equity analysis and valuation of green plains collin...
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Equity Analysis and Valuation of Green Plains Collin Christian [email protected] Hailey Mercer [email protected] Chris Hresko [email protected] Mitch Prda [email protected] Austin Studebaker [email protected]
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Contents Execute Summary ..................................................................................................................................................... 7
Industry Analysis ...................................................................................................................................................... 8
Accounting Analysis ............................................................................................................................................. 10
Financial Analysis .................................................................................................................................................. 12
Valuation Analysis ................................................................................................................................................. 15
Business Description ............................................................................................................................................ 16
Competitors ............................................................................................................................................................. 18
Industry Growth ..................................................................................................................................................... 19
Market Capitalization: ......................................................................................................................................... 20
Five Forces Model .................................................................................................................................................. 20
Rivalry Among Existing Firms .......................................................................................................................... 21
Industry Growth ..................................................................................................................................................... 22
Annual Percent Change ....................................................................................................................................... 24
Concentration .......................................................................................................................................................... 24
Differentiation ......................................................................................................................................................... 26
Switching Costs ....................................................................................................................................................... 26
Learning Economies ............................................................................................................................................. 27
Economies to Scale ........................................................................................................................................... 27
Fixed-Variable Costs ............................................................................................................................................. 29
Excess Capacity ....................................................................................................................................................... 30
Exit Barriers ............................................................................................................................................................. 31
Conclusion ................................................................................................................................................................ 32
Threats of New Entrants ..................................................................................................................................... 32
Economies of Scale ................................................................................................................................................ 33
Conclusion ................................................................................................................................................................ 34
First Mover Advantage ........................................................................................................................................ 35
Distribution Access and Relationships ......................................................................................................... 36
Legal Barriers .......................................................................................................................................................... 37
Conclusion ................................................................................................................................................................ 38
Threat of Substitute Products........................................................................................................................... 39
Relative Price and Performance and Buyers Willingness to Switch................................................. 39
Bargaining Power of Suppliers ........................................................................................................................ 40
Switching Costs ....................................................................................................................................................... 41
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Differentiation ......................................................................................................................................................... 41
Importance of Product for Cost and Quality ............................................................................................... 42
Number of Suppliers ............................................................................................................................................ 43
Conclusion ................................................................................................................................................................ 43
Bargaining Power of Customer ........................................................................................................................ 43
Switching Cost ......................................................................................................................................................... 44
Differentiation ......................................................................................................................................................... 45
Number of Customers .......................................................................................................................................... 45
Importance of Cost and Quality ....................................................................................................................... 45
Conclusion ................................................................................................................................................................ 46
Identifying Strategies that Create Value ...................................................................................................... 46
Vertically Integrating ........................................................................................................................................... 47
Industry Relationships ........................................................................................................................................ 48
Government Regulation ...................................................................................................................................... 48
Geographical Location ......................................................................................................................................... 49
Efficiency ................................................................................................................................................................... 50
First Mover Advantage ........................................................................................................................................ 50
Scale of Production ............................................................................................................................................... 51
Patents/Intellectual Property .......................................................................................................................... 51
Management ............................................................................................................................................................ 52
Conclusion ................................................................................................................................................................ 52
Introduction to Accounting Analysis ............................................................................................................. 53
Key Accounting Policies ...................................................................................................................................... 53
Type 1 Accounting Policies ................................................................................................................................ 54
Vertical Integration ............................................................................................................................................... 54
Government Regulation ...................................................................................................................................... 55
Scale of Production ............................................................................................................................................... 56
Type 2 Accounting Policies ................................................................................................................................ 57
Goodwill ..................................................................................................................................................................... 57
Operating Leases .................................................................................................................................................... 57
Pensions..................................................................................................................................................................... 58
Assessing the Degree of Accounting Flexibility......................................................................................... 58
Operating/Capital Leases ................................................................................................................................... 59
Goodwill ..................................................................................................................................................................... 59
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Evaluation of Actual Accounting Strategies ................................................................................................ 60
Defined Benefits and Pension Plan ................................................................................................................. 61
Research and Development ............................................................................................................................... 61
Goodwill ..................................................................................................................................................................... 62
Capital and Operating Leases ........................................................................................................................... 64
Conclusion ................................................................................................................................................................ 65
Quality of Disclosure ............................................................................................................................................ 66
Qualitative Measures of Accounting .............................................................................................................. 66
Research and Development ............................................................................................................................... 67
Goodwill ..................................................................................................................................................................... 67
Operating and Capital Leasing ......................................................................................................................... 68
Conclusion ................................................................................................................................................................ 69
Identifying Potential Red Flags ........................................................................................................................ 70
Undoing Accounting Distortions ..................................................................................................................... 70
Goodwill ..................................................................................................................................................................... 73
Financial Statements ............................................................................................................................................ 74
Balance Sheet .......................................................................................................................................................... 75
Conclusion ................................................................................................................................................................ 77
Financial Analysis .................................................................................................................................................. 77
Cross Sectional (Benchmark) Analysis: ........................................................................................................ 78
Liquidity Ratios ...................................................................................................................................................... 79
Current Ratio ........................................................................................................................................................... 79
Quick Ratio ............................................................................................................................................................... 80
Conclusion ................................................................................................................................................................ 82
Inventory Turnover .............................................................................................................................................. 82
Accounts Receivable Turnover ........................................................................................................................ 84
Working Capital Turnover ................................................................................................................................. 85
Day Supply Inventory .......................................................................................................................................... 86
Days Sales Outstanding ....................................................................................................................................... 87
Cash to Cash Cycle ................................................................................................................................................. 89
Profitability Ratios ................................................................................................................................................ 90
Gross Profit Margin ............................................................................................................................................... 91
Operating Profit Margin ...................................................................................................................................... 92
Net Profit Margin ................................................................................................................................................... 93
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Return on Assets .................................................................................................................................................... 94
Return on Equity .................................................................................................................................................... 95
Asset Turnover ....................................................................................................................................................... 96
Capital Structure and Leverage Risk Ratios: .............................................................................................. 97
Debt to Equity ......................................................................................................................................................... 98
Altman’s Z-Score .................................................................................................................................................... 99
Financial Forecasting ........................................................................................................................................ 100
Income Statement ............................................................................................................................................... 101
Dividends Forecasting ...................................................................................................................................... 104
Balance Sheet ....................................................................................................................................................... 104
Statement of Cash Flows .................................................................................................................................. 108
Cost of Capital Estimation ............................................................................................................................... 110
Cost of Debt ........................................................................................................................................................... 110
Cost of Equity ....................................................................................................................................................... 111
Backdoor Cost of Equity ................................................................................................................................... 115
Weighted Average Cost of Capital (WACC) .............................................................................................. 116
Valuation Analysis .............................................................................................................................................. 118
Market Comparative Evaluation................................................................................................................... 118
Trailing P/E ........................................................................................................................................................... 119
Forward P/E ......................................................................................................................................................... 120
Price to Book Ratio ............................................................................................................................................. 120
Dividends/ Price ................................................................................................................................................. 121
PEG ............................................................................................................................................................................ 122
P/EBITDA ............................................................................................................................................................... 122
EV/EBITDA ............................................................................................................................................................ 123
Intrinsic Models ................................................................................................................................................... 124
Discounted Dividends ....................................................................................................................................... 124
Discounted Free Cash Flows Model ............................................................................................................ 126
Residual Income Model .................................................................................................................................... 129
Abnormal Earnings Growth ........................................................................................................................... 130
Long Run Residual Income Model ............................................................................................................... 132
Sources .................................................................................................................................................................... 135
Appendix: ............................................................................................................................................................... 136
Capital Structures Ratios: ................................................................................................................................ 136
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Profitability Ratios: ............................................................................................................................................ 137
Liquidating Ratios: ............................................................................................................................................. 138
Method of Comparables: .................................................................................................................................. 142
Regressions: .......................................................................................................................................................... 146
Intrinsic Valuation Models: ............................................................................................................................ 149
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Execute Summary
Analyst Recommendation: SELL (OVERVALUED)
52 Week Range $20.31 - $46.28 2010 2011 2012 2013 2014
Revenue 3.25 Million As Stated 2.21 3.02 3.11 2.68 3
Market Capitalization 1.13 Billion Restated 1.95 1.81 3.48 2.49 2.29
Shares Outstanding 37.94 Million
As Stated Restated Trailing P/E $41.88
Return on Equity 23.76% N/A Forward P/E $47.08
Return on Assets 8.98% 8.64% PEG Ratio $31.70
Price to Book $30.60
Price to EBITDA $57.59
Estimated Adj. R^2 Beta Size Adj Ke EV/EBITDA $53.11
3 Month 9.80% 1.25 13.70%
1 Year 9.80% 1.25 13.70%
2 Year 9.90% 1.25 13.70% Discounted Dividends $11.07
7 Year 9.90% 1.25 13.70% Free Cash Flows $40.11
10 Year 9.90% 1.25 13.70% Residual Income $14.80
Abnormal Earnings Growth $10.69
As Stated Restated Long Run Residual Income $29.30
WACC 4.76% 10.30%
Backdoor Ke 18.97%
Lower Bound Center Upper Bound
Size Adjusted Ke 6.34% 13.70% 21.06%
WACC (BT) 6.43% 10.30% 14.18%
Intrinsic Valuations
GPRE - Nasdaq (5/4/2015)
Cost of Capital
Altman's Z-Score
Financial Based Valuations
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Industry Analysis
Green Plains Inc. is a specialty chemical company located in the Great
Plains region of the United States. Being one of the top ethanol companies, their
main competitors include Valero, Archer-Daniels Midland, and Future Fuel. We
chose these as Green Plains’ main competitors, as a sample of the ethanol
industry, because they obtain similar levels of business activities and corporate
structure. Overall, the ethanol industry is one of high risk, with high fluctuating
sales revenues over the past recent years. Due to government standards and
regulations, the ethanol industry has grown to be a multi-billion dollar industry,
with sales expected to grow even more in upcoming years. In order to
understand the competitive nature of the ethanol industry, we conducted the
Five Forces model in order to accurately evaluate it. Below is a summary of our
findings.
The rivalry amongst existing firms within the ethanol industry is high
due to many factors such as high industry growth, geographic location of plants
in correspondence to suppliers, and innovative ways to produce, market, and
distribute to the consumer. Although differentiation in the product is low, ethanol
remains to be a required portion of gasoline meaning there will always be a need
for it. There is also competition from foreign competitors and can expect
continual opposition with increased foreign production.
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Because companies face a heavy regulation constantly, it is not
easy for a new company to acquire a new plant therefore making the level of
new entry low. Learning economies and first mover advantage also make it
difficult for new to competitors to arise. By being able to influence pricing and
create trends other companies looking to join the industry look to be irrelevant.
The Mid West and Great Plains regions are for the most part taken up along with
a good portion of the suppliers as well, so finding a place to operate would see
almost impossible. Aside from the location and suppliers, distribution access and
relationships that have already been made by existing companies are another big
reason potential competitors deter from joining.
The threat of substitute products is mixed in that is research being done
to potentially find an alternative fuel source but nothing has been proven yet.
Brazil, one of the largest ethanol producers in the world, is working producing a
product from sugar cane that will be equally as efficient but at a lower cost.
The consumer base for the restaurant industry has a mixed-high level of
bargaining power over the companies we are evaluating. The increase in
production of ethanol and lower overall use of fuel in the United States has cause
downward pressure on the ethanol price. Because there is low differentiation in
products, companies can move from supplier to supplier to get the same
product, but might be facing a high switching costs due to the number of
suppliers relative to buyers. Consumers are also looking for the least expensive
ethanol in regards to price as well as transportation. Ethanol companies are at a
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disadvantageous compared to the consumer bargaining power. That being said,
given the fact there is an over supply of ethanol in the market and the price of
oil decreasing, we believe consumers have just a mixed-high level or bargaining
power.
Companies in this industry have low-mixed bargaining power over their
suppliers. Suppliers influence the price the customer pays for goods and the
structure of the contracts between the seller and the buyer. When there are
limited companies in the industry or few substitute products from which the
buyer can choose from, suppliers can become more powerful with their
bargaining power.
Overall, the ethanol industry is highly competitive. By evaluating these
companies operations and corporate strategy we have determined several key
success factors including government regulation, scale of production, and vertical
integration.
Accounting Analysis
Alongside looking at the nature of the ethanol industry, we also analyzed
the accounting polies and procedures presented within the recent 10-K. Because
of the flexibility allowed with reporting by GAAP, it is important analyze
companies financial to make sure there is no distorted information within their
annual and quarterly reports. If a firm does not have a decent amount of
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disclosure, it can be difficult to value. Though it is not required by GAAP to
provide certain information, it is management’s responsibility to inform its
investors of quality information regarding their financial statements.
First, we will identify Green Plains’ Type 1 policies, which include vertical
integration, government regulation, and scale of production. We have analyzed
Green Plains’ disclosures about their key success factors and believe they
disclosure information regarding these factors at the level of other companies
within the industry.
Type 2 accounting policies that have a wider degree of margin for
reporting and possible fabricated results for Green Plains include disclosure about
their operating lease structure as well as lack of disclosure regarding research
and development costs. These items are accounted for in their financials with a
high degree of flexibility and are considered potential red flags.
The majority of Green Plains’ leases are identified as operating, with a
small portion not worth restating identified as capital leases. Because they have
a majority of operating leases, this allows Green Plains to leave a large portion of
liabilities placed off the books. By capitalizing the leases, we are able to see a
better picture of Green Plains’ actual liabilities and obligations.
Through our analysis, we have determined Green Plains’ disclosure is a bit
deceptive to the public due to no disclosure of research and development costs
or any future plans of having any.
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Financial Analysis
The next step after analyzing the accounting policies is to move on to the
financials of the company. A great way to compare and contrast different
companies in an industry is by using ratios. The ratios that we used help describe
the state of liquidity, capital structure, and profitability of the industry and Green
Plains.
Current ratio, quick ratio, inventory turnover, accounts receivable
turnover, cash to cash cycle, and working capital turnover are all a part of the
liquidity ratios. The liquidity ratios shows us how fast Green Plains can turn
assets into cash compared to the other companies in the ethanol industry.
The profitability ratios allow us to see how Green Plains turned revenue
into profit. We showed Green Plains relative to the other companies in the
ethanol industry during the ratio section. The ratios tell us whether Green Plains
is performing up to or below the standard in the industry.
Ratio Performance Trend
Current Ratio Average Increasing
Quick Ratio Average Increasing
Inventory Turnover Average Decreasing
A/R Turnover Average Decreasing
Cash to Cash Cycle Average Increasing
WC Turnover Aveage Increasing
Liquidity
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The capital structure section shows and talks about how Green
Plains is doing compared to the other companies in the industry. Capital
structure ratios allow us to be able to tell how good Green Plains is doing with
their debt and financing. You could also call these your operating and investing
activities. We used the debt-equity ratio and the Altman’s Z-Score to help us
establish where Green Plains was in the industry.
Ratio Performance Trend
Gross Profit Margin Below Increasing
Operating Profit Margin Below Increasing
Net Profit Margin Below Increasing
Asset Turnover Average Declining
Return on Assets Average Increasing
Return on Equity Above Increasing
Profitability
Ratio Performance Trend
Debt to Equity Below Declining
Altman's Z Score Average Declining
Capital Structure
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After we got all the ratios we then preceded to forecast Green Plains’
financial statements out 10 years. For the income statement we based
everything off the sales growth that we believed to be somewhat accurate.
Forecasts are reasonable guesses so nothing is perfect when it comes to it. The
balance sheet we used the asset turnover ratio to forecast the assets. During the
equity section we forecasted the retained earnings off of what we felt the
dividends would be in the future. Once we got the forecasted assets and the
equity, we then were able to forecast the liabilities. The forecasts for the
statement of cash flows was harder and lot more unpredictable. With that being
said we can conclude that the statement of cash flows are not as accurate as the
other financial statements.
We then found the cost of debt by taking the rate multiplied by the weight
of long term debt and capitalized operating leases. After the calculation we came
up with 6.13%.
Another step in the financial analysis was determining the cost of equity.
We were able to calculate the cost of equity by using the capital asset pricing
model. The formula for CAPM is below.
Ke= Rf + Beta (MRP) + SP
We were able to find the beta by taking regressions and finding the
highest R^2. Once we got the beta we then calculated the cost of equity. We
finally added the size premium to the cost of equity by figuring out the size
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decile from the market value of the largest company in the industry. The number
that we came up with and used for the remainder of the evaluation was 13.70%.
We found that our industries risk is mostly firm specific and not as much from
the market.
Finally, after getting the cost of equity and debt for Green Plains, we were
able to come up with a weighted average cost of capital (WACC) of 10.40%
before tax.
Valuation Analysis
After completing a comprehensive industry analysis, accounting analysis,
forecasts and financial analysis, we are able to determine a value for Green
Plains Inc. We are then able to base our valuations off of the 4/1/15 adjusted
closing price of $29.32 as undervalued, fairly valued or overvalued.
