VeraSun: Victim of Costly Corn

UBS Investment Research analyst Chris Shaw warns the ethanol producer will have to pay more for corn after the price surge

Investors have been moving away from ethanol producers like VeraSun Energy (VSE) in recent months, as oil prices plummet and some bet the push for alternative fuel will also wane. On Jan. 16, UBS Investment Research analyst Chris L. Shaw pointed out another problem for VeraSun: the rising cost of the corn used to make its product.

To be sure, corn prices have been climbing mainly because of the strong demand coming from VeraSun and other ethanol producers (see, 1/10/07, "Commodities: Who Profits from Corn's Pop?"). The 2005 Energy Policy Act requires the purchase of about 7.5 billion gallons of ethanol by 2012.

Corn scheduled for March delivery soared beyond $4 a barrel on the Chicago Board of Trade Jan. 16. During the previous session, corn prices had gained more than 5% after the U.S. Dept. of Agriculture's forecast on the size of the corn crop came in lower than expected. UBS' Shaw thinks that corn prices will stay near their current heights in 2007 and in 2008.

That translates into higher costs for VeraSun. The company buys investments to protect against corn price fluctuations, but only three months ahead of time.

Profit "margins for ethanol producers should deteriorate significantly in 2007. Rising corn costs and lower ethanol prices year-over-year will be the biggest factors in the decline," Shaw said in a research note.

After lowering 2007 and 2008 earnings estimates to reflect such factors, Shaw trimmed his target price on VeraSun's stock to $21 from $28. The stock was trading at around $17.20 on the New York Stock Exchange near closing time Jan. 16, down 6.3% from the previous session. VeraSun shares have plunged from a 52-week high of $30.75 hit on June 14.

(UBS has done business with VeraSun during the past 12 months, but Shaw certifies that the views in the report are accurate and not related to compensation.)

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