Energy analyst still stoked about ethanol

Falling pump prices are nice, but they shouldn't lull Americans into complacency about the need for alternatives to fossil fuels, President Bush said Thursday. "I welcome the low gasoline prices," Bush said in remarks at a renewable-energy conference in St. Louis. "However, it's not going to dim my enthusiasm for making sure we diversify away from oil."

If there's a segment of the alternative energy sector that can use a little presidential encouragement, it's the ethanol producers.

Some of the nation's biggest ethanol producers went public in June amid hoopla and optimism, as crude-oil prices were flirting with record highs. But shares of two of the biggest producers -- VeraSun Energy (VSE, news, msgs) and Aventine Renewable Energy Holdings (AVR, news, msgs) -- have slumped since their debuts, and both are still trading below their IPO prices.

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CNBC video: Brazil's big ethanol push

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The reason: Ethanol prices have slackened as the cost of a barrel of crude oil has fallen about 25% from its peak last summer.

But investors shouldn't rush to write off ethanol companies, said Pavel Molchanov, an energy analyst at Raymond James Financial (RJF, news, msgs), on CNBC's "Power Lunch" on Thursday.

"Ethanol is a very economically viable fuel today even without the subsidies, though (subsidies) add to the appeal," he said.

Ethanol is a type of alcohol, produced in the U.S. principally from corn. Ethanol is used as a cleaner-burning additive to gasoline and as an alternative fuel to power flexible-fuel vehicles. There are about 100 ethanol plants in the United States, and 38 under construction.

"Insofar as there is still tight (oil) refining capacity, there is still minimal production capacity around the world, alternative fuels such as ethanol help to fill in the gap, and they will become increasingly important as a component of the global energy mix," Molchanov said.

Molchanov's top ethanol pick is VeraSun Energy. He also likes Aventine Renewable Energy Holdings. "Longer term, the (ethanol) industry is going to grow at double-digit rates," Molchanov said. "We're very comfortable with the space going forward."

VeraSun Energy

It's the nation's second-biggest ethanol producer, after Archer Daniels Midland (ADM, news, msgs), and the biggest producer focused primarily on the production and sale of ethanol and its byproducts. "(The company) is free-cash-flow positive, with zero net debt," Molchanov said. "The stock is trading at 13 times earnings. Phenomenal value, with a double-digit growth rate."

The Brookings, S.D., company raised $420 million through its $23-a-share offering in June, and its stock closed its first day of trading up 30%. The stock fell to a low of $14.88 on Oct. 4. Shares closed at $18.80 on Thursday.

Ian Horowitz of Soleil Securities Group lowered his rating on the stock to "hold" from "buy" on Oct. 6, citing softening ethanol prices. "Even if gasoline prices begin to increase again, refiners are becoming more selective and discretionary in their ethanol purchases and will continue to pressure producers for pricing advantages," Horowitz said in a note to clients.

Ethanol prices may fluctuate, but refiners will continue to buy all of the ethanol they can get, Molchanov said. Refiners and distributors have historically blended ethanol with gasoline to increase octane and reduce tailpipe emissions. Geopolitical concerns and a federal mandate to use renewable fuels have contributed to increased ethanol demand.

Raymond James initiated coverage of the stock on Sept. 14 with a "strong buy" rating.

According to Zacks, the average brokerage recommendation on VeraSun Energy is moderate buy.

Aventine Renewable Energy Holdings

The Pekin, Ill., company produces ethanol at its facilities in Illinois and Nebraska.

The company last summer raised about $390 million through its $43-a-share offering. But the stock closed down on its first day of trading and moved steadily lower. The stock has rebounded a bit since hitting a low of $19.28 on Sept. 25. It closed Thursday at $23.26.

Ian Horowitz of Soleil Securities reiterated his "hold" rating on the stock on Oct. 6 but cut his price target to $19 from $25, noting that the company and other ethanol producers were losing pricing power as refiners had became "completely discretionary buyers" of ethanol.

Analysts at JPMorgan Chase (JPM, news, msgs) on Sept. 25 initiated coverage of the stock with an "overweight" rating. Raymond James initiated coverage on Sept. 14 with an "outperform" rating.

According to Zacks, the average brokerage recommendation on strong buy.