There are two different types of valuation models; the method of
comparables and the intrinsic value methods. The method of comparables uses
industry ratios to forecast price per share. The method of comparables is used
as a way to quickly determine share prices and does not represent a
comprehensive valuation compared to the intrinsic value valuations.
The intrinsic value methods that were used to value Green Plains Inc. are
discounted dividends, free cash flows, residual income, abnormal earnings
growth and long run residual income. We have decided to use intrinsic value
methods of valuation to value Green Plains Inc. because they value firms at a
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more comprehensive scope than the method of comparables. The models we
used to value Green Plains Inc. are abnormal earnings growth and residual
income. We chose those two models because they were the least sensitive and
because they connect the balance sheet, cash flows and income statement.
Based off respective sensitivity analysis charts of the two models, we have
determined that Green Plains is overvalued with the cost of equity and perpetuity
growth rates. If the cost of equity value percentages were expanded between
9.5% and 6%, Green Plains Inc. appears to be more fairly valued than at the
other cost of equity percentages. Demonstrating that Green Plains would be
fairly valued at a lower cost of equity.
Business Description
Green Plains Inc., formally known as Green Plains Renewable Energy, an
Iowa based company, was founded in 2004. Their corporate headquarters is
located in Omaha, Nebraska, and their trading headquarters reside in McKinney,
Texas. They operate twelve ethanol plants located in several states along the
Great Plains region and operate in four different segments; ethanol production,
corn oil production, marketing and distribution, and agribusiness (operated by
Green Plains wholly owned subsidiary, Greens Plains Grains Company). Their
primary goal, according to their 10-K, is to “seek to maintain an environment of
continuous operational improvement to increase their efficiency and
effectiveness as a low-cost producer of ethanol”.
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Green Plains Inc. produces a variety of products with their main focus on
the production of Ethanol. They currently operate twelve ethanol plants in the
northern and central regions, which together produce one billion gallons
annually. At maximum capacity, these plants together will consume close to 350
million bushels of corn and also produce 2.9 million tons of distiller grains
annually. The ethanol they produce is marketed, sold, and distributed by an in-
house, fee based marketing company, Green Plains Trade Group LLC (10). Green
Plains Inc. is marketed to a variety of consumers, which include national,
regional, and local markets with a variety of customers including energy
companies, traders, jobbers, retailers and resellers. Green Plains Inc. has two
approaches to meet the challenge of distributing and marketing ethanol to their
vastly located clientele. In their local market, Green Plains Inc. uses large loop
trucks to distribute it product within 150-mile range. For further national and
regional markets, the plants have access to rail lines that allow Green Plains Inc.
to sell their product in an efficient and cost effective way (Green Plains 10-K).
In addition to producing ethanol, Green Plains Inc. also operates corn oil
extraction systems at all twelve of their plants. The corn oil product has a variety
of uses, but is primarily marketed “as feedstock for biodiesel as well as
supplement to livestock feed” (Green Plains 10-K 2014). In addition to those
uses, Green Plains Inc. company website states that other industry uses for corn
oil include: feedstock for rubber substitutes, rust preventatives, inks, textiles,
soaps, and insecticides (10). The company’s distribution method for corn oil is
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similar to how they also transport ethanol, by truck and rail, but only includes
locations they consider close to their ethanol plants that would turn out a profit.
Another co-product of the ethanol production process is distiller’s grains.
With the one billion gallons of ethanol Green Plains Inc. produces yearly, they
are also able to produce wet, modified wet, and dried distiller grains. After
lengthened production processes, these grains are used for “high-protein, high-
energy, animal fodder and feed supplements which are marketed to dairy, beef,
swine, and poultry industries. Alternative uses have said to include burning fuel,
fertilizer, and weed inhibitors” (Green Plains 10-K 2014). These distiller grains
come in three different forms, wet, modified wet, and dried grains, which all
have different requirements in when they need to be sold. The wet distiller
grains are commonly sold to feedlots and dairies, but can only be sold locally due
to their short shelf life. The modified wet distiller grains are also sold to feedlots
and dairies, but are more broadly sold because of their longer shelf life, lasting
to about three weeks. Lastly, the dried grains have an infinite shelf life as well as
many uses, and therefore are sold to any vicinity (10).
Competitors
Green Plains Inc. is the fourth largest ethanol producer in the United
States, and because the ethanol industry continues to grow significantly every
year, they face competition from many different companies of all scales. Their
top competitors in the U.S. include companies such as Valero, Archer-Daniels
Midland Company, and Future Fuel. We based competitors off of their size of
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market share, as well as similarities in business activities. Where there are
differences in these firms we will go more into details about such, assuming all
competitors public information is up to date. Green Plains Inc. also faces
competition from foreign competitors and is expecting even more of an
opposition with increased foreign production and the discovery of cheaper
processes. On a smaller scale, farm cooperatives have also been able to compete
successfully, while also changing the way ethanol is typically produced.
There has been new development, although still in the early stages, of
ethanol being produced from other sources such as switchgrass and popular
trees. However, based on little research, future success in this market cannot be
determined or accounted for yet.
Industry Growth
Although ethanol production has seen increases in production in recent
years, currently the ethanol industry is facing a decline in profitability and
accessibility. According to the Wall Street Journal, the ethanol business is under
pressure from the slide in crude oil as well as a 26.6% rise in the price of corn
since September 2014, boosting the price of the industry’s main ingredient (10).
Many in the industry expect smaller or less efficient producers to begin scaling
back production as profitability falls. The combination of pressures has fueled
concerns that the industry’s most-profitable days may be behind it, for now.
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Market Capitalization:
The market capitalization of Green Plains Inc. of $951.56 million at the
end the fiscal year in 2014, falls into the lower half range of its competitors,
which include Valero, Archer-Daniels-Midland Company, and Future Fuel who are
currently listing market capitalizations of $28.35 billion, $31.39 billion, and
$505.86 million respectively (14).
Five Forces Model
To evaluate Green Plains and the ethanol industry we will use the Five
Forces model. This model allows us to compare and contrast competition within
the industry using rivalry among existing firms, threats of new entrants, threat of
substitute products, bargaining power of buyers, and bargaining power of
suppliers. From this, we can expect the Five Forces model to explain what the
positives and negatives of a company are. Each force has a certain level of
competition and it changes for every industry. There are high, low, and mixed
levels of competition, and this allows us to tell if the company is a cost
leadership or differentiation company. Below is a chart that we believe is the
level of competition for each force.
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Ethanol Industry
Competition
Rivalry Among Existing Firms
High
Threat of New Entrants
Low
Threat of Substitute Products
Mixed
Bargaining Power of Buyers
Mixed-High
Bargaining Power of Suppliers
Low-Mixed
Rivalry Among Existing Firms
Rivalry is always a big part of any industry and it plays a big role in
determining how value is created in an industry. Supply and demand determines
if the companies in the industry will be more competitive with pricing strategies.
When demand is low companies tend to compete with each other at a greater
rate than when demand is high.
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In our evaluation of Green Plains we need to compare the company with
others that are similar and in the biofuel industry. We chose to evaluate Valero,
Archer-Daniels Midland, and Future Fuel as the benchmarks in the industry. Each
company of course has a few different features to its company and may compete
in other industries. We will touch briefly on the companies that we chose as
benchmarks, though, are all mainly in the biofuel and ethanol industry, which is
what we will focus on using the Five Forces model. With rivalry among existing
firms, we will look at industry growth, concentration, differentiation, switching
costs, scale/learning economies, fixed-variable costs, excess capacity, and exit
barriers in the biofuel industry because they are the main drivers of competition.
Industry Growth
The industry growth rate is a measuring tool that enables us to compare
different features of a certain industry. In the past few years the biofuel industry
has soared due to concern of nonrenewable resources. Ethanol is about 10% of
the U.S. gasoline market and plays a huge role in the oil and gas industry as well
(Green Plains 10-K 2014). Ethanol is not the only product that the companies we
are analyzing sell, however. This is important to understand because most
companies in this industry were originally in other industries and added biofuel
as a new branch to their company. For example, Archer-Daniels-Midland was
mainly an agricultural company that produced food and feed for livestock. Once
biofuel became a part of the economy, Archer-Daniels-Midland Company hurried
to join the industry. Since biofuel is relatively new, it was not long before the
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demand spiked and the industry grew rapidly. The chart below shows the
revenue for each company as well as the total revenue for the industry. The
numbers can be found in each company’s 10-K.
Revenue (In Millions)
The chart above proves that revenue for most companies was on quite
the climb from 2009 to 2012. From 2012 to 2013 you can see that the revenue
declined in not only Green Plains, but in the industry in general. Some factors
played into this like the price of corn went up and regulations were starting to
take into effect. The biofuel industry annual percent change in that time frame
was a slight -.32% in the graph below. We could conclude that Valero had a lot
to do with the change since they have obviously the most revenue with $138
billion in 2013. Within the companies evaluated, Valero had about 59.7% of the
revenue for 2013.
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Annual Percent Change
From the tables shown below, you can see that the drastic change in rates
across the industry suggest that segmentation exists within the ethanol industry.
There are large decreases from the year 2011 to 2012 within each company,
mainly due to high corn prices and new regulations proposed affecting ethanol
revenues for the year.
Concentration
The Biofuel industry can be very competitive at times due to the volatility
in prices of natural gas. Weather conditions, natural disasters, government
control, and foreign relations can alter the prices in an instant. In the United
States, Archer-Daniels Midland and Valero are within the top three when it
comes to ethanol production, and control much of the market share in the
industry. Green Plains is believed to be the fourth biggest ethanol producer,
according to the Ethanol Producer Magazine (12). Valero and Archer-Daniels
Midland control much of the shares compared to Green Plains and Future Fuel
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$0.00
$20,000.00
$40,000.00
$60,000.00
$80,000.00
$100,000.00
$120,000.00
$140,000.00
$160,000.00
2009 2010 2011 2012 2013
Market Share in Revenue
Valero Archer-Daniels-Midland Green Plains Future Fuel
due to the different segments of their company. As of the end of 2013, there
were 217 producing plants in the United States with 25 just in the home state
(Nebraska) of Green Plains (Green Plains 10-K 2014). The chart on the next page
shows how much market share each company has in its industry. After observing
everything discussed, we concluded that the ethanol industry as a whole are
price takers because of high competition and regulation.
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Differentiation
The ability to differ in goods and services in the same industry to make a
profit is called differentiation. In the world of biofuel there is not much
differentiation when it comes to the industry. There are some companies that do
make ethanol with sugar-cane instead of corn in Brazil. Consumers are not really
looking for differences in the ethanol but mainly just the price of it. When it
comes to the entire company however the company can differentiate in other
segments of their company. Green Plains extracts all the left over corn oil and
produce non-edible products like soap for humans.
Also, they sell the corn oil to the feedstock companies. Valero has ample more
revenue than the other companies because they are also involved in gasoline,
diesel, jet fuel, propane, and asphalt, just to name a few. Archer-Daniels-Midland
is more like Green Plains in that it deals more with the agriculture part but still
has its distinct differences. For example, Archer-Daniels Midland is also in the
industry of crops for human consumption and supplement ingredients for
medicine. As the industry continues to grow more variables are likely to pop up
and compete with each other.
Switching Costs
Switching costs from one industry to another industry can be very costly
for any company to go through. In the biofuel industry it is almost impossible to
just switch out of it completely because the amount of money involved in the
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assets and capital that the company has invested is too high. Also, most of the
assets that the companies have in this certain industry are only meant to
produce ethanol. Green Plains and the other companies could get the oil from
the corn to produce agricultural products to sell. If they did this they then would
not get all the money from their ethanol sales, which produces the most revenue
by a long shot. As long as ethanol is still in demand, all of these companies will
compete in biofuel. Switching costs for a company’s biofuel segment might occur
if another energy source takes the place of ethanol and biofuel.
Learning Economies
The research and development department plays a key role in present and
future sales. In Archer-Daniels Midland’s 10-K, they have a whole page dedicated
on research and development and discuss how their company always strives to
get the best possible products out on the market for their customers. Some of
the main things that they want to improve on are the efficiency of processing
and the development of food, fuel, and industrial products from crops (3). Green
Plains has figured out how to use real-time production to help look over their
plants to get the best possible outcomes (1). As new technologies and products
come out, it is important to stay ahead of the curve to try and optimize profit.
Economies to Scale
Economies to scale also play a huge role in the biofuel industry due to
many different variables. For one, the amount of corn the companies purchase in
28
Year Valero Archer-Daniels-Midland Green Plains Future Fuel Total Industry
2009 35,629.00$ 31,582.00$ 878.00$ 246.00$ 68,335.00$
2010 37,621.00$ 31,808.00$ 1,398.00$ 343.00$ 71,170.00$
2011 42,783.00$ 42,352.00$ 1,421.00$ 382.00$ 86,938.00$
2012 44,477.00$ 41,771.00$ 1,350.00$ 355.00$ 87,953.00$
2013 47,260.00$ 43,752.00$ 1,532.00$ 414.00$ 92,958.00$
order to make the ethanol. The more corn a company can get usually results in
cheaper bushels of corn when averaged out. Each of Green Plains plants requires
20 to 40 million bushels of corn per year (1). Another important reason to
produce in mass quantity is that it lowers the cost of each gallon of ethanol
produced. The more a company produces, the lower they can sell their ethanol
for, allowing them to be more competitive within their industry. In order to be
able to mass-produce ethanol at one time, it requires a high supply of assets on
hand. Based on the graphs below, it is evident that the size of the company
plays a major role in the assets each company holds. Valero and Archer-Daniels
Midland on average have 29 times more total assets than Green Plains in the
year of 2013, and on average 110 times more total assets than Future Fuel. This
would suggest that Valero and Archer-Daniels Midland serve as a form of
conglomerate within the ethanol industry.
Total Assets in Millions
29
$-
$10,000.00
$20,000.00
$30,000.00
$40,000.00
$50,000.00
$60,000.00
$70,000.00
$80,000.00
$90,000.00
$100,000.00
2009 2010 2011 2012 2013
Total Assets in Millions
Valero Archer-Daniels-Midland Green Plains Future Fuel Total Industry
The graph shows that the companies have acquired more assets year by
year, telling us that that the companies are using economies to scale to their
benefit. Valero is the only company out of the benchmarks that continually got
bigger every year. Green Plains and Future Fuel are both specialized companies
while Valero and ADM are both conglomerates. This explains why the
conglomerate companies have a lot more assets than the specialized ones.
Fixed-Variable Costs
Fixed costs are costs that do not change per amount of activity whereas
variable costs depend on how much of a unit is produced. Some examples of
30
fixed costs could be plant, property and equipment. Also utilities and
management would be good examples of fixed costs. For variable costs
examples could be direct materials and direct labor.
In the biofuel industry, fixed costs are high relative to variable costs, and
also has high overhead compared to other industries. The cost to produce more
ethanol is small for every gallon produced. With high fixed costs there becomes a
risk involved. The companies have to be able to sell a certain amount of ethanol
per year to be able to break even or a make a profit. Being able to cut down on
fixed costs or increase revenue will decide whether a company is successful or
not.
Excess Capacity
Excess capacity is the amount of space that is not utilized or has not been
filled yet. Some companies have more capacity to operate than others, but that
does not mean that they are utilizing it as well. It is important for any business
to cut or utilize their excess capacity to their advantage. If they do not, then they
could fall behind their competitors in just a short amount of time as well as cost
the firm money. We took a look at the revenue per employee ratio to see where
the companies we benchmarked fell in order. This allows us to be able to see if
companies maybe need to think about laying off employees because they just
have too many of them, excess capacity. Our data sources are from the
company’s 10-K’s.
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Revenue per Employee
This chart shows that Valero is getting the most revenue per employee
while Future Fuel is in last. One reason for this is that Future Fuel is a new
company and only began operations in 2005. According to the graph, Green
Plains is the second highest company with revenue per employee and does not
seem to have much extra capacity when it comes to employees.
Exit Barriers
Every company has exit barriers, even if they do not wish to exit the
industry. Some exit barriers include government regulations and high-specialized
costs for certain assets, which could make it harder to exit. If a company were
trying to exit an industry, they would need to look at the long run costs to
determine the consequences.
In the biofuel industry, companies generally have large warehouses and
silos on their properties. These would not be hard to liquidate and turn into cash
if they needed to exit the industry because an active market for assets, with
farmers and other agricultural businesses willing to purchase them. One concern
32
however is that the equipment within the plants are specialized to make ethanol
and ethanol only. You might have a few other machines that help out with other
tasks, but the majority of equipment is specialized to the biofuel industry,
making it harder to sell off and ultimately leave the industry. Overall, the barriers
to exit are split down the middle. If Green Plains got stuck in a situation where
they could not sell off their assets, they would be forced to continue to be
competitive in the biofuel industry.
Conclusion
We concluded that all the elements in rivalry among existing firms makes
the industry highly competitive and are cost leaders. Ethanol has not yet found
any new technology to differentiation the ethanol itself, making competitors have
to change their pricing strategy and sell for a lower cost. For Green Plains, this
means they have to be very competitive because they do not own the majority
portion of the market share.
