that changes in working capital, essentially in accounts receivable and payable, accounted for the drop. The company’s operations are also pretty complex with last year’s profit increase coming from a fast-growing side business that buys, sells and leases rail cars. Grain operations are hedged in the futures markets and it looks like one part of the cash flow change came from increased margin payments. All in all, it doesn'rt look like a rewarding situation.