Vertex Energy: Pioneering “Trash to Treasure” in the Oil Business
Key Highlights
To analyze the potential of Vertex Energy stock, we have employed multiples and public comparables analyses, as well as a Discounted Cash Flow (DCF) approach to conclude that the stock is a BUY. We have also considered fundamental analyses, as well as macro and airline industry factors in our overall calculation.
Company Description Vertex Energy, Inc., an environmental services company, provides various services designed to aggregate, process, and recycle industrial and commercial waste streams, as well as off-specification commercial chemical products. It operates in three divisions: Black Oil, Refining and Marketing, and Recovery. Vertex Energy, Inc. is based in Houston, Texas and went public in 2004 (NASDAQ).
Returns Compared to S&P
Risks
Side effect of oil prices affecting energy markets. However, we note that it is still cheaper to re-refine used oils and distressed hydrocarbons than to drill and incur the higher logistical costs of virgin crude. Vertex Energy is in a great position to provide its customers with very competitive distribution and production contracts across its product lines.
It takes one-seventh the energy to re-refine used oil as opposed to processing virgin crude, which makes their business model sustainable for the future when oil prices begin to climb due to supply concerns and geographical conflicts.
Low EBITDA margins and high costs Despite high revenues, Vertex experiences low EBITDA margins in the 4-6% range due to increased costs and redundant workforce from acquisitions. In the future, we see that management cutting down on extra manpower and integrating the extra capacity and specialized market knowledge to drive revenue and cost synergies.
Business Model
Vertex deals primarily in the used oil recycling industry. This industry is comprised of five main participants:
Generators. These are entities that generate used oil through their operations. Generators include industrial businesses changing lubricants on machinery as well as automotive businesses conducting oil changes on both consumer and commercial vehicles.
Collectors. Typically local businesses that purchase used oil from generators and offer oil collection services, it is estimated that there are more than 700 used oil collectors in the U.S. due to the collection market being highly fragmented.
Aggregators. These are specialized companies that purchase and amass used oil and petroleum by-products from collectors for delivery and sale as feedstock.
Processors. Also known as re-refineries, these businesses convert the used oil or petroleum by-product into a higher-value feedstock or end-product via various processing technologies. Traditionally, re-refineries will utilize vacuum distillation and hydrotreating to remove impurities and contaminated water to create a stable, usable product.
End Users. Businesses that utilize used motor oil as well as products created from re-refining used motor oil. These products include lubricating base oil and recycled motor oil slightly lower in quality than the original product, often called intermediate products. They are usually utilized as industrial fuels or transportation fuel blendstocks.
Industry Background
Recycling petroleum by-products has both financial and environmental benefits, which drive the growth of the industry. Financially, the fact that used oil can be recovered and used as industrial fuel poses great potential as collectors and aggregators can cash in on a product that is unneeded and unusable to the common citizen. Furthermore, the ability to re-refine used oil into higher value, higher quality end products opens the market to processors who are able to recycle used oil into products such as lubricating base oils, fuel oil cutterstock, or transportation fuels. The U.S. market for recycled oil is estimated to between $2.4 and $2.8 billion and over half of the 1.3 billion gallons of used oil generated annually is burned as industrial fuel. Since re-refined oils can be sold at a higher price, the amount of intermediate products will increase as re-refining capacity grows and technology advances, given this high proportion of industrial fuel usage.
The used oil recycling industry is also driven by environmental benefits. Given that used oil can cause an extreme amount of water contamination if improperly disposed, there is high motivation to find an alternative use for used oil. Furthermore, re-refined oil significantly reduces the amount of toxic heavy metals and greenhouse gases introduced to the environment compared to burning used oil as industrial fuel and help conserve petroleum that would go towards producing virgin base stock oil. Re-refined used oil will increase in demand in the future due to the environmental benefits over utilizing used oil as industrial fuel.
With the increase in demand in re-refined oil products from both financial and environmental outlooks, the used oil recycling market has high growth potential through increasing the quantity of environmentally responsible re-refined oil as opposed to industrial fuel. Increasing consumer and industrial awareness can drive extra market growth as 200 million gallons of used oil are still being improperly disposed of instead of being recycled. This, along with increasing demand for re-refined oil and re-refining capacity, will drive market growth for the foreseeable future.
Investment Thesis
Investment Thesis 1: Underpenetrated petroleum recycling industry
There has been a growing eco-friendly trend to recycle used oil. Recycling used oil (UMOs) helps balance the desire for convenient transportation and a clean and healthy environment.
The idea that oil can be recycled is a relatively new idea that has a lot of room for exploration and development. There have been proven cases of successful application of this idea. Used oil can be burned in furnace for heat, used by power plants to generate electricity, processed to be used as industrial burners or as lubricants. Recycling motor oil can help improve fuel economy and reduce greenhouse gas emissions. This industry outlook is aligned with the Obama Administration’s national program to reduce dependence on foreign oil. Moreover, the technology and skills that Vertex Energy provides is expected to accommodate interests of industrial companies with the attractive notion of converting trash to treasure. Recycling used motor oil provides a valuable resource and contributes to the prevention of improperly disposed used oil. The oil recycling industry is underexplored, yet has enormous potential benefits.
Despite the positive outlook of the industry, there are high barriers to entry, which will preserve Vertex Energy against intense competition from newly emerging companies. Participation in this industry requires knowledge of the re-refinery technology. Vertex Energy registered two patents relating to Thermal Chemical Extraction Process (TCEP) technology. TCEP is a technology which utilizes thermal and chemical dynamics to extract impurities from used oil. Vertex Energy plans to continue to improve TCEP technology and invest in additional technologies to upgrade feedstock into higher value end products, to focus more on fuels and lubricating base that command higher market prices than the current re-refined products. We believe that these factors will secure a stable place for Vertex Energy in the industry and serve as drivers for increased revenue and gross margins.
Investment Thesis 2: Vertex Energy is currently undervalued
We believe that the market share price of Vertex Energy has not yet taken into account the potential upsides of their recent acquisitions or the value of their current technology. Vertex Energy has been making aggressive acquisitions to increase the production capacity and achieve vertical integration. They have consolidated feedstock supply through partnerships and acquisitions. Increase in production capacity will provide opportunity for Vertex Energy to increase revenue and maintain better control over the quality and quantity of feedstock. In addition, they are striving to achieve vertical integration by developing their current technology and acquiring complementary recycling and processing technologies. The synergic effect will allow them to leverage customer and vendor relationships and eliminate duplicative overhead costs.
- Gugnir and Partners, 2018 Research Sample.
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