Threats of New Entrants
For companies looking to enter into an industry they must take a look at
the threat of new entrants. The threats of new entrants include economies of
scale, first mover advantage, distribution access and relationships, and finally
legal barriers. Each one of these can pose a threat to a company looking to start
at the same level as its competitors in the industry. If there are not too many
33
barriers or threats for a new company to join they should work on keeping
others from entering the industries market share.
Economies of Scale
When a company or industry produces more or less of product and
savings are proportionate, then it is called economies of scale. The bigger the
company generally means they will be able to save more on costs due to being
able to buy large amounts of raw materials at a time. The biofuel industry
companies like Archer-Daniels Midland are able to have an advantage on the
other smaller companies because they can buy more corn at a time. With
companies being able to buy more corn at a time, it helps save the company
money. Green Plains used 238.74 million bushels of corn in 2012 to produce their
ethanol, while in 2013 used 257.66 million. Using approximately 19 million more
bushels in 2013 shows that they saved money on each bushel of corn because of
the fixed costs (Green Plains 10-K 2013). We compared these numbers to
Archer-Daniels Midland’s 912 million bushels of corn for 2013 to see how much
bigger the top companies are.
34
225,000,000.00
230,000,000.00
235,000,000.00
240,000,000.00
245,000,000.00
250,000,000.00
255,000,000.00
260,000,000.00
2012 2013
Bushels
Corn Bushels Used in Green Plains Ethanol Production
Conclusion
New entrants in the industry would have trouble with the larger
companies and would not be able to buy as much corn or other raw materials to
produce their products. The existing companies however could charge less to
their customers because of less money spent in expenses. We determined that
they have a low level of competition for economies of scale.
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First Mover Advantage
Being able to be the first company in the ethanol industry is an advantage
in many different ways. First, the company or companies could determine their
own prices and trends in the industry. Also, the company could create barriers to
entry for new companies trying to join the industry and take away market share.
Creating exclusive contracts with other outside companies for raw materials is an
example of a barrier that could be created.
Archer-Daniels Midland has expanded its company to other parts of the
world, which serves as a big gain in the ethanol industry (3). Because of this,
they have an advantage over Green Plains and other ethanol plants looking to
enter into places like Brazil. Archer-Daniels Midland will have an advantage on
raw materials and personal connections in the regions. In the United States, any
company looking to start a ethanol company in the Mid-West will have a hard
time due to the many plants already existing in this area.
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The map above shows just how concentrated the Mid-West is and how
hard it would be for a new company to join in the ethanol and biofuel industry in
this area. This area is preferred because the plants are close to most of the
farms that produce corn, making it easier to transport corn as well as fuel to and
from the plants, and therefore decreasing costs for the companies.
Distribution Access and Relationships
Distribution Access is the ability to acquire raw materials or sell off the
finished products. Distribution is huge when it comes to any industry and can
easily deter new companies from joining a certain industry. Within the ethanol
industry, companies rely upon the agricultural industry to supply them with raw
materials such as corn. As we previously discussed, the closer a company is to
the supplier, the cheaper the expenses will be. It can be hard for a new company
to find suppliers that do not already have exclusive contracts with other
companies in the industry. Though farmers commonly do not contract their
entire crop, first mover advantage gives companies that are already established
a better chance of acquiring the crop that is for sale.
The distribution to the company’s buyers is similar to the process of their
suppliers. Companies in the industry sell their biofuel and ethanol to oil and gas
companies. Valero on the other hand can use their ethanol and sell it from their
pumps to average people. Finding a good buyer can be hard at times for new
companies since most companies in the industry already have existing contracts
with the oil and gas companies. This is where relationships are critical in not just
37
the biofuel industry but any in that fact. Supplier and customer relations are
important for connecting the crops to the household consumers, which then
drives up returns for shareholders. Relations can also serve as a barrier for some
companies because they may not have any prior contracts or negotiations. In
order for a new company to become profitable, they must acquire as many
supplier and customer relationships as soon as possible. We concluded that the
industry has a low level of competition when it comes to new entrants trying to
gain relationships.
Legal Barriers
Legal Barriers can be defined as anything that the state or federal
government has imposed on the operations of an industry. Some industries have
different or even more barriers than others because of multiple factors. Some
factors could be due to how hazardous it could be to the environment or maybe
to people’s health. For instance, in the restaurant business every restaurant that
wants to sell alcohol has to get a permit, which can be very costly.
With the concerns and knowledge of greenhouse gases in modern days,
the regulations for emissions have become a lot stricter than the past. In the
biofuel industry there are a lot of regulations due to the emissions that the plants
put out when making the ethanol. The Environmental Protection Agency in the
United States requires owners to report their emissions. The industry has to use
certain equipment to release emissions that are regulated and safe for the
environment. With experiments and new theories always coming out, it can be
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very costly for some companies to keep up with the regulations. To comply with
some of the regulations it can mean that you have to redo most of your plant.
This may not be a big concern for a new company coming into the industry but it
can be difficult for existing companies that already have plants used for other
industries wanting to switch into biofuel.
Other regulations for new entrants to look out for could be minimum wage
and state taxes. It’s always worth looking into which states your company would
have to spend less on in taxes.
Conclusion
The industry is full of barriers to entry, which is one reason it is hard for
companies to join in the market share. For companies trying to reach to the level
of Green plains and the other benchmarks, they will have to overcome scale of
economies, first mover advantage, distribution access, relationships, and legal
barriers. All of the big companies in the industry already have a huge advantage
in cost and quality of their ethanol and biofuel.
In the case of first mover advantage, it will be very hard for new
companies to come into the Mid-West and find a good spot for a plant. All of the
existing companies in the industry already have their relationships with the
farmers in the area since they were able to get there first. For new companies
trying to make a major impact in the market share they will have to set up shop
in other places in the United States or have an innovative idea that could change
the industry. An example for new companies to look at is the companies involved
39
in Brazil. Brazil makes ethanol out of sugar cane, which has proved very
profitable. These companies found a new place and different way to make
ethanol. With this being said the competition is low for new entrants to try and
take market share from the existing companies. This supports that the Biofuel
industry is a cost leadership industry.
Threat of Substitute Products
As every industry evolves, so does the technology around them.
Industries have the risk of becoming affected by substitute products. The
existing products that the industry or company puts out may not be taken over
by an exact substitute. The substitute mainly just acts in place of the old product
and provides the same function. Relative price performance and the buyers’
willingness to switch can play a part of the threat of substitute products.
Relative Price and Performance and Buyers Willingness to Switch
Relative price and performance is the ability for a substitute good to come
in and take over by either its price or performance, sometimes both. In the
biofuel industry the product is typically almost the same price from one company
to another per barrel. Also, all ethanol performs the same way and does not
differ in performance. For the biofuel industry there is not much change when it
comes to relative price and performance.
Typically buyers in this industry are looking for the same thing and that is
a biofuel that is the best solution at the time for the environment and the energy
40
industry. For a company or industry to come in as a substitute then they would
either have a relative product that is somehow a lot cheaper or technology
provided a new product that is a lot cleaner for the environment. We concluded
that the competition in the threat of substitute products is mixed because the
performance doesn’t change but there could be a new and improved product
that could take its place in the future.
Bargaining Power of Suppliers
The bargaining power of suppliers is dependent on the amount of
suppliers that exist in a market. Suppliers influence the price the consumer pays
for goods and the structure of the contracts between the seller and the buyer. If
there are limited companies in the industry or few substitute products in which
the buyer can choose from, suppliers could become very powerful in regards to
bargaining power. As of 2012, corn, which plays a major role in the United States
economy, has been grown on over 96 million acres (13). In the ethanol industry,
there are a large amount of corn producers (third party suppliers) trying to sell to
a concentrated amount of ethanol producers. Grain elevator co-ops (second
party suppliers) consolidate several corn producers to one area. The bargaining
power of suppliers in the industry gains strength when moved to secondary
suppliers because the availability of different suppliers is reduced, thus
eliminating product competition.
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Switching Costs
Switching cost is the ease at which a firm or company can switch from
one supplier to another. The number of suppliers plays a major role in
determining if switching cost will be high or low. For example, if a large
concentration of suppliers competes in the market, the switching cost will most
likely be low and easy to achieve. In contrast, a low concentration of suppliers in
the market leads to a high switching cost that is difficult to achieve. In the
ethanol industry, there is a surplus of third party suppliers in addition to many
secondary suppliers. Ethanol companies purchase the majority of the corn they
buy from third party suppliers, such as local farmers in the area. In this case,
switching cost could be considered low, however, difficulties could also arise
because of relationships with different farmers and the number of contracts they
may operate under.
Differentiation
When buying corn to produce ethanol, little to none product differentiation
exists between suppliers. However, differentiation exists when selecting a
supplier. Though corn is considered a commodity and prices are relevantly
similar, the effect of transportation costs can play a large role in which supplier
an ethanol plant selects. Other factors that may determine which supplier is
selected include average rainfall, water levels, and the ability to grow the corn.
Since it takes approximately 86.4 million gallons of water to produce a 140 acre
42
circle of corn, an ethanol company would not want to select a supplier that
operates in a region that is in a drought or has low water levels.
Importance of Product for Cost and Quality
In the ethanol industry, product costs play a significant role for two
companies competing against each other. However, quality is not much different
from supplier to supplier because the Market sets the standard for #2 corn.
Since all corn is the same, the buyer is looking for the supplier from which they
can purchase corn to produce ethanol at the lowest price possible. In this case,
location plays a significant role because the ethanol companies need suppliers
who can transport the product to them the fastest as well as the least expensive.
Drought and other environmental factors can also come into play when
considering cost. An ethanol plant operating in an area that struggles to grow
corn due to drought conditions may have to pay higher corn and transportation
prices from a supplier in the north where there is an abundant amount of rainfall.
In addition to this, other industries also compete for corn availability. For
example, many cattle producers feed with corn or corn by-products. In the event
of a corn surplus, corn is purchased at a lower price. However, when the supply
is low and both ethanol plants and cattle feeders are competing for corn
supplies, the cost of corn will increase.
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Number of Suppliers
Many third party suppliers as well as secondary suppliers are in the
ethanol industry. Since no differentiation exists in types of corn, a great deal of
competition exists between suppliers. These suppliers must not only compete
against other suppliers but also against themselves, the market, and the
environment. The number of companies in the ethanol industry is small
compared to the amount of suppliers; therefore, this increases the competition
between suppliers. Since so many suppliers are in the industry, the suppliers
become price takers rather than price setters.
Conclusion
After considering all of the information, it is apparent that suppliers are at
a disadvantage in the ethanol industry and their bargaining power is fairly low.
All corn is the same so product differentiation between suppliers is non-existent
in the industry. The supplier must rely heavily on price and location in order to
attract buyers as well as a personal relationship with the ethanol company. This
makes the bargaining power of suppliers low to mixed, and bargaining power of
the buyer to be high.
Bargaining Power of Customer
Consumer bargaining power is dependent on the amount of consumers
that exist in a market and the demand for the product. If the buyer group is
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concentrated, the buyer has high bargaining power. The increase in production
of ethanol and lower overall use of fuel in the United States has caused
downward pressure on the ethanol price. According to Forbes Magazine, in 2014
alone, the United States used almost 5 billion bushels of corn to produce 13
billion gallons of ethanol fuel. While this may seem like a large number, there is
little ethanol content in gasoline. Within the ethanol industry, gasoline producers
(the customer) have gained bargaining power. As gasoline producers reach the
government requirements for ethanol use and the price of oil decreases, there is
less incentive and opportunity to lower the cost of gasoline by adding ethanol to
their product. Since oil companies are able to purchase large volumes compared
to the supplier’s sales, they are able to play competitors against each other.
Consequently, gasoline producers currently have the advantage to bargain for
lower ethanol prices due to over-supply and low demand of ethanol.
Switching Cost
Switching cost for oil companies when buying ethanol in most cases can
be difficult and high due to the small amount of ethanol producers in the United
States. Oil companies tend to enter into contracts with ethanol companies that
can last many years making it difficult to switch from supplier to supplier,
especially with the tight supply of ethanol and suppliers barely keeping up with
demand. The number of suppliers of ethanol in the industry is small compared to
the number of consumers due to the permits required for ethanol production
which is hard to get, making new plants unlikely to be built for years. This would
45
usually mean that the supplier would have most of the bargaining power and
switching cost could be high for consumers.
Differentiation
All corn ethanol is the same, therefore there is no product differentiation.
Shipments from different suppliers are often combined, therefore requiring an
identical product.
Number of Customers
Ethanol and oil each play a significant role in in the United States
economy. According to ethanolproducer.com, there are 207 publicly and privately
traded ethanol plants operating in the United States as of January 31, 2015.
Though there are a few amount of ethanol plants in the United States, they are
producing at a surplus amount. Many of the big oil companies that buy from the
ethanol companies also produce their own ethanol, causing an even larger
surplus of ethanol. Because of this, ethanol companies are considered to be price
takers while the oil companies are price setters.
Importance of Cost and Quality
There is little to no difference in the quality of ethanol between companies
competing against each other to produce. The main difference is the price in
which the ethanol companies can produce and sell the ethanol to oil companies.
Oil companies are looking for the cheapest ethanol in regards to price as well as
46
transportation. Since ethanol must be transported by truck or train due to its
water-solubility, location can play a major role in which ethanol plant an oil
company buys from. Ethanol companies must figure out the best way to produce
and price their products in a way that attracts oil companies in order to have
higher sales.
Conclusion
After reviewing all the information it is obvious that the ethanol companies
are at a disadvantage and oil companies are at an advantage when it comes to
consumer bargaining power. Given the fact that there is a lot of ethanol in the
market right now and with the price of oil down, oil companies then have high to
mixed bargaining power. There are two types of categories for creating a
competitive advantage, being cost leadership and differentiation. For the
majority of the ethanol industry, there is not much differentiation amongst firms,
and the product itself cannot be differentiated very much. Therefore cost
leadership is a key factor in determining value. When looking for strategies that
create value, we are looking at activities that drive costs down due to the fact
that the ethanol industry is a price takers market.
Identifying Strategies that Create Value
Ethanol competitors are largely competing on price and not differentiation.
There is a wide range of activities that can help drive down costs and ultimately
47
allow for a more efficient means of productions of ethanol. These strategies may
range from pure location, operating activities to personal relationships.
Vertically Integrating
It has been displayed in most industries that owning the means of
production throughout the whole process from producing the corn to distribution
of ethanol drives down prices. It allows the business to plan, control and react
quicker when producing products. The official term for this type of management
and operation is vertical integration. In the ethanol industry there are three basic
stages, the first being growing/obtaining grains, secondly producing ethanol and
thirdly selling and distributing the finished product. When firms aren’t vertically
integrated, there are a lot of middlemen that need to make money and thus that
drives up the cost each time a middleman is involved. Thus by eliminating the
middle man at every step possible and executing their job as efficiently or better
will help drive down the price of the final product.
Firms in the ethanol industry can vertically integrate in several ways;
including, owning fields that produce the grains, owning silos that store the
grain, owning holding tanks, owning blending plants to blend their ethanol with
other fuels as well as owning the means of distribution. It is important to
remember that just because a company is vertically integrated doesn’t always
mean that it is beneficial, in other words it isn’t guaranteed to help drive down
prices.
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Industry Relationships
The agricultural industry functions a little bit different than other
industries in that relationships are a key driving force for deal making, cost
minimization, growth and efficiency. The agricultural industry values character
and a firms’ connotation can determine the success of a business within the
industry. For a company to be successful in this industry, a company needs to
build positive relationships. For example an ethanol company would want to
develop strong relationships with local farmers to get a pick of the best crop and
ultimately the best price. The relationships built can cut out other competitors
and become a key value driver for the firm.
Government Regulation
When government regulation is mentioned in most cases it bodes bad
news for the industry or company, but for once government regulation is actually
benefiting companies in the ethanol market. With more and more public support
to curb carbon emissions, the U.S. government has been writing regulation to
utilize ethanol in gasoline at higher percentages. With more ethanol being
required to be in gasoline, it will in turn drive up the demand for ethanol.
Additionally, more government regulation is being put in place to put
more ethanol in gasoline in colder regions, because it is harder to rid carbon
emissions when it is cold. Thus the colder the weather conditions, the more
likely ethanol will be in demand.
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It would be important to recognize a company for their potential lobbying
team that would work to drive positive legislation for the market. It is common
to have a rather large lobbying budget in the energy sector because it is well
documented how energy companies have gained beneficial legislation from
lobbying.
Geographical Location
A huge component to the ethanol industry is geographical location in
relationship to the ethanol’s plant, supply of grain and where it needs to
distribute its finished product. Ethanol producers must first consider where their
supply of grain is located, which for a majority of the industry is located in the
Midwest. Corn is the main ingredient in the production of ethanol and is grown
the most in Iowa, Nebraska and Illinois (8).
