Earnings Call Transcript - REX Q2 2023

Operator, Operator

Greetings, and welcome to the REX American Resources Fiscal 2023 Second Quarter Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. I would now like to turn the conference over to Mr. Doug Bruggeman, Chief Financial Officer. Please go ahead.

Douglas Bruggeman, CFO

Good morning, and thank you for joining REX American Resources' fiscal 2023 second quarter conference call. We'll get to our presentation and comments momentarily as well as your question-and-answer session. But first, I'll review the safe harbor disclosure. In addition to historical facts or statements of current conditions, today's conference call contains forward-looking statements that involve risks and uncertainties within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements reflect the company's current expectations and beliefs but are not guarantees of future performance. As such, actual results may vary materially from expectations. The risks and uncertainties associated with the forward-looking statements are described in today's news announcement and in the company's filings with the Securities and Exchange Commission, including the company's reports on Form 10-K and 10-Q. REX American Resources assumes no obligation to publicly update or revise any forward-looking statements. I have joining me on the call today, Stuart Rose, Executive Chairman of the Board; and Zafar Rizvi, Chief Executive Officer. I'll first review our financial performance and then turn the call over to Stuart for his comments. Sales for the second quarter decreased by 11.8%, primarily due to lower unit pricing across all products as well as slightly lower ethanol gallons sold year-over-year. Ethanol sales for the quarter were based upon 69.1 million gallons this year versus 71.4 million in the prior year. We reported gross profit of $18.4 million this year versus gross profit of $14.1 million in the prior year as we benefited from lower corn and natural gas pricing over the prior year second quarter. SG&A increased for the second quarter from $6.7 million to $8.6 million. This increase is primarily related to stock incentive executive compensation expense upon issuance during the quarter. As highlighted in the press release in the second quarter, the company made a change in the method of accounting to begin classifying shipping and handling costs as cost of sales rather than within selling, general and administrative expense as historically presented, in order to improve the comparability of gross profit and SG&A reported. The company has applied a retrospective application of this new accounting policy. I'd like to point out this change only impacts cost of goods sold and selling, general and administrative expense and has no impact on earnings reported. We had income of $3 million from our unconsolidated equity investments in this year's second quarter versus $3.6 million in the prior year as the prior year number included approximately $1.6 million of income for our share of their COVID relief grants received from the USDA in the prior year. We reported interest and other income of $3.3 million versus $8.2 million in the prior year. The prior year included approximately $7.8 million from the aforementioned USDA COVID-19 relief grants received by our consolidated plants. In the current year, the company has continued to benefit from higher interest rates on our cash and short-term investments. These items led to income before income taxes and non-controlling interest of $16.1 million compared with $19.2 million in the comparable year ago period. However, excluding the benefit of the COVID-19 relief grants received in quarter two of last year, income before income taxes, non-controlling interest increased 64.3% to $16.1 million in quarter two of the current year versus $9.8 million in the prior year. We reported a tax provision of $3.8 million for this year versus a provision of $4.3 million in the prior year. This led to net income attributable to REX shareholders of $9.1 million for their share versus $11.2 million in the prior year second quarter. Net income per share attributable to REX shareholders were $0.52 for this year versus $0.63 in the prior year. I'll now turn the call over to Stuart for his comments.

Stuart Rose, Executive Chairman

Thank you, Doug. Earnings right now are running at a rate in the third quarter that is expected to be significantly better than last year's third quarter. Our cash balance is approximately $284 million, uses include short-term investments, which we expect during the third quarter to earn a higher rate than the second quarter. Ethanol expansion, which Zafar Rizvi, our CEO, will talk about later. Stock buybacks continue, but only on dips; we have not had dips recently. So at the moment, we have not bought back stock, but we'll buy back if we see dips. We're also looking at our carbon capture operation that is well on its way, which again Zafar will talk about later. We also have hopes, if possible, to use our carbon capture operation, not just for our operation, but for others which may come along eventually that could also be a use of our cash. I'll now turn the call over to Zafar Rizvi, who will talk more about our ethanol operation and our carbon capture operation. Thank you.

