GPRE: Sometimes a cheap stock is just a cheap stock

September 26, 2018

GPRE: Sometimes a cheap stock is just a cheap stock

If you spend a lot of time paying attention to the stock market, you start to build a pretty long list of stocks that you follow. A lot of the stocks you pay the most attention to are the ones that have been the most productive for you in terms of functional trading; they’re the ones that you’ve been able to turn back to on multiple different occasions, with generally positive results. You keep using them because they’re familiar, and that naturally breeds a comfort level with the information that you’re looking at. It’s true that over time, you’ll inevitably shift your attention away from some of those stocks and towards others, and that’s a good thing, because if you’re doing that it means you’re probably doing a good job of finding new opportunities over time. Even so, I really like having a pretty diverse list of stocks that I can pay attention to on a regular basis, and that I’ve worked with in the past, because I often find myself cycling back to old friends to find new trading opportunities.

Another reason I like maintaining a pretty consistent of stocks that I’m familiar with comes from the fact that I try to put a lot of focus and attention not only on whether they’re a good bargain right now, but also on their fundamental strength. The thing about quality is that effective management teams tend to stay effective over long periods of time; they don’t generally just suddenly stop being effective. That doesn’t make the stock immune from market cycles, or from the ebb and flow of sentiment and momentum; but it does often mean that when the stock cycles into a period of depressed pricing, there’s a good opportunity in the making.

The problem with the situation I’m describing is that it simply doesn’t always hold true. There are always exceptions to the rule, and it is true that sometimes companies change management, or the market and economy shifts away from the model a company has been working effectively with in the past, but that no longer applies to current conditions. Sometimes even effective management teams slip, and when they do, that can mean that the fundamental strength investors like me were able to identify in the past simply isn’t there anymore. It makes me pretty sad when that happens, because my discipline dictates that I have to push an old friend aside and leave it alone for the time being, until hopefully it crosses my path again sometime down the road with a better story to tell.



Green Plans Inc. (GPRE) is a good example of what I mean. This is a stock that I’ve been following, to a greater or lesser extent, for almost four years. The company’s focus on ethanol makes it an interesting alternative player to traditional, oil-focused energy producers. Despite their small-cap status in the broader market, they are among the biggest ethanol producers in the global marketplace. Initially, I was drawn not only to the interesting niche they occupy in the energy market, but also to a company with a strong fundamental profile, and a value proposition that provided me with a number of profitable income-generating trading opportunities. Watching the stock increase to nearly $30 per share in late 2016 was a validation of my analysis at the time, which had the stock worth far more than the $21 range it was at when I started paying attention to it in early 2015. From that point, however the stock dropped back to below $20, and it has stayed in a range between about $16 on the low side and $19 at the top end since late 2017. That’s a tempting technical pattern for a value-focused investor like me, because it hints at a lot of upside if the stock can pick up some good bullish momentum again.

The problem with that temptation, however is that the nearly one year and a half that have passed since the last time I traded the stock has seen a change in its fundamental strength – but not for the better. The critical measurements that I’ve come to rely on now point to a company with less-than-useful liquidity, declining operating margins, and contradicting value-based information. The sum total should give investors more reason to stay away than to look for any really useful opportunities.



Fundamental and Value Profile

Green Plains Inc. is an ethanol producer. The Company owns and operates assets throughout the ethanol value chain, including upstream, with grain handling and storage through its ethanol production facilities, and downstream, with marketing and distribution services. It operates through four segments: Ethanol Production, Agribusiness and Energy Services, Food and Food Ingredients, and Partnership. The ethanol production segment includes production of ethanol, distillers grains and corn oil. The agribusiness and energy services segment includes grain procurement. The food and food ingredients segment includes a cattle feedlot operation. The Company’s master limited partnership, Green Plains Partners LP (the partnership), provides fuel storage and transportation services by owning, operating, developing and acquiring ethanol and fuel storage tanks, terminals, transportation assets and other related assets and businesses. GPRE’s current market cap is $714.7 million.

  • Earnings and Sales Growth: Over the last twelve months, earnings increased by more than 95% while sales increased by a little over 11%. Growing earnings faster than sales is difficult to do, and generally isn’t sustainable in the long-term; but it can also be a positive mark of management’s ability to maximize their business operations. In the last quarter, earnings increased almost 97% while sales decreased by 5.5%. The real trouble comes when you look at the company’s margin profile; over the last twelve months, Net Income was only 1.4% of Revenues, and it declined to less than 0% in the last quarter. Net Income in the last quarter was negative by nearly a million dollars, which isn’t a positive indication for a small-cap stock.
  • Free Cash Flow: GPRE’s free cash flow for the trailing twelve months is negative, at -$134 million, which I take as a negative despite the fact that the number actually improved from about -$200 million in the prior quarter. This, along with the declining Net Income/Revenue strongly suggests the company has poor liquidity characteristics and could have trouble servicing even the generally conservative level of debt they carry.
  • Debt to Equity: GPRE has a debt/equity ratio of .74. This should be a conservative number, but given that long-term debt is more than three times the level of cash and liquid assets along with continually negative cash flow and negative net income, even a conservative number doesn’t inspire confidence.
  • Dividend: GPRE pays an annual dividend of $.48 per share, which translates to a yield of about 2.78% per year. That’s a little above the average of stocks in the S&P 500 right now.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for GPRE is $25.05 per share and translates to a Price/Book ratio of only .69 at the stock’s current price. By itself, that’s a number that makes me pay attention, simply because there just aren’t very many stocks in the current market environment trading below their Book Value per share. Comparing that to their historical Price/Book average offers more than 60% upside, with a long-term target in the $27.50 range, which isn’t too far from the all-time the stock reached in late 2016. That optimistic view is counter-balanced, however by the fact that the stock Price/Cash Flow ratio is 42% above its historical average, and suggests the stock’s fair price is actually around $10 per share. That’s a contradiction that my value analysis can’t justify.



Technical Profile

Here’s a look at the stock’s latest technical chart.

 

  • Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s downward trend from mid-May of this year to its July low; it also informs the Fibonacci retracement lines shown on the right side of the chart. The stock’s narrow range since late July is pretty easy to see, with a high range a little above $18, and support around $16.50. That a narrow range that the stock appears to set to break above; but the truth is that there is limited upside, with immediate resistance only about $1 away against support that is about the same distance from the stock’s current price. Realistically, the stock would need to push above the $18.50 resistance level shown by the 50% retracement line, and probably surge to around $19, before any kind of high-probability bullish signal could be identified. If the stock breaks below immediate resistance at around $16.50, you should expect to see it test its 52-week low around $15 per share yet again.
  • Near-term Keys: There just isn’t a lot to like about GPRE’s technical chart right now; there isn’t a great signal for either a bullish or bearish short-term trade, even if the stock does manage to finally break out of the range that has defined it for the last two months. The long-term proposition just isn’t justifiable, either, with a declining fundamental profile that doesn’t suggest there is much upside to really be had. Sometimes, a cheap stock is cheap because it is supposed to be. That seems to be the case with GPRE.