The United States dominates the global ethanol market. It produces over 15 billion gallons of the fuel each year and exported a record 1.7 billion gallons in 2018. That's a lot easier to do with some of the world's most productive agricultural land and coastlines brimming with export terminals.
Then again, moving product from the American Corn Belt to the Gulf Coast isn't without obstacles. Ethanol cannot be transported in existing oil products pipelines due to its chemical properties, which risk degradation and corrosion of most steels. That makes an army of railcars, highway tankers, and storage facilities a requirement for any business seeking to be minimally competent in ethanol logistics. And that's exactly the barrier to entry that allows Green Plains Partners LP(NASDAQ: GPP) to thrive.
The ethanol logistics leader isn't without a few warts, but its units have beaten the total return (stock performance plus dividends) of the S&P 500 in the last three years thanks in large part to a double-digit distribution yield. Considering the guaranteed contracts it has with its parent, plus the potential to diversify its revenue stream in the years ahead, this high-yield renewable energy stock might be worth a closer look.
A businessman looking through binoculars.
Image source: Getty Images.
Logistics: The best ethanol play of all?
Let's be blunt about it: Ethanol stocks have not been great investments. The low-margin industry has undergone significant consolidation over the years, which today results in the top five domestic producers wielding 44% of the nation's production capacity.
Two of the largest producers, Archer Daniels Midland and Valero Energy, barely rely on contributions from their ethanol production segments. Green Plains(NASDAQ: GPRE) is the largest publicly traded company focused exclusively on the ethanol value chain, with 1.1 billion gallons of annual production capacity, but tough market fundamentals forced it to sell off a few production facilities and its vinegar business in 2018.
That's what makes Green Plains Partners intriguing. The business generates fee-based revenue determined by throughput volumes regardless of the price of ethanol. It's essentially the ethanol equivalent of an oil and gas midstream business -- and the close relationship with Green Plains provides a predictable stream of revenue and income.
Green Plains Partners collects fees for logistics services including storing ethanol produced by its parent and leasing railcars required to transport production to oil refineries or export terminals. For example, on the storage front, Green Plains is obligated to pay $0.05 per gallon and must supply a minimum annual volume of 943 million gallons. That's worked out pretty well for the partnership in the last two years and provided sky-high operating margins:
Metric
2018
2017
Change (YOY)
Revenue
$100.7 million
$107.0 million
(6%)
Operating expenses
$37.8 million
$42.8 million
(12%)
Operating income
$62.9 million
$64.1 million
(2%)
Net income
$55.7 million
$58.9 million
(5%)
Distributable cash flow
$58.5 million
$64.0 million
(9%)
Distribution coverage ratio
1.01x
1.08x
N/A
Data source: SEC filing. YOY = year over year.
The decrease in year-over-year operating metrics is the result of the parent downsizing its ethanol production fleet in the final months of 2018. That affected the minimum volume obligations with the partnership, although the effects will be more significant in 2019 as full quarters of lower throughput are experienced.
It's worth pointing out that Green Plains Partners will see a commensurate decrease in operating expenses and remain comfortably profitable. The cash distribution is likely to drop from the $1.90 per share paid last year, but considering the yield was 12%, unitholders are still likely to receive a significant payout. Nonetheless, there are notable risks for income-seeking investors to consider.
Ethanol storage tanks.
Image source: Getty Images.
Are these risks a deal breaker?
Green Plains Partners generated nearly 94% of its total revenue from Green Plains in 2018. That's both an advantage and a disadvantage, as the recent downsizing demonstrates. The partnership has attempted to diversify its business in recent years, but hasn't been successful.
In early 2018 it formed a 50-50 joint venture with Delek Logistics Partners, which acquired two light products terminals in Texas and Arkansas. The JV expected to generate up to $11 million in net income in 2019, but regulatory hurdles torpedoed the acquisition of the initial assets. The JV still exists on paper, although there's no word yet on whether it's pursuing additional deals.
Meanwhile, Green Plains and Jefferson Energy Companies built and operate an ethanol export terminal in Texas. The parent was expected to offer its stake in the project to Green Plains Partners in 2018, but the pair have extended the negotiation period to last through the first half of 2019. The delay was likely due to management focusing its bandwidth on asset sales, which also lowered the revolving credit facility (based on operating performance) of the logistics business. Securing the export terminal would help to significantly diversify revenue and earnings for the partnership, especially as America continues to set record ethanol exports each year.
Another risk that may not come across the radars of investors is the fact that Green Plains Partners is very thinly traded. It sports an average trading volume of just 60,000 shares, which can expose unitholders to significant volatility (and long periods of extreme boredom).
An ethanol production facility.
Image source: Getty Images.
A high-yield stock to keep on your radar
Despite a history of beating the S&P 500, I think Green Plains Partners is a little too risky for most individual investors at this time. It would be wise to wait until the first quarter or two of operations with lower throughput volumes are in the books to gauge how the business will be affected by the recent restructuring of its parent. Additionally, it would probably be best for the partnership to retain slightly more cash flow than it did in 2018. That extra cash could come in handy for crafting and executing a strategy to diversify away from its reliance on Green Plains, such as acquiring the Texas export terminal or building a (more) independent nationwide ethanol logistics network. If the year ahead goes smoothly and management executes, then this could prove to be a lucrative ethanol investment.
Maxx Chatsko has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
