Will a 'going concern' note burn your money?

We are still in the midst of “annual report season” as companies have been submitting their 10-K filings with the SEC. Or in some cases delaying those filings.  There is one theme that has been much stronger during this recession than during any recent years, and that is the dreaded “GOING CONCERN” notice from auditors in the amount of companies which are well known.  And this year’s round of GOING CONCERN notes has a host of names that were formally great stocks.

A going concern is the ability of a company to continue to operate as things are now and not go out of business or have to liquidate its assets.  The out is of course that the company must be able to raise enough capital or exit certain operations to stay operational.   Here are some of the big names with the notes that have come out this week:

Aventine Renewable Energy Holdings, Inc. (NYSE: AVR) has already been in trouble for some time.  The former high-flying ethanol sector is now junk.  Aventine warned that it might have to file for bankruptcy protection and it has the going concern note attached.  And ethanol is still viable?

Blockbuster Inc. (NYSE: BBI) posted a loss after items, and the company’s CEO said that many other companies are also facing the same challenges.  The auditor’s note of a going concern is said to be in place until its financing is complete and its liquidity is assured.  The good news is that this one rose this week on the financing discussions.  It seems that video rental stores are still like smokers, the numbers keep declining each year yet they still exist.

Crocs, Inc. (NASDAQ: CROX) said that its annual report will have a going concern note from independent registered public accounting firm, Deloitte & Touche, that raises doubt about the company’s ability to continue as a going concern.  The company had more than $51 million in cash and equivalents and $22.4 million in credit facility borrowings which mature next month.  Ugly shoes that were meant for gardening couldn’t stay mainstream for too long.

Eddie Bauer Holdings Inc. (NASDAQ: EBHI) was also hit hard this week on its massive losses.  The company’s report will have a going concern note because of the current economic situation and restrictions under amendments to its term loan agreement.  It looks like the company was in compliance at the end of 2008 but 2009 looks like it will be a different story.  The preppy retailer has not gone without a troubled history.

MGM Mirage (NYSE: MGM) posted a fourth-quarter net loss after recording a $1.2 billion write-down.  This reflects a difficult environment, but it has also prompted the MGM’s auditor to raise doubts about its ability to continue as a going concern.  Can people afford to go to casinos in a recession when they know that the odds are stacked against them when they walk in the doors?

There were many others over the last week, namely in the auto parts sector and in speculative companies.  But these companies above either have household names that have been there for some time or were not that long ago traded as great growth stocks.  What a difference a year makes.

JON C. OGG
MARCH 20, 2009

• Aegon (AEG) Cut to Sell at UBS.
• Ascent Solar (ASTI) Cut to Sell at Cantor Fitzgerald.
• Aventine Renewable (AVR) Cut to Underperform at Credit Suisse.
• Northeast Utilities (NU) Cut to Hold at Jefferies.
• Royal Dutch Shell (RDS-A) Cut to Hold at Citigroup.

JON C. OGG

This deal does not sound like a winner for ADM, which is the largest ethanol producer in the US. It’s hard to believe that ADM sees ethanol as anything but a transition transportation fuel, until something better (more efficient and cleaner) than gasoline comes along. Corn-based ethanol was a winner for the company because it supported ADM’s overall agricultural business. Sugar cane-based ethanol doesn’t offer the same overlap.  Then there is that great new development from Aventine over its “going concern” which shows more holes in ethanol.

This whole deal may just be wishful thinking on the part of some Brazilian shareholders. That’s where I come down on today’s report.

Paul Ausick
March 17, 2009

Beacon Power Corporation (NASDAQ: BCON) was supposed to be one of the fly-wheel winners in advanced battery technologies.  It also recently took a hit after it raised cash.  Yet the annual report yesterday said that the company will need to raise more cash to satisfy “Our continuation as a going concern.”  That doesn’t mean it is there quite yet, but it does need funding from 2009 to 2011.

Environmental Power Corporation (NASDAQ: EPG) develops, owns, and operates renewable energy production facilities in the United States.  Its annual report noted a going concern as well, yet the company said it is pursuing a number of financing avenues.  The leash looks pretty short as it said it “hopes to obtain the financing it requires by the end of the first half of 2009.”

Verenium Corporation (NASDAQ: VRNM) is down over 10% this morning at $0.345.  The cellulosic ethanol and high-performance specialty enzymes developer disclosed the going concern note.

Let’s hope that if these firms head to D.C. with their hat in hand to ask President Obama for money that they don’t fly a private jet.

JON C. OGG

Good news is so scarce in the ethanol business these days thatPacific’s bookkeeping adventure is also boosting Aventine Renewable(NYSE:AVR) by about 2%, to $0.95/share. Ethanol stocks are probablyalso getting a little boost from yesterday’s announcement by thefederal EPA that it is increasing next year’s requirement for renewablefuels by 2.1 billion gallons, to 11.1 billion gallons, for 2009. That’sabout 8% of expected US gasoline consumption for next year.