Due to the fact that it takes roughly 26lbs. of corn to produce one gallon
of ethanol (6.5lbs.), it is rather obvious that it would cost far more to transport
grain further than it would be to transport the finished product (7). Therefore it
is important for ethanol producers to be located as close to the source of where
the firms get their corn. One more important factor that plays into the transport
of grain from the fields to the plant is whether the grain arrives via rail network
or truck. The ease of access to the plant by either rail or truck can become a
value addition, due to the fact that once again the position of the firm can help
drive down costs. Simple examples of this are if the plant was located just off an
interstate or right off the main line of a railroad. In some instances
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transportation could be cheaper by truck and at other times it could be cheaper
by rail. It is possible that the most cost effective means of transportation could
fluctuate.
Efficiency
When mass-producing products, as a company you want to be as efficient
as possible. Efficiency helps drive down costs of the final product. At every step
of the process it is essential that steps are taken to enhance efficiency, from raw
material inputs to shipping of the finished goods. In the ethanol industry there
are a lot of possibilities to enhance efficiency. Anything from good relationships,
geographical location and technology has the potential to improve efficiency and
ultimately helps drive down the cost of the finished product. Additional value is
credited to a business that takes these steps in and industry that competes
heavily on price.
First Mover Advantage
Like most industries, the company that enters the market first or adopts a
operation enhancing activity has a major advantage in terms of setting trends,
price and general operations. In the ethanol industry, if an ethanol producer is
the first to move into a new region, they have a major advantage. The company
would have an extra big advantage if they were to move into a region first and
are supplying what the market demands, due to the fact that if a new company
51
would try to move in, it would be difficult for the incoming company to steal
away enough business to make a profit.
Additionally it is important to recognize if a company in the industry is
continually researching and investing in technologies that could lead to more
efficient operations. Technology can provide a competitive advantage in terms
of driving down costs.
Scale of Production
Scale of production goes along with efficiency in many ways, in that the
more product that is produced, generally helps drive down costs. It is more
efficient to ship goods in bulk and produce more products in larger batches than
constantly shipping in smaller quantities and running multiple smaller batches
than one large batch of product. Ultimately producing more products will help
drive down prices, which is the name of the game for ethanol producers.
Recognizing factors a firm takes when scaling up production to guide down costs
creates value for the firm.
Patents/Intellectual Property
A company’s research, technology and methods developed within the
company provide a competitive advantage within the industry. Holding key
patents and rights to technology within an industry can prove to be a
distinguishing competitive advantage amongst other players in the market.
Either the other players in the market have to pay up to license the technology
52
or methods, driving up their costs or competitors will have to develop new
methods to achieve the same end goal, also costing more resources and funds.
A firm’s intellectual property is taken seriously and most firms will fight viciously
to protect it.
Management
The team that is putting together and executing the strategies and
operations has a major influence on the success of the business. It is
managements’ responsibility to execute and grow shareholder value. The
management teams’ age, experience and relationships are factors that can play a
pivotal role in the success or failure of a firm. Key relationships amongst the
management team can open new doors and business deals that can improve
cost leadership. The management teams age should be taken into consideration,
because a team that is executing and young suggests that sustainability is
possible for years to come versus an executive team that is older and will be
retiring soon, creating uncertainty.
Conclusion
With all the key value driver possibilities, it is important to note that just
because a firm is a leader in several categories doesn’t mean that they create
value for the firm. It is the interactions, combinations and execution of the key
value drivers that will govern the value of a firm. With this idea, along with the
ability to sustain key value drivers, value can be assessed and derived.
53
Introduction to Accounting Analysis
We will take a closer look into the accounting aspects of Green Plains
based off the five forces. In our accounting analysis, we will be able to analyze
and measure the cost behavior of the company. We will also discuss how key
accounting policies and the degree of potential accounting flexibility will affect
Green Plains. Also when evaluating actual accounting strategy, we will be able to
identify red flags that might pop up. When using key accounting policies we will
attempt to tie them together with our value drivers in the industry analysis. Once
we have tied them together we will then use them to help assess the degree of
potential flexibility. Companies can disclose or place certain items on the financial
statements in many different ways based off of different accounting policies.
After we have figured the degree of potential flexibility we will use it to help
come up with a relative and actual accounting strategy. Using all of this
information we can determine the red flags for Green Plains and adjust the
accounting parts in the financial statements that are distortive.
Key Accounting Policies
A business and industry that can be changed in financial statements can
be analyzed by a company’s key accounting policies. Net income is based on
when expected rather than when there is actual cash flow, which is known as
accrual accounting. Accrual accounting can manipulate a company’s financial
statements.
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We will discuss two different types of accounting policies known as type
one and type two. The format and disclosure of the information from the key
value drivers we discussed earlier while looking at the whole industry is known
as type one. Type two takes a look at the individual company’s potential
distortive items on its financial statements, specifically the balance sheet.
Type 1 Accounting Policies
Under the type one accounting policies we will look at the format and
disclosure of the information from the key value drivers in the ethanol industry.
In the ethanol industry we decided the three main value drivers are vertical
integration, government regulations, and scale of production.
Vertical Integration
In the ethanol industry vertical integration plays a huge part because it
helps save costs, time, and risk. First, vertical integration saves a lot of money
when you can cut out the middleman and do it yourself. For example, in the
ethanol industry they can save a tremendous amount of cash by keeping their
unused corn they bought in bulk in their storage silos. This also plays a key role
in being efficient in time with the corn. During the seasons that corn is not
available, the companies can keep a huge amount of corn in their silos without
having to wait till the next available time the corn is produced. Even if it is in
season they don’t have to wait for the corn to be transported if they always have
a reserve amount in their silos. Risk is also a huge part of vertical integration
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because of numerous things. When using vertical integration companies can
mitigate risk by not relying on other companies to supply your raw materials or
transport the finished product. In the ethanol business the companies using
vertical integration don’t have to rely on storage facilities to hold their corn but
instead have their own storage silos. As a vertically integrated firm, Green Plains
states on their 10k they “maintain disclosure controls and procedures that are
designed to ensure information be required to be disclosed in the reports file
under the SEC’s regulations”. That being said, they actually disclose very little
knowledge on the process of their vertical integration. Overall, vertical
integration is a huge value driver and can help make a company a lot more
profitable in the long run compared to others in the industry that don’t use it.
Government Regulation
Government regulation in the ethanol industry is definitely one of the
biggest value drivers. The reason for this is because in the modern era people
have been putting more emphasis and responsibility on being more energy
efficient. Also people want to be greener and help save the environment around
us. With this being said, the government has seen pressure to pass laws helping
to protect the environment. When it comes to the gas we use, the government
has mandated that a certain amount of ethanol is supposed to be in it. This helps
create demand for ethanol and a big market for the ethanol industry. With added
pressure for more government regulation, we will probably see a higher demand
for ethanol in the coming years.
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Scale of Production
One other value driver that we concluded as a key component in the
ethanol industry is the scale of production. Scale of production can either make
or break a company in the ethanol industry based on how much corn they turn
into ethanol at a time. If the scale of production is used correctly it can create a
lot of value for a firm and put it past its competitors. Since the industry as a
whole are price takers, the companies are highly competing on price. Many
reasons go into this like the lack of differentiation but the high fixed-variable
costs help create the massive scale of production. In the industry the fixed
assets are by far more expensive than the variable costs. Some examples include
storage, equipment, and facility operations. The more ethanol you can produce
at a time will result in lower fixed-variable cost per unit produced. In 2001 Green
Plains produced 1.8 billion gallons of ethanol to 13.3 billion in 2013. (1) Green
Plains saved a lot of money in 2013 per gallon of ethanol compared to a gallon of
ethanol in 2001. This can be concluded with the rest of the industry like Archer-
Daniels-Midland and Valero. Future Fuel is fairly new but you could also conclude
that they have grown in scale of production since they started in 2005. So
obviously ethanol companies try and push the limits on how much ethanol they
can produce at a time and try and take advantage of scale of production.
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Type 2 Accounting Policies
Type two accounting policies deal with items on a company’s financial
statements that have a wider degree of margin for reporting. This leads to
fabricated results that can lead to over stated performances. Accountants at the
firm can use items such as R&D, leases, Pension Benefits and goodwill to
fabricate results because they have looser accounting standards. Green Plains
Inc. as well as the rest of the industry has Operating Leases, Pensions and
goodwill as detectable items on the financial statements. These three items will
be discussed below.
Goodwill
Goodwill is the comprised of what the company determines as competitive
advantages as well as other intangible assets. Goodwill is the premium a firm will
have to a pay in order to purchase a said company. A lot of companies will
recognize competitive advantages and other intangible assets far past their
usefulness, failing to properly impair the assets over time. These actions
effectively overstate financial statements and performance.
Operating Leases
Lease liabilities can be recognized in two different ways under GAAP. Due
to operating leases off-books nature, there is a possibility that an
understatement could occur. The other way that lease liabilities can be
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recognized is when a firm records a lease as an operating lease, in which it is not
recorded as an asset, rather an expense.
Pensions
Pensions consist of money put away for employees’ retirement and due to
the fact that many companies provide pensions, it creates accounting problems.
The problems lie with when to properly expense pensions. As soon as an
employee is employed, a pension asset is created and a pension liability is
created. The pension asset decreases over time to zero as the pension liability
increases due to time value of money. The value of the pension liability can be
determined at any point in time, using the present value formula. The liability
can always easily be known, but the problem lies with the pension asset amount.
To determine the pension asset, the company must estimate employee service
life as well as the value of the employee. The pension expense is the difference
between the changes in pension liability and the pension asset.
Assessing the Degree of Accounting Flexibility
In many industries there is flexibility in how managers can use accounting
policies, some use them in an honest way and other use them to manipulate
results. When a company has a greater degree of accounting flexibility, it is
important to understand how it is used, because it will help provide information
on how the company is run. Within the degree of accounting flexibility mangers
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will have to provide estimations that become important when talking about
Leases/Operating Lease, Goodwill, Pensions and research and development.
In the ethanol industry companies have flexibility in how the policies and
estimations in Leases/Operating Leases, goodwill, pensions and research and
development. Within Green Plains Inc. research and development as well as
pensions do not represent a significant portion of financials, therefore we will not
be discussing those aspects. On the other hand, Operating Leases as well as
goodwill represent a significant enough part of the financials to be analyzed.
Operating/Capital Leases
Operating/Capital Leases have some of the widest accounting
interpretations that companies can use to misrepresent financial results.
Operating and Capital leases work in two different ways. Operating leases simply
are recorded as operating expenses directly decreasing the cash flows. Capital
leases on the other hand are the present value of the leases and are recorded as
an asset. It is important that these capital leases are properly discounted back
and devalued over time.
Green Plains Inc. has operating leases of $31.8 million, another of $1
million of agreements, and capital leases of $10 million.
Goodwill
Intangible assets such as brand image as well as costs from merging and
acquisition costs are characterized as goodwill. These are costs that a company
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pays for acquiring a company’s competitive advantage. Goodwill is essentially a
premium that a company pays over the market value of the assets gained minus
the actual assets and liabilities acquired.
Goodwill is extremely easy to overstate due to the fact that intangible
assets can be abstract and biased due to personal opinion. Not only can it be
over realized, but it can also be under depreciated or impaired over its useful life.
Thus effectively overstating assets, understating expenses and overstating net
income. Green Plains Inc. has $40,877,000 of goodwill, representing 20% of the
net fixed assets for 2014. We determined that goodwill representing 20% or
more of net fixed assets as being an aggressive accounting strategy, but due to
the fact that goodwill isn’t 30% or more of net fixed assets, goodwill is within the
parameters of not being material enough to be restated.
Evaluation of Actual Accounting Strategies
When disclosing accounting information, we used different strategies as
well as different standards of what we feel are necessary to share with the
public. Investors and other benefactors rely on this information to make
important economic decisions on the company they are evaluating. Two types of
accounting strategies we used; one being an aggressive approach, which reports
a higher income than actually earned by overstating assets and retained
earnings, while the other being a more conservative approach that overstates
liabilities which lowers the earnings of the company. Although GAAP does have a
required minimum amount that has to be disclosed, companies have the ability
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to alter their statements where they deem most beneficial. Through these
alterations, we can change the true perspective of their actual value. When
valuing a company, it is important to understand the transparency they portray
and the approach they take when stating financial information.
Defined Benefits and Pension Plan
Green Plains Inc. provided a pension plan up until January 1, 2009, when
the benefits became frozen. They are still obligated to fulfill the requirements of
previous benefactors, but the amount is not large enough to be relative to the
accounting strategy.
Research and Development
There are no research and development costs reported on Green Plains’
income statement. That being said, the company does mention ongoing research
processes throughout the 10-K that could increase efficiency and profitability, but
does not associate any specific costs. Also included in their 10-K, Green Plains
Inc. discusses new risks of cellulosic ethanol that could replace corn ethanol,
which could in turn reduce their profitability. This information is beneficial to
potential investors and also provides one of the few examples of their level of
transparency to the public.
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Goodwill
Goodwill is measured as the excess of the cost of the purchase over the
fair value of the identifiable net assets (assets less liabilities) purchased. This is
classified as an intangible asset that if not impaired properly, will cause an
overstatement of assets (15). Because goodwill is an intangible asset, firms can
choose whether or not to impair goodwill during the year and at what rate.
Green Plains has a more aggressive approach when it comes to their goodwill,
and chooses to postpone impairment because of its immaterial amount. Goodwill
accounts for approximately 20% of Green Plains net fixed assets, making it
irrelevant and non-altering of investor’s perceptions of the company’s value.
In order to measure whether goodwill is being used aggressively or
conservatively, we took the goodwill amount from each of our main competitors
over their net fixed assets for the past five years.
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Green Plains does not have much goodwill stated on their balance sheet in
the past five years, with new additional goodwill from years 2011-2014. In this
way it is not a large portion of their total assets, long term assets, or PP&E.
Green Plains and Archer-Daniels Midland were in fact the only two out of the four
ethanol companies to have identified goodwill on their balance sheets, and just
Archer-Daniels Midland would need to restate goodwill in year 2014. By delaying
their goodwill, Green Plain indicates that they have more of an aggressive
accounting strategy. They also state in their 10-K that they would only feel the
necessity to impair goodwill under the circumstance the carrying amount of an
asset exceeds its estimated future cash flows, and has no plans of impairing
goodwill in the near future. Green Plains somewhat discloses the two-step
0%
5%
10%
15%
20%
25%
30%
35%
2010 2011 2012 2013 2014
Green Plains
Valero
Archer-Daniels
Future Fuel
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process they use if they deem necessary to perform impairment on goodwill, but
this only represents the process and not any actual impairment.
Capital and Operating Leases
In order to be able to compete successfully in the ethanol industry, Green
Plains must expand their production process to additional plants and equipment.
For this to happen, they must obtain operating and capital leases in their
business. Although both capital and operating leases deal with acquiring land
and equipment for use, they differ on how they effect the books as well as how
they are recorded. Capital leases allow the firm to accept some of the risk of
ownership, making it a liability recorded on the balance sheet. Operating leases
however obtain no ownership and therefore are treated as a rent expense (14).
Due to Green Plains having operations located in various states
throughout the U.S., they hold a majority of operating leases, which would
classify them as having a more of an aggressive accounting strategy. They lease
certain facilities and parcels of land under agreements that expire at various
dates. For accounting purposes, rent expense is based on straight-line
amortization of the total payments required over the lease term (1). Having
these high operating leases and managing their accounting in this way gives
them the advantage of reporting lower liabilities ultimately showing a higher net
income. Green Plains also has capital leases as well, totaling $10 million but we
did not find this to be material or relevant enough to their accounting strategy.
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As shown in the chart above, operating leases of $32.8 million, $20.8
million, $19.2 million in years 2014, 2013, and 2012, respectively were not a
large portion of total expenses. In retrospective, these operating leases account
for a small percentage of the company’s operations and are amortized over the
life of the lease. Because Green Plains is open to sharing the allocation of where
their operating leases costs derive from, we have concluded they have a fairly
high level of disclosure, and their method of accounting dealing with leases by
keeping them off the balance sheet shows they have an aggressive approach to
accounting these leases.
Conclusion
Overall, Green Plains has shown more of an aggressive accounting
strategy when accounting for both goodwill and operating leases. In doing so,
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
2012 2013 2014
Operating leases
Total expenses
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this leads to a bit of a deception to the public to make their business appear to
be more profitable than actually so, as well as to seem more attractive to
investors. The main reasons for concern would be the non-disclosure of research
and development costs and any future plans of having any. Goodwill and
operating leases provide adequate information to draw conclusions on future
costs and operational plans.
Quality of Disclosure
GAAP is the governing body of accounting rules and policies that
determine the recordings of financial information as well as the level of
disclosure. Within GAAP there are discrepancies that managers and accountants
can use to report and disclose information in different ways, some significantly
altering the financial results and can be deem results falsified. When determining
the quality of disclosure in Green Plains Inc. it is important to understand the
level and depth of the ways they provide their accounting methods and
procedures. The amount of info disclosed is also important, seeing how GAAP
doesn’t always force multiple items to be made available. There is a higher
likelihood of quality of disclosure with more information that is disclosed to the
public.
