McDermott sees mergers ahead in ethanol finance outlook
The negative margins of 2012 are expected to continue well into 2013 for the U.S. ethanol industry. While those tough times have many worried about its financial stability, Scott McDermott, a financial advisor with Ascendant Partners Inc. who is close to several independent plants, says not all ethanol producers are struggling by any means. “We see a number of companies that are fine,” he said. “The top third are fine—they’re not making a lot of money, they’re not making big investments, but they are making enough money to meet their obligations.”
McDermott described the current situation as a margin compression, which unlike the 2008-’09 or 1995 ethanol industry downturns, is not as steep, though longer lasting. Responding to the lessons learned, many ethanol producers worked hard in the past few years to improve their financial and operating performance preparing the business to endure tough margin environments. “The top and middle third have been doing anything and everything they can to improve performance without spending a lot of money,” McDermott said.
Of the 15 to 20 plants Ascendant Partners works with in their benchmarking program, all have improved their ethanol yields by at least 10 percent over the last three years, compared to the previous three-year period. “A big part of that is technologies to get at more starch,” he said. Other big areas of improvements include energy efficiency and upgraded coproduct value. “The biggest one is corn oil,” he said. “Today, if you don’t have corn oil extraction, you’re falling behind the pack. Corn oil is the most profitable thing they do, although it’s just a small part of the total volume.” He added that corn oil extraction rates have improved by 25 percent over the last three years.
Improving operational and financial performance has been critical for many ethanol producers, McDermott adds. “If they wouldn’t have done those improvements in the last three years, they wouldn’t be still doing okay today.”
“A big chunk of independent plants have been very focused on getting their debt down,” McDermott continued. “Many have fairly low debt, and that’s why they are in the middle pack.” That’s good, he adds, “but we challenge them that, in the end, [the focus on being debt-free] can sometimes keep them from making the improvements they need to keep them competitive.”
“I’m very proud of a lot of the companies we’ve worked with, because they’ve taken this to heart,” he said, saying the improved financial acumen among boards has brought investment discipline into the business. “They are doing a much better job of making prudent investments. Some are taking on some debt, but they’ve done the homework to make sure the investment is actually improving the earnings of the business.”
McDermott adds that he is concerned that some companies that have not positioned themselves well for a drawn-out negative margin atmosphere, may wait too long to act. “There is a group that are running out of options, and the longer they wait to proactively address things, the more likely they are to go under and have to make decisions that will hurt the value of the business.” Weaker companies, that thought they would make it through the downturn, can get into a situation where there are few options, he says.
“We do anticipate there will be more idled plants, and there will be some distressed sales of companies and some bankruptcies this year,” McDermott said. But, he also reports that some companies are idling, rather than burning cash, sitting out the downturn until they can operate profitably again.
“This industry needs more of that maturity,” he adds, citing other commodity-based industries such as oilseed processing or wheat milling. “When the long-term markets look tough, those guys have no problem sitting out a year or more to endure a market downturn.”
McDermott also predicts that the ethanol industry will begin to see more merger activity. “So far consolidation has meant companies selling and others buying. We think we’re heading into a period where companies will merge for management or for a better balance sheet. They will give up some of their independence, but will also maintain a chunk of their investment in the business.”