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Ethanol demand brings big profit for producers

Construction continues on an ethanol plant in Laddonia, Mo. New energy regulations and high gas prices have increased demand for ethanol and led to an investment boom in the handful of publicly traded companies that produce the fuel additive made from fermented corn that allows cars to run more cleanly. James A. Finley / AP
/ Source: The Associated Press

Only a handful of investors knew about The Andersons Inc. and its grain storage and rail car businesses a few months ago. Even in its hometown, the company is better known for stores that feature a wide range of microbrews, fresh breads and garden supplies. But the company's recent entry into the burgeoning ethanol industry has sent its stock soaring.

Investors are betting that new energy regulations and high gas prices could lead to an earnings bonanza for companies like The Andersons, ADM and Pacific Ethanol that produce the fuel additive made from fermented corn that allows cars to run more cleanly.

"Right now making ethanol is almost like having a money machine," said Spencer Kelly, an ethanol analyst for the Oil Price Information Service in Rockville, Md. "Ethanol looks strong as long as gasoline prices stay strong and corn prices are low."

The Andersons, founded by Harold Anderson in 1947, turned a grain mill into an agribusiness that had $1 billion in sales by 1995 and went public a year later. The company's move into ethanol production is a natural step given its network of grain elevators and its large rail fleet, which combined account for most of its profits.

Chairman Richard Anderson and former chairman Thomas Anderson, two of the founder's sons, remain among the company's biggest shareholders along with other family members. Richard Anderson's shares were worth $6.5 million two years ago and are now worth $28.5 million. The family has donated to Catholic charities and local institutions; before it went public, The Andersons required that its partners donate a percentage of their annual profits to charity.

The surge of interest in ethanol was first fueled last July when Congress passed an energy bill requiring the U.S. to use 7.5 billion gallons of renewable fuels by 2012. Ethanol producers now have the capacity to produce about 4.3 billion gallons.

U.S. refiners are clamoring for more ethanol also due to the phaseout of a natural gas derivative called methyl tertiary butyl ether, or MTBE, that allows gasoline to burn more cleanly but also has some health risks. Refiners are stopping use of MTBE because Congress refused to grant them protection from lawsuits.

Private investments in ethanol plants also have soared in the last year. Farmer-owned co-ops built most of the plants during the 1990s, but now only six of the 42 new or expanded ethanol plants under construction nationwide are farmer-owned, according to the Renewable Fuels Association trade group.

Those new plants will be able to produce 2 billion gallons each year.

Individual investors, though, can put money into only a few public companies making ethanol.

Shares of Decatur, Ill.-based Archer Daniels Midland Co., the nation's biggest ethanol maker, have been trading at 52-week highs in recent weeks, closed at $36.24 on the New York Stock Exchange Monday. And shares of Pacific Ethanol, which plans to open its first plants this year, nearly doubled in January, the same month that President Bush touted ethanol in his State of the Union speech. Shares closed up 15.7 percent on Monday on the Nasdaq Stock Market at $33.88.

Pacific Ethanol, based in Fresno, Calif., should be making a profit by next year, said Paul Resnik, an analyst with Dutton Associates, an equity research firm based in El Dorado Hills, Calif.

"Their first plant is still in the future, but the long-term strategy is sound," he said.

The Andersons' stock has been rising since 2001 when it traded below $8 a share. But the stock really took off last November, when it was trading around $40 a share, after posting strong earnings from its rail car operations and announcing plans for a second ethanol plant. Its shares closed up 5.6 percent Monday at $91.40.

But Resnik also warned that alternative energy company stocks are likely to be volatile.

"These stocks have moved a long way in a short time," he said.

The cost of ethanol's main ingredient, corn, can move up and down based on the weather's effect on the crop. A sharp increase in corn prices would translate to higher production costs for ethanol makers.

Analysts say a drop in oil prices also could cut into the profits of ethanol makers because ethanol's cost is directly tied to gas prices at the pump. A rush in demand for fuel efficient cars or a decision to drop government incentives for ethanol also could spell trouble.

"There's too many factors out of their control," said Mark Hughes, an analyst with Lafayette Investments in Ashton, Md.

His firm sold its stake in The Andersons at the end of March when shares jumped to $78. He noted that the company has yet to give any profit projections on its two ethanol plants under construction.

"I would take a pause and see how it goes," Hughes said. "I think the big move has been made already."

The Andersons, based in suburban Maumee, is investing about $250 million in two ethanol plants in Michigan and Indiana, which will be supplied with corn it already gets from farmers. The plant in Michigan should open in August.

The plants will have 60 days of grain storage capacity, which should help the company avoid paying premiums for corn whenever it is short supply, said Neill McKinstray, the company's president and general manager for ethanol.

He also said The Andersons' experience in managing corn - a volatile commodity - should translate well to managing ethanol. "Managing risk is what running an ethanol business successfully is all about," McKinstray said.

The Andersons said April 6 it planned to build a third ethanol plant next to one of its grain elevators in Dunkirk, Ind. It also has a small stake in one other plant.

Heather Jones, an analyst with BB&T Capital Markets, predicted that The Andersons will maintain "very nice margins for a sustained period." She lists it as a "buy" with a $96 price target.

"It looks like they will be profitable into the next year or year and a half," she said. "The economics of ethanol are incredibly compelling at this time."