Qualitative Measures of Accounting
The qualitative measures of accounting deal with how the company and
managers disclose their information through words and the connotation
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attributed to their words. Companies can use text to misrepresent information by
bolstering or hiding key informative measures. In this section we will analyze
whether Green Plains Inc. properly discloses information or if they are
intentionally misleading the public. We also need to determine if Green Plains
Inc. is overly embellishing its results through their tone.
Research and Development
When dissecting Green Plains Inc.’s 10-K, very little information is given
regarding research and development operations. They go on to explain their
areas of research and development but Green Plains Inc. does not disclose any
physical expenses for any of their activities. This reporting is vague and
suggests that research and development represents a minuscule part of their
expenses. This leads us to question exactly how much research and
development is occurring.
Goodwill
Green Plains Inc. does not disclose a lot of specifics in terms of their
allocations of goodwill. The most detail Green Plains goes into is that they break
down goodwill into only two categories. $30,300,000 of goodwill is attributed to
their ethanol business and $10,600,000 is attributed to their marketing and
distribution segment. There is also an additional $1,000,000 worth of
agreements recognized as goodwill. There is no further break down with exact
numbers per facility or operations.
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Green Plains Inc. does go into detail how they impair and constantly
reevaluate rates to determine fair value. Green Plains Inc. reevaluates goodwill
per plant and facility annually or when events occur that indicate impairment
could change. Green Plains Inc. will assess if they need to go through a two-
step impairment test; first determining if the fair value is less than the carrying
value, then the company performs a second step. If the estimated fair value of
the reporting unit is less than its carrying value, we complete a second step to
determine the amount of the goodwill impairment that we should record. In the
second step, we determine an implied fair value of the reporting unit’s goodwill
by allocating the reporting unit’s fair value to all of its assets and liabilities other
than goodwill. We compare the resulting implied fair value of the goodwill to the
carrying amount and record an impairment charge for the difference (Green
Plains 10-K 2014).
Operating and Capital Leasing
Green Plains Inc. went into considerable detail when providing information
about their operating and capital leasing. Green Plains Inc. operating leases
covered and identified grain storage, facility, aircraft, transportation, land and
many other small operating items. The in-depth disclosure of the operating
leases is valuable information for insight into the company’s operations.
We determined the 2014 discount rate of 3.37% for the operating leases
based on the cost of borrowing debt in the agribusiness of 3.5% and the rate of
3.25% from the cost of borrowing debt in the corporate segment. We took the
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average of these two figures and got 3.37%. The rate we determined of 3.37%
to adjust operating leases is very close to Green Plains Inc.’s rates of borrowing
debt. Due to the fact that these rates are close to the rate we determined, there
is little cause for concern that operating leases are being over stated.
Green Plains also determined capital leases in a fairly descriptive way.
The term loans and revolving term loans bear interest at various rates, with the
majority of all such loans having interest rates between LIBOR plus 3.85% to
5.50% or lender-established prime rates plus 3.50% to 4.50%. (1) Green Plains
Inc. went on to mention that there are small and insignificant capital leases on
equipment. Green Plains Inc. gives a solid description on the rates they are
borrowing at. Green Plains Inc. has 10,000,000 of capital leases on acquisitions.
In total Green Plains Inc. has 14,000,000 of capital leases between grain facilities
and equipment. They did not go into detail on specific grain facilities or items of
equipment.
This leads us to conclude that the level of disclosure is substantial
considering the detailed demonstration of how they arrived at the rates and how
similar the rates are to what we concluded.
Conclusion
Overall the level of disclosure is sufficient, due the specifics detailed by
Green Plains Inc. Green Plains Inc. specifically describes their rates and locations
of debt.
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Identifying Potential Red Flags
Red flags are classified as items presented on a company’s financial
statements that would cause a concern and call for a deeper look. These areas
cause potential concern for investors who are looking at financial statements in
order to see if the company would be a good investment for them. For Green
Plains we will be looking further into operating leases as we believe this is the
only thing that would present a red flag for investors.
Undoing Accounting Distortions
Undoing and manipulating accounting policies is when someone takes an
account or accounts that could make a difference in an investors or just an
everyday person’s opinion on the worth of a company and restating them so that
they reflect the true worth of the company. After restating these amounts this
lets potential investors see if they want to invest in the company or not after
reviewing the new more reliable financial statements. After reviewing Green
Plains’ financial statements there was one account that we believed needed to be
restated in order to present a true value for the company. The account we
decided to restate was operating leases. We restated operating leases for Green
Plains because that had not yet been capitalized. Although Green Plains
operating leases do not present a huge amount of liabilities, we decided that
they were material enough to be restated because they also have a significant
ability to reduce net income.
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Operating Leases
Operating leases are presented on many company’s 10k’s but they don’t
show up on the balance sheet or the income statement because they are said to
be considered temporary assets. We decided Green Plains operating leases are
large enough, approximately 21%, to be seen as important and needs to be
restated on the financial statements. Rules and regulations under Generally
Accepted Accounting Principles (GAAP) do not require operating leases to be
capitalized so Green Plains is using this as an advantage for their company by
understating their liabilities. To show a more accurate image of Green Plains
financial statements we capitalized operating leases in the best way we see fit
given the information we acquired off of Green Plains 10K. First we had to find
the discount rate to use in order to capitalize the operating leases. We did this by
finding the Corporate and the Agribusiness borrowing rates, adding them
together, and then finding the mean. Below are the graphs and calculations we
came up with for capitalization of the operating leases, in which Green Plains
would show on their financial statements if they were capitalized.
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When restating the balance sheet for operating leases, the asset account
Capitalized Operating Leases Rights must be increased (debited) and the liability
account Capitalized Operating Lease Liabilities must be increased (credited) by
the present value of operating leases for the year. Adjustments must also be
made to the retained earning account based on the effect that operating leases
has on the income statement. Interest as well as depreciation are used by the
company to increase its expenses on the on the next years income statement.
The payment amount on operating leases is removed from the account rent
expense to show that the operating leases bad been capitalized from the
beginning of the year.
Goodwill
Goodwill is an intangible asset on the books of most companies that buy
other companies for a larger amount than what the company was really worth.
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Goodwill would be classified as a competitive advantage that results when a
company buys another company and is presented as an intangible asset on the
balance sheet. Green Plains states in their 10-K what their goodwill consist of
and exactly how they impair their goodwill over the life of the entity. “The
Company’s goodwill currently is comprised of amounts relating to its acquisitions
of Green Plains Ord, Green Plains Central City, Green Plains Holdings II, Green
Plains Otter Tail and BlendStar”. (10-K). Green Plains hasn’t acquired any new
companies over the years being evaluated and has goodwill that is less than
20% of the company’s property, plant, and equipment so we have decided that it
is not necessary to restate goodwill on the financial statements.
Financial Statements
A company’s financial statements are a complete representation of the
performance of the company as a whole. Though there are laws and regulations
regarding what most companies can and cannot report on their financial
statements, there are still a few items presented on it that a company can
manipulate in order to show better performance over a span of time. To show
investors and others concerned with the dealings of Green Plains we have
restated the balance sheet and income statement for the years of 2010-2014.
The adjustment we made between the original statements given by Green Plains
and the restatements are for amortizing operating leases as described above.
Goodwill and Research and Development are two other items on the financial
statements that can be misrepresented but for Green Plains Goodwill did not
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change over the stated years and is less than 20% of plant, property, and
equipment. Research and Development is such a small expense to the company
that we did not feel the need to restate it on the income statement.
Balance Sheet
The balance sheet is a financial record of all the permanent asset, liability,
and stockholder equity accounts. These accounts balances show the company’s
financial position at a certain point in time. Below we restated some of the
balance sheet accounts such as operating leases over the years of 2014-10 in
order to show a more factual representation to future investors of Green Plains’
balance sheet. There was no need for a re-stated income statement, because it
was no effected.
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Conclusion
After reviewing all the financial information and restating the balance
sheet for operating leases by increasing their liabilities, we now believe that
Green Plains balance sheet shows a more realist view to investors as to how to
company is doing financially.
Financial Analysis
In order to determine the Green Plains Inc.’s value, we must do financial
analysis. In financial analysis, we will take a comprehensive look across many
valuable ratios. These ratios include, insight into a company’s liquidity, operating
efficiency, profitability and a firms capital structure. Comparing these ratios of
Green Plains Inc. and the rest of the industry will help determine if there is any
market segmentation.
Liquidity ratios are important to understand, because the ratios paint a
picture of how easily the firm can meet debt obligations. A very important
aspect, because it demonstrates the risk of the firm going bankrupt and what
type of return a investor should expect.
Operating efficiency ratios measure how efficient the company is across all
operations. If operating efficiencies are low, then there is excessive costs that
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can be eliminated and increase profits. Operating efficiency rations also can
demonstrate how well management is managing the business.
Profitability ratios measure a firm’s ability to generate profits in excess of
costs. A lot the profitability ratios revolve around margins and the yield the
company receives on producing products and services. Higher margins are
preferred.
Capital structure ratios identify how the company is financing its
operations. There are two types of financing options; one is through credit or
bank loans. Financing through credit can be dangerous if highly leveraged
because the principal and interest must be repaid, unlike equity financing in
which there aren’t any interest payments and principals do not have to be
repaid.
Cross Sectional (Benchmark) Analysis:
Ratio Cross sectional analysis allows evaluating Green Plains’ efficiency
amongst its competitors. In the following section, we will begin to compare ratios
of liquidity, operating efficiency, profitability, and capital structure and leverage
risk to see how Green Plains compares to its competitors. Green Plains’ main
competitors include Valero, Archer-Daniels Midland and Future Fuel. Followed are
Green Plains’ competitor’s ratios. By comparing these ratios to Green Plains, we
will be able to get a better understanding of how they stand amongst the
industry.
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Liquidity Ratios
Liquidity is a very important part for any company and is valuable to
measure. The main reason for a company to keep up with its liquidity is that they
need enough cash on hand to pay its bills as they become due. Current and
quick ratios are the most commonly used to determine the liquidity of a
company. The variables of the ratios are from the balance sheet. We will use
current assets, current liabilities, and inventory to calculate the liquidity. Because
our restatements only included operating leases, no liquidity ratios were affected.
In the ethanol industry, knowing the liquidity of a firm is important
because of the uncertainty and fluctuation of past years sales in the industry.
With new regulation taking place in recent years, companies such as Green
Plains have needed to maintain higher liquidity ratios in order to remain safe.
Current Ratio
The cash on hand and the assets that can be turned into cash in less than
a year are defined as current assets. Current liabilities are the financial debts
that the company owes within a year. To calculate the current ratio, we took
current assets over current liabilities. From this ratio, we can measure the
different companies’ ability to pay short-term debt.
When observing the companies, Valero had the lowest current ratio, while
Future Fuel had the highest out of the companies evaluated. Green Plains
followed similar trends with Valero and Archer Daniels Midland, while Future Fuel
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had a much higher current ratio. From the graph below, one can see the
segmentation that exists within the industry.
Quick Ratio
The quick ratio is another important ratio when determining the safety net
a company has. Much like the current ratio, the quick ratio takes into account
current assets and current liabilities, however it disregards inventories. To get
the quick ratio we subtracted inventory from the current assets and then divide
by current liabilities. Inventory is not considered very liquid, therefore this ratio
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helps us better see how much of the other current assets a company will have to
satisfy their debts within that year.
As observed in the following graph, Archer-Daniels-Midland had the lowest
quick ratio and Future Fuel had the highest. Much like the current ratio, Green
plains compares much similarly to Valero and Archer-Daniels Midland. Although
Green Plains is doing about the same, this still could become an issue if liabilities
grew much more. Similar to the current ratio, one can see that segmentation
exists in the industry from the difference in Future Fuel. This can be explained by
the large size difference between Future Fuel and the other companies it is
compared to. Because it is a much smaller company, the firm remains more
liquid because of more uncertainty than its’ large and established rivalries.
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Conclusion
As mentioned earlier, Green Plain’s liquidity ratios show trends very similar
to both Valero and Archer-Daniels Midland. Overall, Green Plains had the second
highest quick ratio average and third highest current ratio average. We can
conclude that Green Plains has more current assets in other categories than in
inventory. This is a competitive advantage because inventory is typically harder
to turn quickly into cash. In 2014, Green Plains had a quick ratio of 1.28, which
means that for every $1.00 of current debt, they have $1.28 to cover it. The
ethanol industry remains uncertain at times, so being liquid remains an important
factor for the industry. With Green Plains having a quick ratio remaining close to
1 in prior years, the company may not be viewed as the safest company.
Inventory Turnover
Inventory turnover measures the period of time of how quickly a firm sells
inventory. The inventory turnover ratio is calculated by dividing costs of goods
sold by inventory. Higher ratios indicate that a firm is selling more products and
services and demonstrates firm health. Low ratios indicate that inventory is
sitting and not being sold quickly, tying up capital and is being exposed to
depreciation. These ratios are important to understand when valuing a firm due
to the fact that it demonstrates how successfully a company operates and drives
value.
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After analyzing the graphs, there appears to be two areas of market
segmentation. Green Plains is in the upper bounds with a higher inventory
turnover ratio with Valero. On the other hand there is a lower bound with ADM
and Future Fuels. ADM and Future Fuels appear to be more stable than Green
Plains Inc. Green Plains inventory turnover peeked in 2012 and have significantly
decreased heading for the lower bound segmentation. This is troubling news
considering the rest of the market is not following Green Plains Inc. trend of
decreasing inventory turnover. This leads us to believe that the issue could lie
within the company’s management.
2010 2011 2012 2013 2014
Green Plains 10.72 14.76 19.65 18.11 11.22
ADM 7.52 7.77 6.28 6.8 7.34
Valero 15.99 22.74 22.76 22.44 19.79
Future Fuels 4.543 6.645 6.67 6.87 4.7
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5.00
10.00
15.00
20.00
25.00A
xis
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Inventory Turnover
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Accounts Receivable Turnover
Accounts Receivable Turnover is computed by dividing total sales by the
accounts receivable for the same year. This ratio measures how many times a
company collects its accounts receivable a year. A company wants a high
accounts receivable turnover ratio because that means that they are collecting
their accounts receivable often. The graph below displays how Green Plains does
the best job in collecting accounts receivable compared to the other companies
compared in the industry.
2010 2011 2012 2013 2014
Green Plains 22.22 31.84 41.97 26.85 20.72
ADM 9.18 10.12 26.25 26.91 27.4
Valero 19.68 18.96 16.67 16.58 18.53
Future Fuels 6.23 8.568 14.87 15.217 6.039
0
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15
20
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30
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40
45
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Accounts Receivable Turnover
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Working Capital Turnover
The working capital ratio demonstrates the ease at which the firm
maintains and grows sales with investments. The working capital ratio is
measured by dividing current assets by current liabilities. A higher ratio is
desirable because it is healthier for the business to have a higher degree of
assets over liabilities. We want to see a firm that is efficient with purchasing
assets while satisfying operating costs.
The Graph demonstrates that there is segmentation occurring amongst
Future Fuels and the rest of the industry. Future Fuels is maintaining a much
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2010 2011 2012 2013 2014
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Working Capital Turnover
Green Plains
ADM
Valero
Future Fuels
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higher working capital ratio. Green Plains Inc. is segmented with the rest of the
industry following their trends similar. From the graph, it is determined that
Green Plains is more productive with its working capital to growth sales.
Day Supply Inventory
Day supply inventory measures the period of time required to turn
inventory into revenue. The converting of inventory to revenue is also the first
step in the cash to cash cycle. Day supply inventory is calculated by dividing
inventory by cost of goods sold and then finally multiplying by 365 days. The end
result is the number of days it takes to turn inventory over to revenue. The day
supply inventory is an efficiency ratio that demonstrates how effect a firm is in
turning inventory into revenues. Day supply inventory can be compared to other
companies and industries benchmarks to gauge the efficiency of the valuing firm.
Day supply inventory is also an important ratio because it displays how long a
firm’s capital is being tied up in inventory.
From looking at the graph, we noticed two areas of market segmentation.
Green Plains Inc. has on average the second lowest day supply inventory and
they parallel Valero closely, which are part of the lower bound segmentation.
The upper bound segmentation occurs with Future Fuels and Archer Daniels
Midland. Those two companies average 50 days to 80 day supply inventory vs.
Green Plains Inc. and Valero average 20 days to 35 day supply inventory. Future
Fuels, Archer Daniels Midland and Green Plains Inc. are better comparison than
Valero due to the fact that Valero does a large percentage of their revenue
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through other revenue streams rather than ethanol. Based off of that
information, Green Plains has a significantly better day supply inventory than
Future Fuels and Archer Daniels Midland. The graph also demonstrates that
Green Plains is more efficient in not keeping their capital tied up in inventory.
This could be explained due to the fact that Green Plains Inc. has a high debt to
equity ratio and is needs to keep liquidity in check to pay obligations on debt.
The current trend throughout the industry is increasing day supply inventory.