Zafar Rizvi, CEO

Good morning, everyone. Thank you, Stuart. As I mentioned in the previous call, we saw improvements in the early stage of the second quarter, which led to a profit that was better than in the first quarter of 2023. We are pleased with our team. They produced better results than in the previous quarter and even better than last year's second quarter after considering the total $9.4 million impact of the COVID-19 grants. According to the EIA August 23rd report, ethanol stock and production dropped during the week ending August 18th. We have also seen natural gas prices drop considerably, which has a positive impact on our financial results. The August 11, 2023, USDA report showed an expected output of 15.1 billion bushels of corn, the second highest on record, and 175.1 bushels per acre yield for the year 2023-'24. We are pleased with the early forecast of corn yields in Marion, South Dakota this year: 145 bushels per acre compared to 132 bushels last year. Approximately 458,000 more acres of corn were planted this crop year compared to last year. We expect corn yield in the Gibson City, Illinois area to be less favorable, which is 201 bushels per acre this year compared to 214 bushels per acre last year. But almost 700,000 more acres were planted this year compared to last year. Looking ahead, the drop in ethanol and DDG export could negatively affect future results if this continues. Ethanol exports through June 2023 were 705 million gallons compared to 828 million gallons in 2022. During the same period, ethanol exports have dropped 15% since 2022. DDG exports through June 2023 were 5.1 million metric tons compared to 5.7 million metric tons, a decrease of approximately 584,000 metric tons compared to the same period in 2022. Considering all these factors, if we continue to source corn at a reasonable price, increase the export of ethanol and DDG, and do not face any major logistics problems, we believe that at this early stage of the third quarter, we will be profitable and even better than last year and could exceed this quarter's results. Let me provide an update on our carbon sequestration project and the One Earth Ethanol Energy plant expansion. As I mentioned in our previous call, we are pleased to publish the inaugural sustainability report early in the year, highlighting what we have accomplished while addressing sustainability in the economy and our social responsibilities as a whole. We believe our carbon capture project will further advance our sustainability goals and financial impact that improves company performance for our shareholders. We have budgeted approximately $165 million to build a carbon capture and storage facility, the expansion of the One Earth Energy plant to 200 million gallons annually, and other projects related to reducing carbon intensity. We plan to build the One Earth Energy sequestration carbon capture and storage facility in Gibson City. The contract to build the capture and compression facilities have been signed, and long-lead items were ordered earlier. We expect facility construction to start in the middle of September. The delivery of all modular compression equipment for the facility is scheduled for February 2024. The construction of the facility is expected to be completed by July 31st, 2024, at which time testing of the facility will commence. We continue to complete the paperwork for different government permits and requirements of agencies while we are waiting for the EPA to approve the Class VI permit for carbon injection. We have answered two inquiries from the EPA regarding Class VI permits. This is a highly technical, very time-consuming project, and it depends on several local state and federal agencies' approvals. Unfortunately, we cannot predict when we will receive all these permits from different local states and federal governments or any delays in construction. In another update, our NuGen ethanol facilities partnered with Summit Carbon Solutions, a developer of the world's largest carbon pipeline, and a decent Big River Resources entered an agreement with Navigator and other carbon pipeline companies. We are pleased about the significant milestone we have reached so far and hope that different government agencies will complete their approvals by this year or early next year. Regarding the One Earth Energy plant expansion, we have plans to increase ethanol production to 200 million gallons a year. We have received an EPA permit to produce 175 million gallons per year for this facility. We must achieve 175 million gallons per year production, which is expected late next year before we can apply for a 200 million gallons per year production permit, because this is a two-step process. We have to achieve 175 million before applying for 200 million gallons. So this facility will be capable of producing 200 million gallons from day one. The plant's current capacity is approximately 150 million gallons a year. We continue to evaluate other projects that would improve energy efficiency and reduce carbon intensity. The clean fuel production credit, Section 45Z, which is related to a reduced fuel carbon intensity score, could provide as much as a dollar a gallon depending on the carbon intensity of the ethanol produced and sold. If we successfully achieve these goals, we will be prepared to provide low carbon ethanol and bioproducts with a social impact on reducing carbon in the atmosphere and a financial impact that improves company performance for our shareholders. In summary, we are pleased to announce a profitable quarter, actually the 12th consecutive profitable quarter, continuous progress on our carbon sequestration project, a plan to increase ethanol production at One Earth Energy to 200 million gallons to maximize 45Z benefits, and signed carbon offtake agreements with the pipeline companies at NuGen and Big River. Once again, we could not achieve these milestones without the hard work and dedication of our colleagues. We are very appreciative of their efforts in achieving these positive goals. I'll give the floor back to Stuart Rose for additional comments.

Stuart Rose, Executive Chairman

Thank you, Zafar. In conclusion, our results again this quarter outperformed most of the industry, especially the other public companies. And going forward, during the next quarter, again, we expect to do significantly better in the third quarter of this year than we did in the third quarter of last year if our results continue in the same manner as they have thus far this quarter. We feel we have the best ethanol plants among the best in the industry; our location is good, and the crops look like they'll be pretty good to very good this year. We were a little worried about that earlier, but things seem to have improved. The biggest asset we have, as Zafar said earlier, is that we believe we have the best people working for us in the ethanol industry, and these are the same individuals that will be working for us and for our shareholders in the carbon capture industry. If we can replicate what we did in the ethanol sphere within carbon capture, we anticipate having a much larger and significantly more profitable company. I'll now leave the floor open to questions.

