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Downloadable 10+ page PDF report attached in this post with our detailed analysis inclusive of a financial model: IS/BS/CF forecasts, rigorous ratio analysis, DCF valuations & price targets.
Introduction – FutureFuel (NYSE:FF): Strong Net Cash, Regular Dividend Payouts & Undervalued
A steady business, stable cash flows, low CAPEX, pretty much no debt, regular dividend payouts and piling up of cash on the balance sheet characterizes FutureFuel’s business and financials. Net cash to market cap of 58% in 2019 and 46% on our 2020 estimates [before and after the payout of the large special dividend] demonstrates the strong balance sheet position of the company. Importantly, this is the second such significant one-time dividend paid out by the company. While some volatility in financials is expected in the near term, particularly on account of the chemical business, we believe the 5% decline in the stock price YTD factors this in. Moreover, FutureFuel’s 2020 P/E of 8.6x and 2021 P/E of 8.4x, respectively, we believe, take in to account the potential negative impact on 2020 financials and provide investors with an attractive entry point and a favorable risk-reward scenario.
Stock down -5% YTD, favorable entry point
Additionally, FCF yield of 12.4% and net cash to market cap of 46% [our 2020 estimates] provide investors with comfort on the balance sheet. FutureFuel’s profitability numbers can show large variations because of mark-to-market changes on financial instruments. Our model forecasts a steady state business for the company and our estimates don’t factor in the impact of such mark-to-market changes. We have also included a short-term impact from COVID-19 on 2020 financials. The stock is an under-covered gem with absolutely no formal research coverage or recommendations.
Valuations and Target Price: Upward Potential of 32% on Strong Financials
On our steady state estimates for 2020/2021, FutureFuel trades at attractive P/E valuations of 8.6x/8.4x. This compares to the 5-year average P/E of 9.5x for the stock. The company also has strong FCF yield of 12.4% and 12.7% for 2020 and 2021, respectively. These factors, along with the 46% net cash to market cap, in our view, indicates a favorable risk-reward scenario. FutureFuel’s stock price is also down 5% YTD. We value FutureFuel using an 11x P/E multiple on our steady state 2021 EPS estimate of $1.41 and arrive at a target price of $15.50. This target price implies an upward potential of 32% from the current stock price.
Steady 5-year Growth in Net Income
With two stable sets of business segments in biofuels and chemicals, profitability for FutureFuel has been fairly steady over the years. The company’s 5-year net income CAGR has been 11%.
While there has been some variation on a year-on-year basis given business and operating conditions, overall business has remained stable. While 2020 might see some downtick on the financials, especially owing to declines in the chemicals business, we expect this to stabilize going ahead. Additionally, with enough demand for biofuels, we estimate that revenues in this segment too will continue to grow.
Cash on the Balance Sheet has been Piling Up
With no debt on the balance sheet as of end 2019, and a significant cash balance [including short-term investments] of $317M, or $7.25 per share, FutureFuel’s net cash to market cap of ~58% looks very robust. Even after accounting for the recently announced special dividend of $3.00/share, FutureFuel’s cash balance [including short-term investments] should amount to $240M or $5.50/share, still a strong net cash to market cap ratio of 46%. Over the last five years, with a steady core business, the company has been piling up cash which has gone from $154M in 2015 to the $317M in 2019. Looking ahead, with no debt repayment obligations and no major planned CAPEX, we see cash to continue increasing, raising the possibility of further special dividend payouts a few years down the line. One thing to note, however, is the volatility in earnings for the company which have been impacted by retroactive reinstatements of certain tax credits, mark-to-market accounting for commodity derivatives that are used for hedging purposes and mark-to-market on marketable securities. Despite the fluctuations on account of these factors, cash balances for the company have continued to increase.
Strong Record of FCF
Free Cash Flow/Share (Source: Bloomberg Terminal)
Despite volatile EPS on account of changes in tax credit and mark-to-market gains and losses on financial instruments, FutureFuel has a strong track record of generating strong free cash flows. This is witnessed in 2019 FCF yield of 5.1%. 2019 FCF numbers were impacted by a large increase in working capital. On a steady state basis, we forecast 2020 and 2021 FCF yield of 12.4% and 12.7%, respectively. With limited historical CAPEX spends and management indicating that there are no major CAPEX plans in the coming year, we anticipate that free cash flow will continue to remain steady. For reference, 2018 FCF yield stood at 11.6%.