Below is a graph of Green Plains and its competitor’s day supply inventory.
Days Sales Outstanding
The days sales outstanding is the second step in the cash to cash cycle
and measures the amount of time in days it takes to collect on their account
2010 2011 2012 2013 2014
Green Plains 24.54 22.34 21.66 21.02 26.36
ADM 48.57 46.99 58.09 53.69 49.7
Valero 22.83 16.05 16.04 16.26 18.44
Future Fuels 22.84 23.68 21.55 24.07 23.89
0
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70
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Days Supply Inventory
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receivables. Essentially, the day sales outstanding ratio demonstrates how
efficient a company is in collecting receivables. The day sales outstanding can
shed some light on the type of customers that a company sells to, the credit
requirements a company has on customers purchasing their product, and the
effect on cash flows. Day sales outstanding is calculated by dividing accounts
receivable turnover by 365 days.
The graph demonstrates that Green Plains does a very good job in
collecting their receivables. Green Plains on average has the lowest day sales
outstanding. The graph also demonstrates a common trend of convergence
2010 2011 2012 2013 2014
Days Sales OutstandingGreen Plains Inc.
16.4 11.5 8.7 13.6 17.6
Days Sales OutstandingArcher Daniels Midland
39.74 36.05 13.91 13.56 13.32
Days Sales OutstandingValero
18.54 19.25 21.9 22.01 19.7
Days Sales OutstandingFuture Fuels
58.61 42.63 24.55 24 60.44
0
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Days Sales Outstanding
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among the industry to quicker collection times of accounts receivables. Green
Plains leads the industry due to the pressure of their need to stay liquid to pay
off debt obligations. The industry convergence move could also be attributed to
stricter credit terms for customers that help the industry collect receivables
quicker and at a higher rate.
Cash to Cash Cycle
The cash to cash cycle can be described as how fast a company can convert
cash. In order to calculate this ratio we took the day supply inventory plus days
sales outstanding. This ratio can be very valuable to most companies. Below is
the graph for the cash to cash cycle. Green Plains had a low cash to cash cycle
when compared to the rest of the industry. From 2010 to 2012 the cycle went
down and then rose from 2012 to 2014. Future Fuels was struggling with the
cash to cash cycle and never got close to becoming in the same realm as the
other companies.
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Profitability Ratios
Probabilities ratios are an important measure companies can use to
compare its earnings compared to its expenses and other costs during a specific
time. More than any other accounting measure, a firm’s profits demonstrate how
well its management is making investment and financing decisions (17). Having
a higher value compared to other competitor’s ratios in the industry is an
indicator that the company is doing well financially and has a well-functioning
cost structure. In some instances, companies that have seasonal value, such as
retail, experience higher revenues in peak periods; however for Green Plains this
does not apply. Following are different probability ratios that were used to
compare the different companies in the ethanol industry.
2010 2011 2012 2013 2014
Green Plains 14.83 14.7 16.99 19.06 22.18
ADM 52.58 51.77 51.9 47.5 41.92
Valero 12.98 11.14 11.91 11.55 13.28
Future Fuels 19.57 20.67 19.88 21.2 23.33
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Cash to Cash Cycle
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Gross Profit Margin
The gross profit margin shows us what percent of revenues will be left
over after the cost from sales has been deducted, as well as shows
managements effectiveness in allocating costs. Higher percentages mean that
company has more opportunity to pay for other expenses, such as labor and
operating costs. The ratio is found by taking the total revenues minus the cost of
goods sold over sales. Below is Green Plains’ gross profit margin compared to its
main competitors in the industry.
Aside from Future Fuel, there is little segmentation between the
companies, which may be caused by different processes in production of the
same product or different management structure. For the most part, each
company was able to keep a steady percentage between each year, except for
2010 2011 2012 2013 2014
Future Fuel 18.8% 20.3% 16.9% 23.0% 21.8%
Valero 4.64% 4.59% 5.24% 4.66% 6.36%
ADM 6.23% 5.33% 4.00% 4.33% 5.87%
Green Plains 7.1% 4.8% 2.8% 5.7% 11.6%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
50.0%
Gross Profit Margin
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Green Plains. As well as having the lowest gross profit margin out of all the
benchmark companies, they also had the most varied percentage from each
year. Reasons for this could be the rise in corn prices hitting Green Plains harder
than other competitors and increased difficulty in operating efficiency in 2012.
Operating Profit Margin
Operating profit margin, also known as net profit margin, measures how
profitable a company’s sales are after all operating expenses, including taxes and
interest, have been deducted (17). A company must have a positive margin in
order to be able to pay off its fixed costs. Green Plains again had the lowest
operating profit margin compared to all other competitors, with the trend of
Future Fuel leading the industries continues. 2012 also proves to be a year in
which all benchmark companies experience a drop and in this case knocking
Green Plains below 1%.
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Net Profit Margin
Net profit margin is calculated by taking net income divided by net sales.
This margin represents the total profits by the company, and allows them to
track the changes in ability to maintain financial growth or added value by their
sales. It is evident to see that Green Plains, only being founded in 2004 and
being a fairly new competitor in the industry, has a lower net profit margin than
the other companies, while it has the third highest growth rate from 2012 to
2014. In previous years Green Plains has experienced a drop in profit margin,
but indicators predict a rise as the years progress.
2010 2011 2012 2013 2014
Future Fuel 14.7% 16.9% 13.6% 20.7% 18.5%
Valero 2.28% 2.92% 2.88% 2.87% 4.51%
ADM 3.96% 3.33% 1.89% 2.08% 3.52%
Green Plains 3.1% 1.7% 0.7% 2.4% 7.7%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
Operating Profit Marins
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Return on Assets
The return on assets is measured by how much of the net income is
generated compared to a company’s total assets at the year beginning. It serves
as an indicator of how profitable the company is relative to its total assets. The
formula for calculating return on assets is net income over total assets. This ratio
is a key statistic, for it allows a company to make sure it is not only growing its
revenues, but its net income as well. Having a higher return on assets is not only
a sign of being more profitable, but also proves to be favorable for investors.
Below is the comparison between Green Plains’ benchmark companies. Green
Plains ROA serves to be the lowest compared to its competitors over most years,
2010 2011 2012 2013 2014
Future Fuel 10.5% 11.3% 10.1% 17.0% 17.6%
Valero 0.39% 1.66% 1.50% 1.97% 2.77%
ADM 3.13% 2.52% 1.52% 1.49% 2.77%
Green Plains 2.3% 1.1% 0.3% 1.4% 4.9%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
Net Profit Margin
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and even lower after restatements. This causes us to question if net income is
growing steadily along with Green Plains’ revenues.
Return on Equity
The rate of return a company earns on stockholder’s equity is known as
return on equity. We calculated the rate by dividing the year’s beginning
stockholder’s equity by the net income. Companies can use this to determine
how much they used equity to gain revenues.
In the ethanol industry the return on equity can change a lot from year to
year based on how much net income and equity fluctuate. Over the span of the
2010 2011 2012 2013 2014
Green Plains 3.45 2.68 0.86 2.93 8.98
ADM 6.11 5.52 3.05 3.02 5.12
Valero 0.88 5.2 4.77 5.93 7.82
Future Fuels 6.7 9 9.7 17.9 11.5
GP Re-stated 3.2 1.53 0.86 2.83 8.64
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Return on Assets
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five years we evaluated the industry, Green Plains had the lowest and highest
ratio. In 2012 every company had the lowest ratios for their company in the five
years. This makes sense because in 2012 the ethanol industry experienced a
down year with corn prices at a high and not as much demand. For example,
Green Plains had a ratio of 2.37. In 2014 Green Plains was at a high with 23.76.
Asset Turnover
The Asset Turnover ratio is an indicator of the efficiency with which a
company is deploying its assets. Asset Turnover can be found by dividing total
sales by total assets. The higher the asset turnover the better for the company,
meaning that it has more revenues per dollar of assets. For the first year, each
company’s asset turnover ratio is increasing steadily. Then the trend for each
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company, with the exception of Future Fuel, is that their ratios begin to steadily
decline over the years 2011-2014. This means that they are starting to get less
money per dollar of assets, which is not a good sign. Because Green Plains
restatements affect total assets, the asset turnover is affected and is lower in
most years excluding 2012, though not as low as Future Fuel. This is caused
mainly because of 2012’s higher asset amount due to the uncertainty of the year
because of higher corn prices and drought, as well as a decrease in sales.
Capital Structure and Leverage Risk Ratios:
Capital structure refers to the way a company finances its assets using a
combination of debt and equity. The capital structure ratios show how a firm
finances the purchase of its assets (16).
2010 2011 2012 2013 2014
Green Plains 2.54 2.45 2.25 2.11
ADM 1.95 2.19 2.01 2.02 1.85
Valero 2.25 3.13 3.19 3.01 2.82
Future Fuels 0.6 0.8 1.0 1.1 0.7
GP Re-Stated 1.42 1.42 2.53 1.98 1.75
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3.50
Asset Turnover
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Debt to Equity
The debt to equity ratio measures total liabilities to total equity identifying
the liquidity of the firm. Through this ratio we can identify the breakdown of the
financing activities of the firm. Specifically, if the firm is financing their endeavors
through creditors (bank loans), then the debt to equity ratio will be higher. If the
firm is financing their project from shareholders however, then the debt to equity
ratio will be lower. Companies that are utilizing bank loans for financing activities
are engaged in the process of leveraging. Leverage can be expensive, due to
interest payments, and the debt must be repaid unlike equity financing. A lower
debt to equity ratio usually indicates a more stable business. Different industries
generally have different debt to equity ratio benchmarks, so it is important to
identify those key numbers and compare the companies to the rest of the
industry, as well as recognize if there is any segmentation within the industry
additionally.
2010 2011 2012 2013 2014
Green Plains 1.81 1.81 1.75 1.81 1.29
ADM 0.47 0.44 0.34 0.27 0.28
Valero 0.5 0.41 0.36 0.32 0.28
Future Fuels 0.36 0.34 0.37 0.26 0.29
GP Re-stated 2.01 2.9 1.86 1.81 1.29
00.5
11.5
22.5
33.5
Debt to Equity
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After first glance at the debt to equity graph, there is clear market
segmentation between Green Plains Inc. and the rest of the industry. Green
Plains Inc. averages a debt to equity ratio four to five times higher than the rest
of the industry. The high debt to ratio indicates that Green Plains Inc. uses a
high degree of leverage compared to the rest of the industry, thus as an investor
we would demand a much higher rate of return. The high debt to equity ratio
compared to the rest of the industry raises concerns of the longevity of the
Green Plains Inc. due to interest and the principle that needs to be paid.
The rest of the industry is following a pattern of a decreasing debt to
equity ratio, while Green Plains Inc. remained unchanged until 2014. In 2014
Green Plains Inc. experienced a sharp decrease in their debt to equity ratio due
to significant increases in equities. In Green Plains Inc.’s 10-K it states that in the
future Green Plains Inc. will start to finance purchase of assets through the
issuance of equity securities rather than through creditors, but it in doing so will
also dilute the shareholders equity. The management has recognized that is
willing to take actions to improve their liquidity.
Altman’s Z-Score
Altman’s Z-Score takes 5 different equations or ratios added up to
compute. The equations we use are, (Working Capital/Total Assets) + (Retained
Earnings/Total Assets) + (EBIT/Total Assets) + (MVE/BVL) + (Sales
Revenue/Total Assets). We add up all 5 of these ratios for all the companies we
are benchmarking against in the industry and that gives us the Altman’s Z-Score.
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For the most part, each of these companies is safe from bankruptcy.
Future Fuels and Green Plains look to have the lowest numbers but this is
nothing to be worried about seeing that it only puts them in the gray area. Both
Green Plains and Green Plains re-stated are in no danger of bankruptcy in the
near future.
Financial Forecasting
When forecasting financial statements such as the income statement, the
balance sheet, and cash flows, trends, ratios, and assumptions are used to
calculate or estimate future balances for each of the financial statements
2010 2011 2012 2013 2014
Green Plains 2.21 3.02 3.11 2.68 3.00
ADM 3.2 3.84 3.3 3.3 3.04
Valero 3.00 3.83 4.11 3.92
Future Fuels 1.68 2.36 2.65 3.43 2.7
GP Re-Stated 1.95 1.81 3.48 2.49 2.29
0
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Altman's Z-Score
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referred to above. This information is important for understanding the intrinsic
value of the firm. The most important forecast are the short term forecast
because one dollar today is worth more than one dollar in the future. The short
term forecast will have a greater impact on the company’s future. These are also
most important because the long-term forecasting is based off the first couple of
year’s trends. When forecasting we looked at Green Plains statements for the
last 5 years and used those numbers to forecast out ten years past the current
year 2014.
Income Statement
We started with the income statement by forecasting sales growth.
According to Scott Erwin of the University of Illinois’ department of agricultural
and consumer economics, “The focus on the changing profit outlook of ethanol
produces can obscure the fact that the industry is also coming off the best year it
has ever had in terms of profitability.” While the future of ethanol is facing an
uncertain future as the political battles about its usefulness continue, last year
most U.S. ethanol producers were swimming in profits like they have never
experienced (17).
After researching the industry, we used logical assumption to predict the
sales growth over the next ten years based on the previous 5 year increasing
trend in sales growth. We believe Green Plains’ sales peaked in 2014 but will not
be able to continue growing at such a high rate. 2014’s high profits were a result
of high ethanol prices, as well as relatively low corn prices. As a result we
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forecasted out our sales growth conservatively to increase by 6.75% in 2015
followed by 7% in 2016 and similar trend for the next 8 years.
After projecting the sales growth over the next 10 years, we created a
common sized income statement by taking each line item on the income
statement and dividing it by total sales from that year. By looking at the common
sized statement, it is easier to depict trends within the company and use that as
a basis for future percentages. From here we could see that Green Plains cost of
goods sold increased from 2010 to 2012 and then slowly began to decrease.
When forecasting we decided to keep within this range, with cost of goods sold
at 94% in 2015 and 93.5% in 2016. Until better technology is developed and
there is a better solution to ethanol production we expect cost to stay about the
same. When looking at total operating expenses there was a slight increase in
2012 most likely caused by higher corn prices due to a drought that year. When
forecasting out the next ten years, we decided to keep expenses within the 2 to
5% range like the previous 5 years. Since the only item that needed to be
restated for Green Plains in order to show a more realistic image of the company
was operating leases, which only touch the balance sheet in the form of non-
current assets and non-current liabilities, there was no reason for us to restate
any amounts on the income statement. Both Green Plains forecasted income
statement and common size income statement are stated below.
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Dividends Forecasting
Green Plains began paying dividends in 2013 with a dividend payout of 4
cents per share paid out in November of 2013 and in September of 2013. In
February of 2014 and May 2014, Green Plains again paid a dividend of 4 cents
per share. Their dividends increased 50% to 8 cents per share in mid 2014,
when they paid an 8-cent dividend in August of 2014 and again in November.
The first quarter of 2015 had dividends of 8 cents and we expected the last two
quarters to remain the same. As a result of Green Plains’ strong sales growth
forecast, the dividends paid for each year grew from 8 cents a share in 2014 up
to 28 cents a share in 2024. With our forecasted dividends, we multiplied this by
our shares outstanding (about 37 and a half million) in order to forecast our
retained earnings.
Balance Sheet
After forecasting the income statement we found a trend in Green Plains’
asset turnover over the past 5 years and found that it had been decreasing at a
steady rate and used it to forecast out the next 10 years. We forecasted that the
asset turnover ratio would follow the current trend and decrease from 2.11 in
2014 to 2.05 in 2015. Using the forecasted asset turnover ratios and our
forecasted percentages for current and non-current assets, we were able to find
our total assets. We expect the cash and accounts receivable to remain within
similar percentages as the previous five years. Non-current assets are expected
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to also remain within the 50 to 60% with goodwill staying within 2 to 3% and
property, plant and equipment within the 50 to 55% range. We believe this to be
true because no information was presented relaying any news of requiring new
plants. Green Plains accounts receivable seemed to have no trend from 2010 to
2014, which makes it hard to draw a conclusion for its next 10 years. Using the
inventory turnover ratio we can forecast out inventory for Green Plains’ balance
sheet. Over the past 5 years, Green Plains’ inventory turnover has ranged from
10.7 to 19.65. We expect Green Plains to stay within this range for the following
10 years.
After forecasting assets for Green Plains, we next began to forecast total
stockholder’s equity. When forecasting stockholders equity, we used the IGR
method and assumed that no new shares would be sold and no new treasury
stock would be acquired. For this reason the only thing that would change is
Green Plains retained earnings. Retained earnings was forecasted by taking the
previous years retained earnings, plus or minus net income or net loss, and
subtracting out dividends paid for the current year. After finding stockholders
equity we were then lastly able to find liabilities on the balance sheet by
subtracting total assets from stockholders equity, and use our current ratio to
distinguish between current and non-current liabilities. Below our Green Plains
forecasted balance sheet and common size balance sheet.
