FF - FutureFuel: Unique RINs Accounting Transforms Q2 EPS To Loss Stock Tumbles

2023-09-12 06:24:11 ET

Summary

• FutureFuel's biofuel production generates renewable energy credits (RINs) that were not recognized as revenue in Q2, leading to a reported loss.
• Nervous investors unfamiliar with RINs accounting caused a 30% drop in FutureFuel's stock price.
• FutureFuel's Q3 earnings are expected to exceed $0.50 per share due to the recognition of RINs revenue and the timing mismatch.

• FF’s biofuel production generates renewable energy credits (RINs) as a byproduct. Rather than capitalizing RIN assets at cost when generated, FF defers recognizing their value until they are sold.
• Capitalizing RINs when generated would have increased reported Q2 adjusted EPS by up to $.39 -- from $.23 loss to a profit of $.12 to $.16 (depending on tax rate).
• Nervous investors unfamiliar with RINs accounting and shocked by the Q2 loss promptly drove FF’s stock price down over 30% within one month.
• Due largely to its $300 million market cap, coverage of FF by Wall Street analysts is negligible. Consequently, few analysts have been motivated to defend the stock.
• Since $.39 in revenues per share has been transferred from Q2 to Q3 with virtually no corresponding cost, reported Q3 EPS will probably exceed $.50.

Overview of FutureFuel

FutureFuel (FF) is a financially solid manufacturer and distributor of biofuels and chemical products. FF’s biofuels business focuses upon the production and sales of both biodiesel and petrodiesel products, marketing them throughout the United States. The company’s chemicals business produces custom chemicals for individual customers, in addition to products with a broad clientele.

The company has a solid balance sheet, with $500,000 in debt and a cash balance of $166.7 million. This cushion will serve FF well should it encounter future threats to its business, be they economic, competitive, or regulatory.

During the first six months of 2023, biofuels accounted for approximately 75% of FF’s revenues, with chemical products accounting for the other 25%. Custom chemicals contribute roughly 80% of chemical product revenues, the other 20% being derived from multi-customer chemicals.

As the table below indicates, FutureFuel’s financial metrics are extremely attractive – Q2’s earnings slump not withstanding. In the context of a trailing 12 month calculation, it becomes apparent that reported Q2 earnings were not indicative of FF’s “true” performance.

According to Seeking Alpha figures as of 9/9/23, FutureFuel’s financial ratios vis-a-vis its peers in the Materials Sector were as follows:

Except for Price/Cash Flow (P/CF), FF’s value metrics have been far superior to the median firm in its sector. And the P/CF figure is on the high side largely because of FF’s large cash balances – which boost a company’s market cap but contribute little to cash flow.

Impressive as these metrics are, they are made even more attractive by the company’s current circumstances. That is, FF as portrayed by its most recent financials, is obscenely undervalued, and those financials don’t even hint at the existence of RINs generated in Q2 that fetched $19.5 million in Q3.

Had the $19.5 million in RINs arising from Q2 sales transactions been recognized as revenue in Q2 rather than Q3, adjusted EPS would have been between $.12-$.16 (depending on tax rate) -- rather than the reported loss of $.23. Similarly, revenues would have been approximately $105 million rather than the $85 million reported -- down just 11% YoY rather than 28%.

Since the $19.5 million will be added dollar-for-dollar to both FF's Q3 revenues and operating income, I'm expecting the company's reported results for Q3 to be perceived as a big positive surprise. And for FF stock to reach above $10 shortly thereafter. Not an unreasonable expectation, given that FF was trading in the neighborhood of $10 immediately prior to its release of Q2 figures.

Nor would it be unreasonable to consider the possibility of FF being acquired by an oil company seeking to burnish its ESG bona fides, following in the footsteps of Renewable Energy Group's 2022 acquisition by Chevron (CVX).

Moreover, FF's extremely low TTM EV/EBIT (Trailing 12 Month Enterprise Value divided by Earnings Before Interest and Taxes) of 3.71x (as calculated by Seeking Alpha as of 9/9) would make it an attractively priced target -- even after tacking on a generous takeover premium.

Basis For My Estimated Q3 Adjusted EPS Exceeding $.50

I take the $.39 per share in Q2 RINs net revenue transfer to Q3 and add the $.12-$.16 that Q2 would have earned had the RINs revenue not been transferred.

This gives us a Q3 earnings estimate of $.51-$.55. That figure is admittedly rough, but it does provide guidance that factors in the cost/revenue timing mismatch of the RINs.

The following tables capsulize the effects of capitalizing RINs at the time of their generation.

An Extraordinary Crash and Its Aftermath

FF stock fell 36% between 8/7/2023 and 9/7/2023 – from $10.24 to $6.55. Given that FF had $3.80 per share in cash, this plunge was even more astounding. Subtracting this $3.80 from FF’s stock price at its nadir left us with a decline in enterprise value from $6.44 to $2.75 (a 57% nosedive).

Aside from investors’ failure to fully comprehend FF’s accounting, FutureFuel’s removal from the S&P SmallCap 600 Index (and ETF) after the 9/1/2023 close also contributed to its stock’s swoon. FF stock, which had closed at $7.12 that day, fell steadily the following week before bottoming out on 9/7 at $6.55. The steady gains experienced since then were largely predictable, since the losses were caused to a great extent by an artificially created supply/demand imbalance that had little effect on FF’s fundamentals.

It’s also possible that the stock’s poor performance immediately prior to 9/1 was caused to some degree by traders who had correctly anticipated FF’s replacement by S&P days (or even weeks) in advance. To the extent that this occurred, the degree that FF bounces back from its 9/7 close may be enhanced.

Risks To FutureFuel Investors

The following outlines several, though not all, of the most significant risks faced by FutureFuel investors:

• The possible return of Covid-19 and/or similar illnesses could disrupt the company’s access to raw materials needed by FF, as well as adversely affect demand for FF’s products.
• The loss of governmental mandates and incentives such as the BTC (biomass-based diesel tax credit) could be injurious to the company’s business.
• Changes to existing federal and state regulations could be detrimental to FF.
• Changes in California’s Low Carbon Fuel Standard or the credits associated with it could materially reduce FF’s California revenues.
• Loss of market share to competitors – including those selling alternative fuels – could harm the company.
• Volatility in commodity prices could reduce the profitability of FF’s products.
• Hindrances to reliable, economical transportation by rail, truck, pipeline, and other modes of moving raw materials and finished goods could materially reduce the company’s profit margins.
• Reduced support for biofuels among automakers and trade groups could reduce demand for FF’s products.
• Future growth in the biofuel industry is heavily reliant upon investment in the infrastructure required to transport and deliver biofuels effectively.

In addition, FutureFuel is a small cap stock and, consequently, vulnerable to a variety of risks to a greater degree than larger cap, household name investments. Such risks include greater price volatility, lack of liquidity, and increased sensitivity to unsteady economic conditions.

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