South Dakota-based VeraSun Energy (VSE) is a cool ethanol play as the race to meet the 7.5 billion refinery requirement for ethanol usage mandated by Congress continues to take shape. Over the long-term, the benefit of owning VeraSun is that it acts as a hedge against rising oil prices. Oil is coming off recent lows of $58 dollars a barrel.

As a result, drivers in certain states may have noticed the brief reprieve in gasoline prices over the past several weeks. As politicians continue to debate the fate of U.S. involvement in the Middle East and with uncertainty concerning the intentions of OPEC nations, the price of oil will tend to fluctuate and it is likely to climb higher during 2007.



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In the United States, VeraSun is the second-largest producer of ethanol behind Archer Daniels Midland Co (ADM). VeraSun's goal is to produce more than a half-billion gallons of renewable fuel annually. Archer Daniels Midland's current capacity is 1 billion gallons of ethanol with its existing facilities. VeraSun is currently building a new facility near Hartley, Iowa that will be capable of producing 110 million gallons of ethanol a year.

The plant is scheduled to open during the first half of 2008. VeraSun's existing operational capacity includes ethanol facilities in Aurora, SD and Fort Dodge, IA which produce 230 million gallons a year combined. VeraSun is also considering the development of a large scale biodiesel facility which could utilize distiller grain from its other facilities.

There is a considerable amount of capacity being developed by in the ethanol space. Along with VeraSun and Aventine Renewable Energy (AVR), the upcoming IPO of Minnesota-based U.S. BioEnergy under the ticker symbol USBE will be the third new offering in the ethanol space this year.

However, the established players are not sitting idle. Archer Daniels Midland is focused on increasing its capacity by 50% and Pacific Ethanol (PEIX) also has plans to build out 420 million gallons of ethanol capacity over the next 4 years.




VeraSun's initial public offering took place in June this year at $23 a share and trickled down to a low of $14.88 in early October. During the same time frame, light crude oil prices fell on the New York Mercantile Exchange from the high $70 range to the low $60s. The trend suggests that while rising oil prices benefit ethanol stocks, falling oil prices have the opposite effect.

For the trailing twelve months VeraSun's PEG (Price-to-Earnings Growth) ratio of 1.33, below the industry mean of 1.66, suggests that the stock is currently inexpensive. The PEG ratio is calculated by dividing the PE (Price-to-Earnings) ratio by the trailing twelve months earnings. Therefore, assuming a constant price, the higher the growth rate, the lower the PEG ratio. By my calculations VeraSun registered a growth rate of nearly 25% with a relatively high PE ratio of 32.95 in comparison to the industry average PE ratio of 21.24.

VeraSun's high PE ratio could mean that analysts have high expectations of its future earnings growth. VeraSun's larger competitor Archer Daniels Midland also has an attractive PEG ratio of 1.40 and a low PE ratio of 15. Archer Daniels Midland's forward PEG ratio is also respectable at 1.45, but VeraSun's forward PEG ratio is well below 1.00 at 0.78, further supporting the future value of the company.

Investors seeking an ethanol play with bright future prospects and attractive valuations can rest assured that VeraSun delivers in both categories.



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Tickers in this Article: VSE, ADM, AVR, PEIX

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