Alto Ingredients (NASDAQ:ALTO), a micro-cap firm, has made a name for itself in the American specialty alcohol market, where it is currently thought to be the market leader. It now maintains five alcohol production facilities with a total capacity of 350 million gallons. ALTO manufactures and distributes necessary materials (dry yeast, liquid feed, distiller grains, maize gluten meals and feeds, and so on) in addition to specialty alcohol. ALTO’s customer base is concentrated in end markets such as food and beverage, consumer goods, beauty, and so on.

EBITDA Profile Is Set to Rise 

Novice investors who have only glanced at ALTO’s recent EBITDA trajectory may be put off by three consecutive negative readings on the EBITDA front, including the first quarter of 2023.

On the recent earnings call, management implied that crushing margins were improving, and with a rebound in travel activity in the spring and summer months, one would think these fuel-grade ethanol margins would hold up well at least in Q2 and Q3. ALTO has already completed a few transformational projects (more on that later), which could result in a $10 million increase this year.

Overall, despite a negative reading of more than -$5m in Q1, FY23 consensus statistics for ALTO imply that the company could be on track to achieve positive EBITDA of more than $8m per quarter for the next three quarters. ALTO would be priced at a 5% discount to its long-term EV/EBITDA average of 18.3x at the FY23 forecast of around $19m.

That’s not awful, but if you extend your investing horizon by a few years, you’ll see a completely different valuation background, making ALTO look like a real steal.

Before we get to medium-term valuations, it’s worth noting that ALTO is currently in the midst of a transformation path to lessen its natural vulnerability to the swings of ethanol-crushing margins. ALTO has been expanding its footprint in high-margin product areas like grain-neutral spirits (GNS), maize oil, and high-quality protein to assist this.

ALTO updated the distillation of its GNS systems last year to produce high-quality 190-proof and low-moisture 200-proof products utilized in the food and beverage, pharmaceutical, and personal care industries. Management is currently placing its GNS products on a spot purchase basis for the remainder of the year, even as they begin discussions about annual contracts for next year; they expect these products to contribute $5m of EBITDA per year, with a potential run rate of $9m by next year.

Corn-oil prospects are even more appealing (given its beneficial properties as a cooking agent), and the market is expected to increase over the next decade. Management has been implementing new technology (CoProMax tech material) to increase corn oil production in one of their facilities (by around 40% in pounds per bushel), and it will soon be expanded to three other plants. These improvements are expected to increase group EBITDA by $9 million a year per plant, for a total benefit of $36 million by FY25.

ALTO has improved its manufacturing capabilities, plant efficiency, and fuel sourcing, in addition to producing higher-quality products. Efforts have been undertaken to expand their maize storage facilities, which will now provide them with plenty of breathing room during the corn-procurement activities. This is estimated to increase EBITDA by $2 million per year. ALTO will also have a new natural gas pipeline operational next year, which will assist lower energy expenses by $4 million per year.

All of these initiatives will result in ALTO’s EBITDA increasing fourfold over the following three years, reaching $67 million by the end of FY25. At that FY25 EBITDA run rate, you’re looking at a ridiculously cheap specialty commodity investment, with a projected EV/EBITDA multiple of less than 5x.

This year, the ALTO stock has had a bumpy ride, but despite the turbulence, it has still managed to provide positive returns of more than 20%, handily outperforming its micro-cap counterparts.

The recent upswing will undoubtedly fuel the enthusiasm of ALTO’s management team, which has been opportunistically buying back stock since they believe it is undervalued. For reference, the business is now undertaking a $5 million repurchase program (it was originally intended to be a $10 million program, but was later reduced by ALTO’s lenders) and has already spent one-third of its war chest in Q1 alone. ALTO has another $3 million on the way, which will most likely be deployed in the next quarters and could provide some support to the stock price.

It’s also worth noting that, despite the significant alpha generated this year, there appears to be plenty of room for additional rotation momentum. ALTO has performed in comparison to the iShares Micro-Cap ETF; despite a doubling of the ratio from earlier this year, it is still a long way from breaching the midpoint of its medium-term range.

Having said that, investors should be cautious because there are still a few issues to be concerned about.

To begin, check ALTO’s own weekly price patterns over the last two years; while there have been occasional surges in the stock price, it’s safe to conclude that we’re dealing with a long-term declining channel.

If one were to consider a long position at current levels, using the channel’s two borders as guideposts, the risk-reward (R:R) on offer appears unappealing at just around 0.2x (ideally, you want to get in when the R:R shifts to 1x or above).

Investors should also keep in mind that, despite a reasonably solid upswing since April, this has done little to deter short-sellers. On the contrary, short interest has increased by around 47% since the end of March.

Finally, investors should keep in mind that the recent rally has been fueled primarily by retail interest (which isn’t necessarily a bad thing, but more broad-based participation would have been preferred); on the other hand, the guys with deep pockets–the institutions–continue to reduce their stake in ALTO every other month. Effectively, their net shares owned are down by 20% year to date.

Featured Image: Freepik @ Paulina

Please See Disclaimer