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REX Stores Picked A Bad Time To Bet On Corn

Posted: Jul 14, 2008 10:00 AM by Eric Fox

Tickers in this Article: RSC, CC, BBY, PEIX, VSE, XNL

Many retailers have been suffering from the current economic conditions of low consumer confidence and spending, and on the surface it appears that REX Stores (NYSE:RSC) is no exception.

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It's most recent quarterly financials saw revenues of $47.1 million and 12 cents worth of diluted earnings per share for its first quarter of fiscal 2008, both of which represented declines on a year-over-year basis. RSC also reported that comparable store sales declined 0.3%. Some investors may dismiss the results as just another retailer suffering under the weight of reduced consumer spending due to high gasoline prices and the weak economy. However, REX Stores stands out among retailers as having significant investments in alternative energy, particularly ethanol.

From Traditional Retailer To King of Corn
REX Stores began life as a retailer of electronics and appliances, and has grown to operate 115 stores in 34 states. Starting in 1998, it began to make selected investments in alternative energy. Concurrently with these investments, it began to divest stores that were either at the end of their lease and unprofitable, or when the real estate that it owned where its stores were located, could be sold off to a third party.

As recently as January 2005, Rex Stores had 234 stores operating in 37 states, but as its new strategy has played out, it has reduced its store count by more than half. During fiscal 2007, which ended January 31, 2008, the company closed 78 retail stores and invested the proceeds in its ethanol initiatives.

Terrible Time to Bet on Ethanol
This transition, from a retailer of electronics, competing with Best Buy (NYSE:BBY) and Circuit City (NYSE:CC), may be almost complete, as REX Stores finally announced in its earnings press release what many investors have been hoping for: "the launch of a strategic alternative review process of its retail segment ... including opportunities to monetize its real estate portfolio."

Unfortunately for REX Stores, this bold move from retailer to ethanol producer is coming at a particularly bad time in the ethanol business, as it is currently suffering weak margins as prices for its main feedstock, corn, soar due to poor harvest conditions in growing areas. The price of natural gas, another important cost for ethanol producers, is also rising. This has led to negative margins for many producers.

RSC currently has four major investments in Ethanol

Company	Capital Investment (Millions)	Capacity (Gallons in Millions)
Levelland Hockley County Ethanol, LLC	$16.5	40
Patriot Renewable Fuels, LLC	$16.0	100
One Earth Energy, LLC	$50.8	100
Big River Resources, LLC-W.	$20.0	192
Total	$103.3	432

Ethanol on the Ropes
While it is unclear whether the strategy that REX Stores is pursuing will succeed long term, it is clear that it is hurting the company in the short term as conditions in the ethanol industry have deteriorated as of late. Corn, which is the main feedstock of ethanol, has been soaring in price as flooding and wet weather in the Midwest is cutting government estimates of the size of the crop.

Unfortunately, while spot and futures prices for ethanol have increased, it has not moved high enough to offset the higher costs, leading to losses for many plants. Other ethanol producers are also suffering from ethanol industry conditions, with Pacific Ethanol (Nasdaq:PEIX), Verasun Energy (NYSE:VSE) and Xethanol (NYSE:XNL) all trading at or near their 52 week lows.

The Bottom Line
The latest quarter results were not good for REX Stores, with both its retail and alternative energy business showing weakness. Retail is suffering from a weak economy and slower growth in consumer spending on discretionary items, while alternative energy is being hurt by soaring input costs of corn and natural gas. The transition from retailer to alternative energy is not proceeding as smoothly as management would like, but if they can successfully pull it off and industry conditions improve, its shareholders that have patience today may be more than fairly rewarded in the future.

By Eric Fox

Eric J. Fox, is the founder of Brittain Capital Management, LLC., which manages the Alesia Fund, LP., a Value oriented long/short investment partnership. You can read more of his views on investments at his blog - Stock Market Prognosticator.

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