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Statement of Cash Flows
The last part of the financial statement forecasting is the statement of
cash flows. For this section we forecasted operating activities as well as investing
activities. To find the estimate in operating activities we first compared our cash
flows from operations to sales, operating income, as well as net income, to find
which ratio had had the most stability. We found that all of the comparisons had
outliers (indicated in the yellow cells), but that cash flows from operations
compared to operating income had the most reliable trend. We used the average
of the past five years to then forecast out the next 10 years of our operating
cash flows. Next, forecasts of cash flows from investing activities were found by
finding trends within Green Plains’ net current assets from the past five years.
We also found that capital expenditures as a percentage of sales range from .77
to 1.84 for years 2010 to 2014. By finding our cash flows from operating and
investing activities, we added them together to find our free cash flow, in which
we are able to use in our valuation models.
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Cost of Capital Estimation
To estimate Green Plains’ cost of capital, we will calculate their weighted
average cost of capital (WACC). This is the average rate a company is to pay out
to its security holders to finance its assets. With all else remaining constant,
WACC increases as the beta and rate of return on equity increases. With an
increase in WACC, there is also a decrease in valuation as well as a higher risk.
Cost of Debt
The cost of debt is the effective interest rate that a company pays on its
current debt obligations. Cost of debt can be measured on a before tax basis or
after tax basis, which is the most common due to the fact that interest expense
is deductible. There is a positive correlation between the cost of debt and the
associated risk. Green Plains Inc. provided a weighted average interest rate in
their 10-K, which they stated as 6.50%. The interest rate provided will be used
to calculate as stated and restated financials.
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Weight = LT debt or capitalized / total
A weight was assigned to Green Plains Inc.’s capitalized operating leases
and long term debt that was derived from the total of the two components. We
then multiplied the two categories weights by their interest rates to get the
weighted average cost of debt for Green Plains Inc. After restating the
financials, we observed that the weighted average cost of debt was slightly less
than the stated weighted average cost of debt with 6.13% vs. 6.50%. Ultimately
the slight deviation signifies that Green Plains is slightly less risky than originally
presented.
Cost of Equity
The cost of equity is measured by using the capital asset pricing model,
otherwise known as CAPM. The formula for CAPM is the risk free rate (Rf) plus
cost of debt (as stated) Amount Rate Weight W*R
LT debt 399440 6.50% 100% 6.50%
Cost of Debt (restated) Amount Rate Weight W*R
LT Debt 399440 6.50% 88.12% 5.73%
Capitalized OL 53843 3.37% 11.88% 0.40%
Total 453283
6.13%
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the systematic risk (beta) multiplied by the market rate premium (mrp). Also
with what we are doing we included a size premium (SP), which is just added to
the CAPM formula. We called this the 2-factor cost of equity.
Ke = Rf + beta ( mrp) + SP
In our analysis we took regressions from 10 years, 7 years, 2 years, 1
year, and 3 months. Each time frame we broke it down into 72, 60, 48, 36, and
24 months to help get a better feel and more data to go off of.
In order to find each one of these variables we take different approaches.
First, the risk free rate is based off the Treasury bond’s yields for 3 months, 1-
year, 2-years, 7 years, and 10 years. In order to find the numbers for each of
those we went to the St. Louis Fed Reserve website. After we found these
numbers we then converted them into a monthly rate instead of the yearly rate
that it was given.
After we found the risk free rate for each month we then found the
market rate premium by subtracting the risk free rate by the S&P 500 returns
from each month. Once we calculated the market rate premium for the months
we then ran regression analysis’ using the monthly return as our X variable and
the market rate premium as our Y variable. The regressions give us our betas
that we use in the CAPM formula. The regressions also give us the 95% limits for
the beta as well as an adjusted R-squared. The adjusted R-squared is used to tell
how much systematic and unsystematic risk is involved in Green Plains. We
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found that Green Plains has a lot more unsystematic risk, which means a lot of
the risk is firm specific.
Now that we have the information needed, we can calculate the cost of
equity for the different amount years and regressions. Also we could calculate
the 2-factor cost of equity by just simply adding the size premium to cost of
equity. We determined the size premium was 1.7% based out of the Business
Valuation textbook. We got 1.7% based off that Green Plains was just past the
6th size decile.
Size Decile
Market Value
of Largest
Company
Percent of Market
Represented by
Decile
Avg. Annual
Stock ReturnBeta Size Premium
1 – smallest 235.6 1 21 1.41 6.4
2 477.5 1.3 17.2 1.35 2.9
3 771.8 1.7 16.5 1.3 2.7
4 1,212.30 2.2 15.4 1.24 1.9
5 1,776.00 2.6 15 1.19 1.8
6 2,509.20 3.5 14.8 1.16 1.8
7 3,711.00 4.3 13.9 1.12 1.2
8 6,793.90 7.4 13.6 1.1 1
9 15,079.50 13.6 12.9 1.03 0.8
10 – largest 314,622.60 62.3 10.9 0.91 -0.4
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We decided to go with the 60 months in the 10 year regression because it
is tied for the highest adjusted R-squared. The reason for this is because it
shows that it measures more systematic risk (market risk) than any other
regression. As a result, we will use a beta of 1.25 with an upper bound of 2.17
and a lower bound of .33 with a confidence level of 95%. Yahoo has Green
Plains’ beta at 1.10 as of April 8th 2015. Obviously our beta is higher but Yahoo’s
beta is still within our confidence level. With that being said we conclude that we
think Green Plains is a little more risky than what Yahoo has.
Months Beta Beta LB Beta UB R^2 MRP RF Ke SP 2 Factor Ke LB Ke UB
72 1.29 0.15 2.42 5.40% 8% 2% 12.32% 1.7% 14.02% 4.90% 23.06%
60 1.25 0.33 2.17 9.80% 8% 2% 12.00% 1.7% 13.70% 6.34% 21.06%
48 1.18 -0.04 2.41 5.60% 8% 2% 11.44% 1.7% 13.14% 3.38% 22.98%
36 0.91 -0.94 2.75 -0.02% 8% 2% 9.28% 1.7% 10.98% -3.82% 25.70%
24 1.23 -0.9 3.35 1.80% 8% 2% 11.84% 1.7% 13.54% -3.50% 30.50%
Months Beta Beta LB Beta UB R^2 MRP RF Ke SP 2 Factor Ke LB Ke UB
72 1.29 0.15 2.42 5.50% 8% 2% 12.32% 1.7% 14.02% 4.900% 23.06%
60 1.25 0.33 2.17 9.80% 8% 2% 12.00% 1.7% 13.70% 6.340% 21.06%
48 1.18 -0.04 2.41 5.60% 8% 2% 11.44% 1.7% 13.14% 3.380% 22.98%
36 0.91 -0.94 2.75 -0.01% 8% 2% 9.28% 1.7% 10.98% -3.820% 25.70%
24 1.23 -0.9 3.35 1.90% 8% 2% 11.84% 1.7% 13.54% -3.500% 30.50%
Months Beta Beta LB Beta UB R^2 MRP RF Ke SP 2 Factor Ke LB Ke UB
72 1.29 0.16 2.45 5.50% 8% 2% 12.32% 1.7% 14.02% 4.98% 23.300%
60 1.25 0.33 2.17 9.90% 8% 2% 12.00% 1.7% 13.70% 6.34% 21.060%
48 1.18 -0.04 2.41 5.60% 8% 2% 11.44% 1.7% 13.14% 3.38% 22.980%
36 0.91 -0.94 2.76 -0.01% 8% 2% 9.28% 1.7% 10.98% -3.82% 25.780%
24 1.23 -0.89 3.35 1.90% 8% 2% 11.84% 1.7% 13.54% -3.42% 30.500%
Months Beta Beta LB Beta UB R^2 MRP RF Ke SP 2 Factor Ke LB Ke UB
72 1.29 0.16 2.43 5.60% 8% 2% 12.32% 1.7% 14.02% 4.98% 23.14%
60 1.25 0.34 2.17 9.90% 8% 2% 12.00% 1.7% 13.70% 6.42% 21.06%
48 1.18 -0.04 2.41 5.60% 8% 2% 11.44% 1.7% 13.14% 3.38% 22.98%
36 0.91 -0.94 2.75 -0.01% 8% 2% 9.28% 1.7% 10.98% -3.82% 25.70%
24 1.23 -0.89 3.36 1.90% 8% 2% 11.84% 1.7% 13.54% -3.42% 30.58%
Months Beta Beta LB Beta UB R^2 MRP RF Ke SP 2 Factor Ke LB Ke UB
72 1.29 0.16 2.42 5.60% 8% 2% 12.32% 1.7% 14.02% 4.98% 23.06%
60 1.25 0.33 2.17 9.90% 8% 2% 12.00% 1.7% 13.70% 6.34% 21.06%
48 1.18 -0.04 2.41 5.60% 8% 2% 11.44% 1.7% 13.14% 3.38% 22.98%
36 0.9 -0.94 2.75 -0.03% 8% 2% 9.20% 1.7% 10.90% -3.82% 25.70%
24 1.22 -0.9 3.36 1.80% 8% 2% 11.76% 1.7% 13.46% -3.50% 30.58%
3 Month Regression
1 Year Regression
2 Year Regression
7 Year Regression
10 Year Regression
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After adjusting for the size premium, we will use 13.7% for the cost of
equity. Some people like to think of cost of equity as the required rate of return.
In other words, an investor should buy into Green Plains if they do not think they
will earn 13.7%. Green Plains can expect with 95% confidence that the cost of
equity will be in between 6.34% and 21.06%.
Backdoor Cost of Equity
The backdoor cost of equity is another way to find the equity without
using the CAPM. Instead we took the price to book, return on equity, and the
internal growth rate to plus into our formula. This allows us to not just use the
historical data to get a cost of equity.
Price/Book = 1 + ((ROE + Ke)/(Ke-g))
We found that Green Plains had the following values for each of the
ratios.
1.47 = 1 + ((.238 + Ke)/(Ke-.087))
The formula calculates that the cost of equity (Ke) to be 18.97%.
However this is a good way to find cost of equity for some companies, we
believed that this was not for Green Plains. As a group we concluded that the
more reasonable cost of equity for our valuation was the one we found by using
the CAPM.
116
Weighted Average Cost of Capital (WACC)
The weighted average cost of capital can be explained as the rate at
which Green Plains can finance their operations in the company by debt and
equity. In order to calculate the WACC we multiply the proportion of debt or
equity by their individual costs. After we add these two numbers together we get
what is called the overall cost of capital for Green Plains. In the graphs below we
have the stated and the restated WACC for Green Plains.
In order to get the market value of equity we took the total fair value of
assets minus the total fair value of liabilities. We got the market value of
liabilities from Green Plains 10-K. After we got the market values we then
preceded to put them in proportions based off the firms value. The firm’s value is
the market value of liabilities plus the market value of equity. For the rates that
we used we got 6.5% from the 10-K and 13.7% from our cost of equity. Once
we multiplied the rates times the weights we then added up the totals for equity
and debt to 9.41% WACC restated after tax. The tax rate is 28.90% for Green
Plains and we found that in the 10-K. The difference in between the as-stated
and restated WACCs was the capitalized operating leases. We do not have that
much of capitalized operating leases so it did not make too much of a difference
in our WACCs. Sometimes the WACC can be unreliable so we took the lower and
upper bounds for equity found in the regression to come up with a range that
the WACC can fall in with a 95% confidence.
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WACC (as stated) Amount Weight Rate W*R
Market Value of Liabilities 399440 44.41% 6.50% 2.89%
Market Vaule of Equity 500049 55.39% 3.37% 1.87%
WACC 4.76%
Firm Value 899489 WACC after tax 3.93%
tax rate 28.90%
WACC (restated) Amount Weight Rate Weight*Rate
Market value of liabilities 453283 47.54% 6.50% 3.09%
Market value of equity 500049 52.66% 13.70% 7.21%
WACC 10.30%
WACC after tax 9.41%
Firm value 953332 Tax Rate 28.90%
WACC LB (restated) Amount Weight Rate Weight*Rate
Market value of liabilities 453293 47.54% 6.50% 3.09%
Market value of equity 500049 52.6%6 6.34% 3.34%
WACC 6.43%
WACC after tax 5.54%
Firm value 953332 tax rate 28.90%
WACC UB (restated) Amount Weight Rate Weight*Rate
Market value of liabilities 453283 47.54% 6.50% 3.09%
Market value of equity 500049 52.66% 21.06% 11.09%
WACC 14.18%
WACC after tax 13.29%
Firm value 953332 Tax rate 28.90%
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Using this data we can conclude that Green Plains’ cost of capital will be in
between 5.54% and 13.29% after tax with 95% confidence.
Valuation Analysis
The valuation analysis is the last step in our evaluation of Green Plains
and what we consider the most important part. The intrinsic valuation and the
market comparative valuation are the two methods we decided to use in order to
see if Green Plains is undervalued, fairly-valued, or overvalued. As analysts we
wanted to find the price per share for Green Plains. After using both methods we
decided that the most important method is the intrinsic valuation method
because there is not as much room for error as the market comparative
valuation. Also we concluded that the market shows that Green Plains is
undervalued but that our calculations based on the intrinsic models shows that it
is overvalued.
Market Comparative Evaluation
The market comparative evaluation is composed of trailing P/E, Forward
P/E, Price to Book, Price Earnings Growth, P/EBITDA, and the EV/EBITDA
multiples. We considered ourselves as 10% analysts while valuing the Green
Plains. The numbers that we used for the Green Plains and the industry came
from May 1st, 2015. After we calculated all of the multiples by using the average
of the industry, we realized that they all fluctuated in price per share by a good
amount. The one thing that mostly remained the same was that they showed
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that Green Plains was undervalued with a few exceptions. This evaluation
method is a good indicator but it has some room for error because we only used
three companies in the industry to get what we thought were fair values for
Green Plains.
Trailing P/E
The trailing price to earnings ratio tells us how many years or profits
Green Plains is paying for their stock. We started with taking the May 1st, 2015
closing share price and then dividing it by the earnings per share in the past year
for each company. After we did that, we then got the average of the ratios from
the companies in the industry without Green Plains. We then used the average of
the industry to come up with a new share price, $41.83. The actual price at May
1st, 2015 for Green Plains was $31.02 while we got $41.83 for the fair value. We
concluded that Green Plains is undervalued based on the trailing P/E multiple.
Ratio Market Value 5/1/2015 Should Sell for Value
Trailing P/E 31.02$ 41.88$ Undervalued
Forward P/E 31.02$ 47.08$ Undervalued
P/B 31.02$ 30.60$ Fairly Valued
PEG 31.02$ 31.70$ Fairly Valued
P/EBITDA 31.02$ 57.59$ Undervalued
EV/EBITDA 31.02$ 53.11$ Undervalued
Competitors P/E Results
Valero 8.6 Average 10.58
ADM 14.51 GP EPS 3.96
Future Fuel 8.62 Should Sell 41.88$
Value Undervalued
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Forward P/E
The forward price to earnings ratio is like the trailing price to earnings
ratio but instead it uses forecasted years instead of previous years for the price
per share. Like the trailing ratio we calculate this by taking the price per share
over the earnings per share for the industry. We then used the average to get a
number that we believe is fair for Green Plains based off this multiple. Green
Plains should have a price per share of $47.08 when using the forward P/E
multiple. This number is not very accurate however because it is based on
forecasted price’s per share. We concluded that while using the forward P/E
ratio, Green Plains is undervalued as of May,1st 2015.
Price to Book Ratio
The price to book ratio is calculated by taking the price per share and
then dividing it by the book value per share. We found the book value per share
by taking the stockholder’s equity and then dividing it by the outstanding
common stock shares. If Green Plains had preferred stock then we would have
Competitors P/E Results
Valero 9.36 Average 11.89
ADM 13.79 GP EPS 3.96
Future Fuel 12.52 Should Sell 47.08$
Value Undervalued
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subtracted it from the stockholder’s equity before dividing it. The average price
to book ratio in the industry excluding Green Plains was 1.44. We then calculated
Green Plains’ price per share by multiplying that average by the book value
Green Plains had listed in its balance sheet. We came up with $30.60 price per
share, which would make it fairly valued when compared to the $31.02 as of
May, 1st 2015.
Dividends/ Price
When we were looking at the dividends between companies we noticed
that there was a big gap in between the dividends paid out by each company in
the industry. With a wide range of dividends we were not able to get an accurate
measurement of the value for Green Plains. We believe that this does not play a
big role at all in evaluating Green Plains because it is just one multiple out of
seven.
Compeitors P/B Results
Valero 1.42 Average 1.44
ADM 1.59 GP BV Share 21.20
Future Fuel 1.32 Should Sell 30.60$
Value Fairly Valued
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PEG
PEG stands for price earnings growth ratio. This ratio is calculated by
taking the P/E and dividing it by the internal growth rate. The numbers we found
were from the income statements and balance sheets of each company. We did
this for the industry besides Archer-Daniels-Midland because they were an
outsider when it came to the data. The reason for this is because they paid out a
lot more dividends in 2014 than the rest of the other companies. We were able
to get an average of .926 for the ratio and we then used that to calculate a good
number for the price per share for Green Plains. The growth rate that we used
was the restated internal growth rate that we found earlier of 8.64%. We can
conclude that Green Plains is fairly valued when using the PEG multiple.