There are now 160 firms making ethanol, mostly small and privately held,and using corn as feedstock. US Sugar Corporation, a privately heldcompany, announced that it is considering building a 100 million galloncellulosic ethanol plant in Florida that would use sugar cane bagasseas a feedstock. The plant would be a joint venture with Coskata Inc.,another private company funded by venture firms including KhoslaVentures, whose namesake, Vinod Khosla, was an early investor inPacific Ethanol (and Sun Microsystems (NASDAQ:JAVA), for that matter).

The impetus for the cellulosic plant is the decision by the state ofFlorida to withdraw some of US Sugar’s land from cultivation in aneffort to restore a portion of the Florida Everglades. US Sugar plansto apply to the Florida Energy Office for matching funds to conduct anearly engineering study for the project. The company also wants to geta piece of US Department of Agriculture loan guarantees that have beenearmarked for biofuels that do not use food crops as feedstocks.

Ethanol–the fuel that keeps on giving. As long as the federal government keeps pushing out more money to support it. Sheesh.  The TARP is the acronym for "Troubled Asset Relief Program."  Maybe ethanol companies can band together to get a "TERP" through Congress.

Paul Ausick
November 18, 2009

Like VeraSun and Aventine, Pacific is stuck in the deadly cycle of highfeedstock costs, low prices, and falling demand for gasoline.Each of these companies invested heavily in capacity, only to seedemand fall as consumers drove less in reaction to high gasolineprices. VeraSun is currently in Chapter 11, and its stock has beentaken off the NYSE. Aventine and Pacific are off 52-week highs by about80%.

The glow of corn ethanol was strong when the federal governmentmandated renewable-fuel standards, but what we’ve got here is anexample of the market hammering an industry regardless of federalbacking.

Politically, ethanol’s a winner. It benefits farmers, it reduces carbonemissions, and it replaces foreign oil. That’s why politicians loveit–there’s something for nearlyeverybody.

But the market treats corn ethanol just as it would any other product:does the demand mesh with the supply? The answer appears to be "no."Federal mandates for 11.1 billion gallons of ethanol production by theend of 2009 will certainly be met. But if consumers stop driving,where’s that ethanol going to be sold?

One thing that could happen is that Congress could mandate wider use of85% ethanol (E85). But that would mean a significant change to the USautomobile fleet and to wider distribution of E85. Neither of thosethings will happen quickly enough to save VeraSun or Aventine orPacific Ethanol.

There is some evidence that sharply lower gasoline prices have putdrivers back on the road. And reduced production from OPEC could sendthe price of gasoline back up. That might help prop up ethanol prices abit, but it’s not going to be enough. Corn ethanol was always a poorsolution to low farm prices, improved emissions reduction, and lowerdependence on foreign oil. That simply will not change.

Pacific Ethanol shares are down over 7% at $1.00 on over 300,000shares.  Its 52-week trading range is $0.62 to $9.88 and its averagedaily trading volume is about 800,000 shares.

Paul Ausick
November 10, 2008

Where ADM did not do so well was in its corn processing operations. Operating profit in the division was down by $135 million,with biofuel products off nearly 62% and sweeteners and starches down61%. Revenue was $2.24 billion, a rise of about 47%, thoughvolumes were up just 3%. Mark-to-market losses on corn hedgescontributed to higher feedstock costs and higher energy costs alsodampened profits. Investors liked the news as ADM shares are up nearly18% this morning.

VeraSun (NYSE:VSE), a pure-play ethanol company, didn’t have a backstop and the company is now in Chapter 11 and may be a new net-zero for shareholders.

After the market closed yesterday, Anadarko (NYSE:APC) reportedquarterly earnings of $2.165 billion, or $4.62 per share. Anon-cash gain of $2.193 billion on derivatives and other adjustmentsboosted revenues significantly. Discretionary cash flow (non-GAAP) grewfrom $736 million in the same period a year ago to $1.132 billion thisyear.

Anadarko’s realized prices for both crude oil and natural gas were upabout 58% and 92%, respectively. The company’s share price is up morethan 5% in early trading today.

At the other end of the energy pipeline, refiner Holly Corporation(NYSE:HOC), this morning reported EPS of $1.00 on revenue of $1.72billion. Analysts had been expecting EPS of $0.87 and revenues of $1.71billion.

Net income was down more than 14% from the same period a year ago, andEPS was off nearly 6%. Refining margins were up 18% year-over-year, butreduced throughput and higher costs caused the decline in net income.Holly has $225 million in cash, no debt, and a credit facility for$175, none of which is outstanding. But the drop in net income isrolling over the good news. Holly’s share price is off about 1.2% thismorning.

With pure-play ethanol companies watching their margins and shareprices dive, it’s not unreasonable to wonder what could happen ifPacific Ethanol (NASDAQ:PEIX) or Aventine (NYSE:AVR) will followVeraSun down the Chapter 11 path.