Dividend Payouts and Recently Paid a Special Dividend
FutureFuel has paid out dividends consistently over the last few years, with 2017, 2018 and 2019 dividend at $0.24/share, representing a dividend yield of 2.0%. For the calendar year 2020 too, FutureFuel’s annual report states that a quarterly dividend of the same quantum, i.e., $0.06/share [or $0.24 annually] has been declared. In addition to this normal dividend payout, in end 2019, the company has also announced a special dividend of $3.00/share. This large special dividend amounts to a very large additional dividend yield of close to 25%. This special dividend has been paid out in mid-April 2020. The total cash outflow on account of the special dividend amounts to ~$130M, about 50% of the end 2019 cash balance. In 2016 too, FutureFuel had announced out a special dividend of $2.29/share, which was paid out in 1Q17, and represented ~50% of the company’s end 2016 cash balance. This history of paying out special dividend every few years demonstrates the company’s ability to generate cash and return this to shareholders. With the anticipated build up in cash balances over the coming years, the possibility of another large one-time dividend payment in the next few years remains open.
One of FutureFuel’s two operating segments is its Chemicals business which essentially conducts contract manufacturing activities for specific customers and also manufactures multi-customer specialty chemicals. The contract manufacturing segment represents 44% of FutureFuel’s 2019 revenues while the multi-customer specialty chemicals business, or performance chemicals as FutureFuel classifies it, are 7% of sales. Within custom manufacturing, contracts with customers tend to be long term in nature and span industries like agricultural chemicals, coatings, chemical intermediates, industrial and consumer cleaning, oil and gas, and specialty polymers. In the past, two large products for FutureFuel’s custom manufacturing segment have been a laundry detergent additive for a customer products company and a row crop herbicide. The volumes for the laundry detergent additive have, however, been declining and the customer has now decided to stop purchasing the product altogether. Additionally, the largest customer in the chemicals business accounts for 22% of chemical revenues or 11% of total annual revenue in 2019. Within the performance chemicals segment, the company’s products include a family of polymer (nylon and polyester) modifiers, glycerin products, and several small-volume specialty chemicals and solvents for diverse applications. Revenues in the overall chemical business have fallen in 2019 by 10.5% due to the lower offtake of certain products. Looking ahead, management aims to focus on cost control and margins by looking at the product mix, operational efficiency, customer relationship management and capacity utilization. Additionally, they aim to commercialize other products.
Biofuel Market in the US
One of the advantages to using biodiesel is that it can be used in most existing diesel engines and fuel injection equipment in blends up to 20% [B20] with no significant impact on the performance of the engine. Additionally, biofuels are the only product that meet all the requirements of the US Clean Air Act. Biodiesel, in the form of B20, can also be by federal, state and public fleets covered under the Energy Policy Act to cover their alternative fuel requirements. A significant number of US government initiatives aim to incentivize the production and usage of biodiesel; these include the blenders’ tax credit [BTC], the renewable fuel standard and incentives provided by states to build facilities. Current US biodiesel capacity stands at 2471M tons with a further 191M tons production capacity under construction. With biodiesel production capacity across the US being higher than the federal mandate, the industry remains acutely competitive.
FutureFuel has been in the biofuel business since 2005 and is largely involved in the production of biodiesel and blends of petrodiesel and biodiesel. Additionally, the company is also a shipper of refined petroleum products on common carrier pipelines and to maintain this active status. They also buy and sell petroleum products. Biodiesel production for the company is dependent on a number of factors which include the price of feedstock vis-a-vis biodiesel, competition from alternative fuels and imports, tax credits and government mandates for biodiesel. FutureFuel uses second-generation feedstock like waste vegetable oil, tallow and inedible corn oil to produce biodiesel and has a production capacity of about 58 MMgy. FutureFuel offers a range of blends in its biodiesel product line and its products are marketed across the US. Biodiesel products are typically used in the on-road diesel fuel market and for other supplementary residential, farming and power generation purposes.