P/EBITDA
EBITDA stands for earnings before interest, taxes, depreciation, and
amortization. We calculated the P/EBITDA by first multiplying the outstanding
shares and the price per share as of May, 1st 2015. This gives us the market
value of equity. Next, we just took the market value of equity and divided it by
Compeitors PEG Results
Valero 1.102564103 Average 0.93
ADM -2.985596708 GP BV Share 3.96
Future Fuel 0.750217581 Growth Rate 8.64
Should Sell 31.70$
Value Fairly Valued
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the EBITDA to give us our ratio for each company in the industry. When we
calculated the average ratio for the firm besides Green Plains, we ended up with
a ratio of 6.46 and then used that to get our price per share of $57.59. We
concluded again that Green Plains is undervalued based off this multiple.
EV/EBITDA
The EV/EBITDA is calculated by taking the enterprise value divided by the
EBITDA. The enterprise value is found by adding the liabilities minus the cash
and investments to the market cap. Again, we took the average of all the
companies EV/EBITDA and then used that to come up with a price per share for
Green Plains. We calculated that the price per share based on the EV/EBITDA
multiple is $53.11. We concluded that Green Plains is undervalued while using
this multiple since the actual price per share is at $31.02 as of May, 1st 2015.
Compeitors Mkt. Cap EBITDA P/EBITDA Results
Valero 30,280,000,000 7,590,000,000 3.988981159 Average 6.46
ADM 31,310,000,000 3,760,000,000 8.326764149 GP EBITDA 336140000.00
Future Fuel 459,960,000 65,110,000 7.063959453 Shares Outstanding 37703946.00
Should Sell For 57.59$
Value Undervalued
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Intrinsic Models
The intrinsic models are used to determine how valuable a company is by
analyzing different models. The discounted dividends, discounted free cash
flows, residual income, abnormal earnings rate, and the long-run residual income
models were all used to gather good data on Green Plains. We believe that the
intrinsic models are more reliable than comparing Green Plains against the
market.
Discounted Dividends
The discounted dividend valuation model attempts to value a firm based
off of solely dividends. The discounted dividends model can demonstrate that
dividends are appropriate for valuing firms, while other times dividends are a
poor way to value a firm. The discounted dividends model only values the firm
based off of dividends, therefore the model cannot accurately construct the full
value of the firm. After running the discounted dividends model we identified
that dividends do not represent significant value of the firm.
The discounted dividends model is based on the forecasted future
dividends paid over the next 10 years. In order to forecast the next 10 years of
future dividends, we had to look at the previous dividends paid. Green Plains
Inc. however just started paying dividends in 2013, proving difficult to produce
accurate dividends forecast for the next 10 years. Additionally Green Plains Inc.
increase their dividends three fold from 2013 to 2014 ($0.08 DPS to $0.24 DPS).
125
We knew that this type of dividend growth would not be sustainable, so we grew
out the dividends year by year around 10% to 20% with a few odd years thrown
in above or below the 10% to 20% dividend growth rates to simulate stronger
and weaker years the company has.
Another component of the discounted dividends valuation model is
determining initial cost of equity. The growth rates were calculated from running
regressions at 13.7% with the size premium and lower and upper bounds values
of 6.34% and 21.06%. The upper and lower bounds values were rounded to
6% and 22%. The midway points between the initial cost of equity and the
lower and upper bounds values were calculated by determining a halfway point
at 9.5% and 18%.
Taking a 10% analyst position, the upper and lower bounds value of the
stock were calculated by taking 90% and multiplying it by the price of Green
Plains Inc. at 4/1/2015 (26.39) and the upper bound value was calculated by
taking 110% and multiplying it by the stock price at 4/1/2015 (32.25). The stock
is deemed undervalued if the price falls above the upper bound value,
undervalued if the calculated price falls below the lower bound and fairly valued
if the calculated price falls between the upper and lower bound values. The
perpetuity growth rates were kept relatively low to moderate because Green
Plains Inc.’s annual year over year growth is low.
The discounted dividends model demonstrates that Green Plains Inc. is
mostly overvalued based on our calculated cost of equity upper and lower bound
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percentages, with a larger percentage of the chart being filled in with overvalued
prices. Green Plains Inc. appears to have a chance at being fairly valued
between the 6% and 9.5% cost of equity figures.
Discounted Free Cash Flows Model
The discounted free cash flows model combines both operating cash flows
and investing cash flows to value a company. In order to get the right figures to
calculate the price of Green Plains at 4/1/15 we had to forecast out both cash
flows from operations and investing activities. The cash flows from operating
activities were difficult to estimate because the cash flows from operating
activities were jumping around from negative to positive by significant amounts.
We compared the change in operating income, net income and operations to
sales and found that operating income was the most stable for forecasting cash
flows from operating activities. We subtracted net current assets from net cash
flows from net cash provided by investing activities to get free cash flows from
127
investing activities. After calculating the free cash flows from operations and free
cash flows from investing activities for the next 10 years, we subtracted the two
to get free cash flow from firm’s assets. Next we calculated the present value
factor by 1/((1+WACC BT)^period). We then took the present value factor and
multiplied it by free cash flow from firm’s assets to get present value year-by-
year free cash flows. Next to get total present value year-by-year free cash flows
we summed up the 10 present values year-by-year free cash flows. We decided
to throw out the 10th period perpetuity and use the 9th period perpetuity because
the 10th period’s free cash flow from firm’s assets didn’t make sense compared to
the 9th period. The market value of assets is calculated by adding the perpetuity
at period 9 to total present value year-by-year free cash flows. The book value
of debt and preferred stock is taken from total stockholder’s equity in the
balance sheet. To get market value of equity, we subtracted book value of debt
& preferred stock from market value of assets. We then divided the market value
of equity by the number of shares to get price per share. Then we must take the
price per share and move it ahead to 4/1/15 from 12/31/14. To do this we had
take the price per share and multiply it by ((1+ WACC BT)^(3/12)) to get the
time consistent price at 4/1/15.
The WACC before tax was used to prohibit double taxation. A type 10%
analyst was used, with the upper bound being calculated by multiplying the price
are 4/1/15 by 110% and the lower bound is calculated by multiplying the price at
4/1/15 by 90%. The firm is undervalued if the time consistent price is above the
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upper bound and the firm is overvalued if the time consistent price is below the
lower bound. The firm value will be fairly valued if the time consistent price falls
between the upper and lower bounds.
The model is dependent on the perpetuity cash flow and if this value is
abnormally different than the rest of the cash flows, then the valuation model
may value the company with little accuracy. In our case we had an abnormally
sharp decrease in free cash flows from firm assets and yielded completely
inaccurate time consistent price values. We decided to throw out the problem
year “period 10” and calculate the perpetuity off of period 9. Doing so yielded
results that looked a whole lot more accurate. Based on the sensitivity chart, we
can conclude that Green Plains Inc. is undervalued. However the free cash flows
valuation model is very sensitive to changes in perpetuity growth rates and
WACC BT rates as we saw from the relatively large jumps in prices from each
change of the two variables. The high sensitivity is caused by estimation errors
in WACC BT and perpetuity growth rates.
129
Residual Income Model
The residual income model takes into account the forecasted net income
and dividends for the next ten years. Stockholder’s equity in 2014 is also a
crucial part in this model. We took the percentage in the sales growth from 2010
to 2014 to get the forecasted net income for ten years. We then decided to use
the net income and dividend changes to get our forecasted stockholder’s equity.
Once we got our forecasts we then used the stockholder’s equity and added in
net income while subtracting the dividends from the previous year. After we did
that we found the annual normal income by taking that value and multiplying it
by the cost of equity that we had. The residual income is the difference between
the net income and the annual normal income. We then figured out what the
residual income was when discounted back to year zero to get a present value.
To figure out the terminal value all we did was add up all the residual incomes
from each year at present value. The terminal value is used to figure out the
market value of equity. Once we have the market value of equity we then
divided it by the shares outstanding from 2014 which gives us the model price at
the beginning of 2015. The last thing that we did was to get the model price
consistent with the time right now so we took the number multiplied the factor
to the fourth. We raised it to the fourth because it has only been a quarter so far
in 2015.
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Growth Rate
Ke
The chart shows the sensitivity if the cost of equity or the growth changes
by certain percent. Our lower bound for the cost of equity is 6% and the upper
bound is 22%. This ranges around what we believe to be an accurate
representation of cost of equity, 13.7%. The lower bound for the growth change
is at -10% and then -50% for the upper bound. We concluded that this is the
best model because it ties in the statement of cash flows, income statement, and
the balance sheet. We also concluded that the residual income model is still
sensitive however because we could not get in our range for the price per share
with any of the boxes. Based on the sensitivity analysis we decided that the
residual income model shows that Green Plains is overvalued.
Abnormal Earnings Growth
The abnormal earnings growth is calculated a lot like the residual income
model but instead it takes into account the dividends reinvested into the
company at 13.7%. To start off we used the forecasted net income and
-10% -20% -30% -40% -50%
6% 34.72 33.85 33.46 33.24 33.1
9.50% 21.1 22.16 22.69 23 23.21
13.7% 12.5 13.99 14.8 15.31 15.66
18% 8.01 9.33 10.1 10.61 10.97
22% 5.84 6.9 7.55 7.99 8.31
UB LB
32.25 26.39
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dividends that we had for the residual income model. This is where that we take
the dividends and come up with the amount to reinvest into Green Plains. We
take the net income and the reinvested dividends and add them to get the
cumulative dividends earnings. We then subtracted the normal earnings from the
cumulative dividends earnings to get the abnormal earnings growth. Once we
have the abnormal earnings growth, we then discount all the years back to the
present value and add them up to get the total. We added up the total present
value of AEG to the core net income of 2015 in order to total average net income
perpetuity. That number was then divided by the number of shares outstanding
to get 1.42. We multiplied the 1.42 by the capitalization rate to come up with an
intrinsic value per share. Finally, we then got the intrinsic value per share
calculated in April’s price.
Growth Rate
Ke
-10% -20% -30% -40% -50%
6% $39.54 $40.31 $40.65 $40.84 $40.97
9.50% $23.29 $21.60 $20.77 $20.27 $19.94
13.70% $12.93 $11.48 $10.69 $10.20 $9.86
18% $7.27 $6.31 $5.75 $5.39 $5.13
22% $4.27 $3.64 $3.26 $3.00 $2.81
UB LB
$32.25 $26.39
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We used the same upper and lower bounds as the residual income for the
cost of equity and the growth rate. The cost of equity’s lower bound is 6% while
the upper bound is 22%. The lower bound is -10% and upper bound is -50% for
the growth rate in the sensitivity analysis. We concluded that the sensitivity
analysis shows us that Green Plains is more likely to be overvalued rather than
undervalued.
Long Run Residual Income Model
The long run residual income model is similar to the residual income
model because both models are calculating the market value of equity. The
difference between the two models is that long run residual income model
derives market value by using cost of equity, return on equity and various
growth rates, versus the residual income model uses just changes in the
perpetuity growth rate and cost of equity.
The long run residual income model calculates a market value of equity
with the following equation.
MVE= BVE [ 1 + ((ROE – Ke)/(Ke – g)) ]
Once the market value of equity has been calculated, we divided the
market value of equity by the number of shares to get the price per share at
12/31/14. We then used a perpetuity to grow the price per to share to 4/1/15.
Holding one of the three variables constant for each of the three sensitivity
charts then fills out the sensitivity charts. We then changed the other two
variables that weren’t being held constant.
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The sensitivity charts all consistently demonstrated that Green Plains Inc.
is fairly valued. The residual income model is similar but demonstrates more of
an overvalued view of Green Plains Inc. than the long run residual income
model. The values between the four sensitivity charts were higher on the long
run residual income model than the regular residual income model. The residual
income sensitivity analysis also had larger and smaller extremes.
134
135
Sources
1) Green Plains 10-K
2) Valero 10-K
3) ADM 10-K
4) Future Fuels 10-K
5) http://www.gpreinc.com/ar_archive/2013interactive/
6) http://www.energyresourcefulness.org
7) Howstuffworks.com
8) Census.gov
9) Wall Street Journal
10) Greenplains.com
11) U.S. Energy Information Administration
12) Ethanol Producer Magazine
13) National Agriculture Statistics Service
14) Business Analysis & Evaluation 4th Edition: Palepu, Healy
15) Intermediate Accounting 14th Edition: Kieso, Weygandy, Warfield
16) Corporate Finance Textbook
17) Farm-Equipment.com
136
Appendix:
Capital Structures Ratios:
2010 2011 2012 2013 2014
Green Plains 2.21 3.02 3.11 2.68 3.00
ADM 3.2 3.84 3.3 3.3 3.04
Valero 3.00 3.83 4.11 3.92
Future Fuels 1.68 2.36 2.65 3.43 2.7
GP Re-Stated 1.95 1.81 3.48 2.49 2.29
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
Altman's Z-Score
2010 2011 2012 2013 2014
Green Plains 1.81 1.81 1.75 1.81 1.29
ADM 0.47 0.44 0.34 0.27 0.28
Valero 0.5 0.41 0.36 0.32 0.28
Future Fuels 0.36 0.34 0.37 0.26 0.29
GP Re-stated 2.01 2.9 1.86 1.81 1.29
00.5
11.5
22.5
33.5
Debt to Equity
137
Profitability Ratios:
2010 2011 2012 2013 2014
Future Fuel 18.8% 20.3% 16.9% 23.0% 21.8%
Valero 4.64% 4.59% 5.24% 4.66% 6.36%
ADM 6.23% 5.33% 4.00% 4.33% 5.87%
Green Plains 7.1% 4.8% 2.8% 5.7% 11.6%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
50.0%
Gross Profit Margin
2010 2011 2012 2013 2014
Future Fuel 14.7% 16.9% 13.6% 20.7% 18.5%
Valero 2.28% 2.92% 2.88% 2.87% 4.51%
ADM 3.96% 3.33% 1.89% 2.08% 3.52%
Green Plains 3.1% 1.7% 0.7% 2.4% 7.7%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
Operating Profit Marins
138
Liquidating Ratios:
2010 2011 2012 2013 2014
Future Fuel 10.5% 11.3% 10.1% 17.0% 17.6%
Valero 0.39% 1.66% 1.50% 1.97% 2.77%
ADM 3.13% 2.52% 1.52% 1.49% 2.77%
Green Plains 2.3% 1.1% 0.3% 1.4% 4.9%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
Net Profit Margin
139
2010 2011 2012 2013 2014
Green Plains 10.72 14.76 19.65 18.11 11.22
ADM 7.52 7.77 6.28 6.8 7.34
Valero 15.99 22.74 22.76 22.44 19.79
Future Fuels 4.543 6.645 6.67 6.87 4.7
-
5.00
10.00
15.00
20.00
25.00
Ax
is T
itle
Inventory Turnover
140
141
142
Method of Comparables:
143
144
145
Size Decile
Market Value
of Largest
Company
Percent of Market
Represented by
Decile
Avg. Annual
Stock ReturnBeta Size Premium
1 – smallest 235.6 1 21 1.41 6.4
2 477.5 1.3 17.2 1.35 2.9
3 771.8 1.7 16.5 1.3 2.7
4 1,212.30 2.2 15.4 1.24 1.9
5 1,776.00 2.6 15 1.19 1.8
6 2,509.20 3.5 14.8 1.16 1.8
7 3,711.00 4.3 13.9 1.12 1.2
8 6,793.90 7.4 13.6 1.1 1
9 15,079.50 13.6 12.9 1.03 0.8
10 – largest 314,622.60 62.3 10.9 0.91 -0.4
WACC (restated) Amount Weight Rate Weight*Rate
Market value of liabilities 453283 47.54% 6.50% 3.09%
Market value of equity 500049 52.66% 13.70% 7.21%
WACC 10.30%
WACC after tax 9.41%
Firm value 953332 Tax Rate 28.90%
WACC (as stated) Amount Weight Rate W*R
Market Value of Liabilities 399440 44.41% 6.50% 2.89%
Market Vaule of Equity 500049 55.39% 3.37% 1.87%
WACC 4.76%
Firm Value 899489 WACC after tax 3.93%
tax rate 28.90%
146
Regressions:
WACC UB (restated) Amount Weight Rate Weight*Rate
Market value of liabilities 453283 47.54% 6.50% 3.09%
Market value of equity 500049 52.66% 21.06% 11.09%
WACC 14.18%
WACC after tax 13.29%
Firm value 953332 Tax rate 28.90%
WACC LB (restated) Amount Weight Rate Weight*Rate
Market value of liabilities 453293 47.54% 6.50% 3.09%
Market value of equity 500049 52.6%6 6.34% 3.34%
WACC 6.43%
WACC after tax 5.54%
Firm value 953332 tax rate 28.90%
147
148
149
Intrinsic Valuation Models:
150
151
152
153