ADM hasn’t shown any interest so far in picking up one of these guys,but it might not be a bad idea. Until another gasoline additive (notMTBE) can be found to help keep wintertime air clean, ethanol is stillthe only game in town to meet federal and state mandates for emissions.

For that matter, even a crude refiner like Holly might be interested inan ethanol play. On second thought, that’s not likely at all.

Paul Ausick
November 4, 2008

Recent rumors put VeraSun as potentially being toast, andyesterday’s earnings release from Aventine will do nothing butcontribute to that endless slide. Aventine reported EPS of $0.06against analysts’ expectations of $0.12, and revenue of $599.5 millionagainst estimates of $716.37 million. Excluding non-cash gains of $18.4million, the company managed only to break even.

Aventine also noted that it will delay the opening of its Aurora Westplant in Nebraska by three months and is considering delayingconstruction of another new plant. About two-thirds of Aventine’s cash,$60 million, resulted from tapping its revolving credit line.

Six weeks ago VeraSun was trading around $5.00/share. Then it announcedthat it was expecting to report a loss in the third quarter. The stockpromptly dropped from $5.22 to $1.41, and it closed yesterday at$0.44/share. Pacific Ethanol is equally awful, falling from a 52-weekhigh of $9.88 to close at just $0.86 yesterday.

As gasoline prices fall, and US drivers start to hit the road again,demand for ethanol will certainly increase. But then so will feedstock(corn) prices, and profits will be stifled again.

Here’s something to ponder, but skeptically: could the ethanol producers be too small tofail? If automakers can get a piece of the federal government’s $700billion rescue package, what’s to stop ethanol producers from gettingin line for a handout. After all, ethanol helps farmers, reduces ourdependence on foreign energy supplies, and is less harmful to theenvironment.  Even though we think it a waste of capital, in thesecrazy times of big hand outs and with an unknown White House policy beyond 2008 it seems anything could happen.

As you will see the chart from BigCharts.com over the last two years, these stocks would have been the best way to burn money that you could some up with.

Paul Ausick
October 31, 2008

VeraSun’s stellar report included results from the company’s mergerwith US BioEnergy, which took effect on April 1 and is expected tocontribute 420 million gallons annually of ethanol to revenues. Ethanolprices increased by $0.38 to $2.59/gallon, up 17.1% from a year ago,and production jumped to 256.5 million gallons as new facilities cameonline. Feedstock costs also increased to an average of $5.37/bushel ofcorn, up from $3.62 in the prior year period. That’s a jump of 48%.

Still in all, VeraSun performed much better than Pacific Ethanol(NASDAQ:PEIX), which reported[http://www.247wallst.com/2008/08/247-wall-st-mos.html] a loss for thequarter yesterday. Pacific’s feedstock costs jumped 67% and thecompany’s gross margin fell from 9.8% in the second quarter of 2007 tojust 0.2%. VeraSun’s gross margins also took a big dip, from 19.2% ayear ago to 7.1% this year.

Another ethanol producer, Aventine Renewable Energy Holdings (NYSE:AVR)also posted a loss on July31 for thesecond quarter, even though it managed higher production and a $0.29increase in its average sales price. Aventine took a hit of $8.5million related to auction-rate securities. Without that loss, thecompany would have posted EPS of $0.16 on net income of $6.6 million.Gross margins at Aventine also fell to 5.5%, from the year-agoquarter’s 6.9%.

VeraSun’s volume really helped it, as did it’s average sales price pergallon, which was $0.04/gallon higher than Pacific’s and $0.09/gallonhigher than Aventine’s. VeraSun produced nearly four times as muchethanol as Pacific; its costs were lower; and its sales price washigher. Aventine’s production for the quarter was more than 220 milliongallons. Going forward, size really is going to matter when it comes tomaking a profit from ethanol.

Paul Ausick
August 12, 2008

Analysts have an average target around $6.00 and about the only goodthing you can say for its chart is that if we pretend to not hate USethanol companies and merely look at the chart as it was an ETF is thatit broke its death spiral.  But where it trades on technicals isanyone’s guess.  If you care about moving averages here, its 200-daymoving average is $7.34 and its 50-day moving average is $5.27.  Inorder to be fair and balanced despite our opinion of what the US shoulddo with this industry, it is impossible not to notice that if you wereevaluating it on analyst earnings estimates alone that its earningsestimates have risen for all forawrd and current quarters over the last90 days.

The company has already disclosed that in Q2 it would record a $8.5million charge over the sale of its Auction Rate Securities on top ofthe $21.6 million charge in Q1.  As of mid-June the company said it wasin talks to increase the amount of liquidity available to it under arevolving asset based loan facility.

This need for increased liquidity makes the argument that it tradesunder book value with a $275 million market cap nearly irrelevantbecause all the liquidity is being used to fund the building of newplants over the next year.

Shares are down over 3% today at $6.56 and the 52-week trading range is$3.66 to $17.23.  In 2006 this was briefly north of $30.00.

Jon C. Ogg
July 31, 2008