Operator, Operator

Thank you. Our first question comes from Jordan Levy with Truist Securities. Please proceed.

Jordan Levy, Analyst

Good morning, all, and thanks for the updates. Really exciting updates and a nice quarter. And just thinking about the carbon capture side of things, maybe for Zafar, there's clearly been a lot of Class VI permits that have been submitted for approval, but you all talked about moving forward with construction starting in September and that sort of thing. And I think it's fair to say that you all as a team tend to be pretty conservative with how you approach investment opportunities. So maybe just give us a little bit on how you're thinking about potential for approval and the timeline there on the EPA knowing that you have a timeline and have ordered some of the long lead time equipment?

Zafar Rizvi, CEO

Thank you. As I mentioned, we have two inquiries from the EPA. It has been almost nine months since we applied for the permit. Generally speaking, it takes somewhere between six months to 18 months. So we expect that we will have the permit before the end of 2024. Earlier, since we haven’t had many inquiries for our conversations with the EPA, we understand they are now evaluating the technical aspects of those documents which we provided. So far, we have no inquiries. But if we don't start our construction and we don't do all these things, then the people who haven't started already will be at least two to three years behind because some of these lead items take close to 18 months to two years before you receive them. We initiated our processes earlier. Also, we are expanding our plant to 200 million gallons. Even if there’s a delay, we will still be working on several other projects that can reduce our carbon intensity score, benefiting from 45Z. We may not benefit as much as we would like from carbon sequestration, but we will still see some advantages from carbon intensity reductions earlier in 2025.

Jordan Levy, Analyst

Absolutely. And just thinking a little further about the $165 million that you all talked about being budgeted for carbon capture and plant expansion; if you could help break that down for us in terms of what that all constitutes and any sort of incremental capex that might be required for any additional initiatives?

Zafar Rizvi, CEO

We have not really disclosed this breakdown. This is a budget we estimate, but we have not detailed how much will be for carbon sequestration and how much will be for ethanol facility and other aspects at this stage. However, total budget is estimated to be $165 million, which includes the subsurface area, the well, pipeline for about 4 to 5 miles, and the construction of the facility while also including the expansion of production from 150 million to 200 million gallons. So that total comes to $165 million.

Jordan Levy, Analyst

Great. Just to clarify, Zafar, you mentioned this being kind of a two-step process on the plant expansion, but the $165 million would include the expansion to 200 million, even if you have to show that you can run 175 million first?

Zafar Rizvi, CEO

That's right. The plant will be designed, which we have already constructed some fermentation tanks. The designs will support producing 200 million gallons from day one when the expansion is complete. However, the EPA requires that we demonstrate capacity at 175 million, which is expected late next year before applying for the 200 million gallon production permit. This is a two-step process; we must achieve 175 million first before applying for the 200 million gallons. So even if the 200 million gallons permit is received in early 2025, it applies for the entire year, and we can begin production of 200 million gallons right then.

Jordan Levy, Analyst

Got it. Thank you all so much. I'll hop back in the queue.

Stuart Rose, Executive Chairman

The $165 million also includes many improvements we're making to lower our CO2 intensity, which is technical but makes a significant difference in 45Z calculations. We are working very hard on this and reducing our CO2 score.

Operator, Operator

Our next question comes from Pavel Molchanov with Raymond James. Please proceed.

Pavel Molchanov, Analyst

Thanks for taking the question. You touched on what you've seen in terms of corn purchasing. If we zoom out for a moment, corn is now the cheapest it's been since the pre-COVID era. I'm curious if you think this $4 a bushel number is sustainable?

Zafar Rizvi, CEO

It's hard to say. I think it ultimately depends on production and also how quickly the harvest comes in. The final results could be different than what we see now. There are some heat waves occurring, but we believe that won't majorly impact the corn. We really cannot predict what the future price will be. It's all a matter of supply and demand and export scenarios. International events, such as in Ukraine, can change the corn price. We've seen that Brazil is producing bumper crops; even then, their prices are converging with U.S. corn prices as both have dropped. So this fully depends on several international factors. It's tough to ascertain at this stage.

Pavel Molchanov, Analyst

Okay. Maybe in terms of what you guys can control, are you seeing any opportunistic M&A potential to expand capacity through some asset acquisitions?

Stuart Rose, Executive Chairman

Not currently. We have in the past and have tried hard to find opportunities. But at present, I don't see anything. In fact, I think people are doing better now. The best time to buy a company at the prices we want to pay is when things aren't going so well, and conditions in the industry have definitely improved in the last couple of months. Our focus right now is on carbon capture and exploring various uses for our existing assets. We have three potential carbon capture projects, one of which we hope to have ready in the next couple of years, but we also have two others in discussion with the EPA. I believe focusing on carbon capture projects is more promising than pursuing mergers with other ethanol companies.