FutureFuel doesn’t have any long-term contracts with its biodiesel customers but rather operates on a shorter-term, sometimes monthly, basis at current pricing. As of 2019, the division’s largest customer accounted for 22% of segmental revenues while 58% of the segment’s revenues were comprised of the top 5 customers.
Unlike in the chemical business, management believes that the potential loss of a large customer will not negatively impact the business as biodiesels have a large potential and the product can be resold to other potential customers. Additionally, barring some short-term production, the company’s customers don’t have any purchase obligation anyway. For 2019, FutureFuel’s biodiesel production was slightly lower because the blenders’ tax credit [BTC] wasn’t available which resulted in a weak market for renewable fuels. The BTC was, however, reinstatement in late 2019, until December 2022. Looking ahead, FutureFuel’s management expects some consolidation to occur in the industry. FutureFuel’s biodiesel segment accounts for 49% of the company’s total revenue and fell by 42% YoY in 2019, largely because of lower volumes and a challenging market without BTC. With BTC reinstated, we expect this segment to resume growing. This is demonstrated in 1Q 2020 results, where biofuel revenues were up 20% YoY.
Recently restored BTC credits
There are a number of tax incentives provided to biodiesel through federal statutes over the years. Perhaps the most significant one of these is the $1/gallon BTC that is applicable to all biodiesel. Over the years, the BTC has expired a number of times but has been retroactively reinstated. Most recently, the BTC was not applicable in 2018 and 2019, but in December 2019 has been retroactively reinstated from 2018 to end 2022. Similarly, the smaller agri-based tax credit too has been reinstated for the same time period. States will provide incentives for biodiesel, with over 35 states offering producers with incentives in the form of tax credits, grants, etc., to build facilities. The reintroduction of the BTC, we believe, is positive for FutureFuel. In 2019, production of biofuels for the company had come down because of no BTC. We expect this to reverse over the next 2 years while the BTC is active.
Recently restored BTC credits
The restoration of BTC credits in December 2019 is a positive for FutureFuel. Without the BTC, biofuel revenues in 2019 were hit sharply as volumes fell and the market remained challenging. With the reinstatement, we anticipate an improvement in segment revenues and this can be seen in 1Q 2020 quarterly numbers.
The company has paid out a stable dividend per share of $0.24 for the last 2 years. However, in 2019, FutureFuel also announced a large $3.00 special dividend/share. Looking back, a sizeable special dividend was also announced in 2016. With a large net cash position, the potential to pay out special dividends remains.
Strong Cash Position
As of 2019, FutureFuel had a very robust cash position of $243M, which amounts to ~50% of market cap, and no debt on the balance sheet. Even after the payment of the special dividend, net cash to market cap stands at 46% on our 2020 estimate. We believe this provides the company with enough comfort to weather any issues from COVID-19 and continue paying dividend.
Removal of tax credits or change in laws
FutureFuel’s biofuel business benefits from a number of tax credits offered by the US government. There have been times when certain tax credits have expired but have subsequently been reintroduced by the government on a retrospective basis. In the future, if tax credits are not renewed beyond their current tenure, it could affect profitability and attractiveness of the biofuel business. Additionally, a number of state and federal laws govern the biofuel industry. Changes in these can affect FutureFuel’s business.
Customer losses in the chemical business
The chemical business typically has long-term contracts with suppliers for custom manufacturing. Large customer losses/non-renewal of contracts will impact financials for FutureFuel.
An economic slowdown can negatively affect demand for the company’s biofuel and biodiesel products, as well as impact sales at the chemical business.
Commodity price fluctuations
Price of alternative fuels can fluctuate significantly based on changes in the oil and gas industry. The market for alternative fuel remains volatile and adverse changes can materially impact FutureFuel’s financials.
A steady business, stable cash flows, low CAPEX, pretty much no debt, regular dividend payouts and piling up of cash on the balance sheet characterizes FutureFuel’s business and financials. FutureFuel’s 2020 P/E of 8.6x and 2021 P/E of 8.4x, respectively, we believe, provides investors with an attractive entry point and a favorable risk-reward scenario. The company also has strong FCF yield of 12.4% and 12.7% for 2020 and 2021, respectively, and 46% net cash to market cap. We have a target price of $15.50 for FutureFuel which implies an upward potential of 32% from the current stock price.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.