Should Investors Worry About Pacific Ethanol Stock's 29% Fall in July?

What: Shares of Pacific Ethanol have experienced a rocky 12 months. After reaching multi-year highs in September 2014, the stock fell due to eroding margins across the ethanol industry. Then, after clawing back gains for the first four-and-a-half months of 2015, Pacific Ethanol stock collapsed, briefly entering free fall in mid-July before ending the month -- and year -- down 29%. What gives?

So what: Most of the stock's decline is explained by the significant dilution that occurred as a result of the all-stock acquisition of Aventine Renewable Energy. Prior to the acquisition, Pacific Ethanol had 24.7 million shares outstanding. After the acquisition closed on July 1, the number of shares outstanding swelled to 42.4 million -- an increase of roughly 72%.

The market was fully justified in adjusting the stock price to account for the significant dilution from the Aventine acquisition, but remember how dilution works. While shares slipped 29% in July, the company's market cap actually rose 23% from June 30 to July 31. Staring at the stock price chart looks like the market punished Pacific Ethanol, when it actually handed it a higher valuation.

Dilution aside, in the long term (and actually much sooner), the acquisition will be quite favorable to Pacific Ethanol investors. The company increased its annual ethanol production capacity from 200 million gallons to 515 million gallons -- making it the sixth-largest ethanol producer in the United States, with over 800 million gallons of distribution capacity. The latter volume is what investors can expect the combined company to sell every year moving forward.

Moreover, the company whipped up a solid second-quarter earnings report at the end of July that saw sales grow 10% over the first quarter, a quarterly record volume of ethanol sold, and positive EPS.

Now what: While it may take longer than anyone expects for the ethanol market to rebound (although I wouldn't expect ethanol prices and margins to return to the record levels set in 2014), Pacific Ethanol's business has only become stronger in the last 12 months. The recent slide in share price may have been needed to justify a higher post-dilution market cap, but it doesn't account for the upcoming growth from the Aventine acquisition, nor a potential rebound in the ethanol market in the next 12 to 24 months. Investors need not worry about the share price decline in July.

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