Zafar Rizvi, CEO

It's worth noting that originally, our ethanol facility was at 100 million gallons. We've increased our consumption from both locations from 100 million to 150 million. Now we are growing organically from 150 million to 200 million, signing a notable plan to increase our production capacity. Most importantly, we understand our plants and their corn availability. Thus, we believe that organic growth is preferable to acquiring assets at another location that could potentially be less advantageous than our own.

Jordan Levy, Analyst

Got it. Thanks very much, guys.

Stuart Rose, Executive Chairman

Thank you, Pavel.

Operator, Operator

Our next question comes from Chris Sakai with Singular Research. Please proceed.

Chris Sakai, Analyst

Can you talk about the price of natural gas and how that's affecting your profitability?

Zafar Rizvi, CEO

The natural gas price has considerably dropped over the last year. At this time last year, it was trading close to $6 to $7. Now it's about $4 or lower. This significantly impacts our P&L because it is our second-highest expense. We believe that this will continue at least through this year. Natural gas prices should remain stable or potentially improve, but we cannot predict what will happen in the winter season of January, February, and March, as different scenarios can arise then. But through December, we feel positive that prices will stay similar to current levels.

Chris Sakai, Analyst

Have you considered potentially hedging this price and locking in these prices for the future?

Zafar Rizvi, CEO

We do consider that at these low prices, we certainly do buy natural gas for our ethanol facilities. We do not leave everything open; we do procure natural gas in anticipation of the prices, but especially for January, February, and March, we will analyze the market to see if hedging is feasible at that stage. However, we have secured natural gas purchases throughout the year until December.

Chris Sakai, Analyst

Okay, sounds good. Can you talk about demand for ethanol globally and which countries are demanding it more?

Zafar Rizvi, CEO

Ethanol demand is basically led by Canada, which remains on top of the list. Last month, the Netherlands, the UK, South Korea, and Peru are among the top importer countries from the U.S. However, ethanol export has dropped, as I mentioned earlier.

Operator, Operator

Our next question comes from David Locke with Old Mammoth Investments. Please proceed.

David Locke, Analyst

Good morning, gentlemen. How are you today?

Stuart Rose, Executive Chairman

Good morning.

David Locke, Analyst

Could I ask a quick question about just sort of what do you guys think the cost of new capacity in the industry is in terms of dollars per gallon of throughput? And then related to that, since it doesn't seem like there are any assets trading in the business right now, what sort of ask do holders of assets want on that same metric?

Stuart Rose, Executive Chairman

The cost to build would probably be in the $2.5 to $3 a gallon range, but that's just an approximate estimate as it varies by project. If any plant were even for sale, I would think the buying price would be somewhere in that range as well. The advantage of buying a plant over building one is that you could start operations immediately and take advantage of the 45Z credits or other opportunities for carbon capture. However, at this price point, I don't see anyone currently building plants. Everybody in the industry knows these prices; no secrets exist in the pricing structure.

Zafar Rizvi, CEO

Regarding brownfield expansion, like what you guys are doing in moving one plant from 150 million to 200 million, it's certainly less expensive than $2 per gallon since you already have a lot of equipment and other loading facilities in place.

David Locke, Analyst

Okay. Can you spend a couple of seconds reflecting on any opportunities in sustainable aviation fuel, if there’s anything you guys might do there at some point or if sustainable aviation fuel might absorb some ethanol capacity going forward?

Zafar Rizvi, CEO

Yes, this is one of the reasons that we have expanded our ethanol facility—not only to take advantage of 45Z but in the future, if required, we can pivot to sustainable aviation fuel (SAF). For every two gallons of ethanol produced, approximately one gallon of SAF can be derived. We are discussing with several companies that believe they have the technology to convert ethanol into SAF. We are evaluating the market thoroughly. Once we know that this technology is proven successful, we will certainly implement it.

Stuart Rose, Executive Chairman

That brings to mind an old saying: pioneers take the arrows, and we're not the pioneers. We prefer to observe and see who is successful. We believe someone will eventually succeed in this space. When that happens, we will leverage our position as one of the largest producers of ethanol and be ready to engage in that market.

David Locke, Analyst

Okay. Thanks very much for your time, gentlemen.

Operator, Operator

Mr. Rose, there are no further questions at this time. Please continue with your presentation or closing remarks.

Stuart Rose, Executive Chairman

I just want to thank everyone for listening, and we hope you'll listen and be with us next quarter. Thank you. Goodbye.

Operator, Operator

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line. Have a great day, everyone.