A Look At The Biofuel Industry

| About: Gevo, Inc. (GEVO)

Shares of biofuel companies have had an excellent run so far this year. Among the biggest gainers have been Gevo Inc. (NASDAQ: GEVO), which is up more than 24%, and BioFuel Energy Corp. (NASDAQ: BIOF), which is up more than 25%. Shares of Renewable Energy Group Inc. (NASDAQ: REGI) have gained more than 22% this year, while Pacific Ethanol Inc. (NASDAQ: PEIX) shares have gained more than 10%.

So what is driving shares of biofuel companies higher this year?

At the start of this year, biofuel companies received a major boost after lawmakers signed a last-minute fiscal cliff deal. The deal signed by lawmakers included the extension of tax credits for renewable energy and alternative fuels.

Biofuel companies received another major boost earlier this month after the Environmental Protection Agency (EPA) proposed increasing required use of renewable fuels.

While these are significant developments for the biofuel industry, the big question is which companies are in the best position to capitalize on these developments? Let's start with Gevo, a company I have already discussed in the past.

Gevo's Strong Cash Position

Gevo had seen a huge sell-off in its shares in September last year after the company announced plans to suspend production of isobutanol from corn at its Luverne facility. The company instead decided to shift to ethanol in the near term, with plans to start isobutanol production sometime in 2013.

As I said in my previous article, Gevo's share gains this year have partly been driven by speculation that the company will soon start production of isobutanol at its Luverne facility. The stock also benefited from a stock buyback program announced by the company earlier this year.

At the end of the third quarter of 2012, Gevo had cash and short-term investments of $92.27 million. The company's long-term debt, meanwhile, stood at $45.35 million. Gevo, certainly, is in a solid financial position.

What makes Gevo stand out from other companies in the biofuel space is its focus on isobutanol. Unlike other forms of biofuels, GEVO's isobutanol can be easily blended with gasoline. This means that isobutanol can use the existing infrastructure and therefore provide for easy integration into existing refining and petrochemical production processes.

If Gevo can produce isobutanol at a large scale, the company would definitely become one of the major players in the fast-growing biofuel space.

Commenting on the company's plan to shift to ethanol, CEO Patrick Gruber, Ph.D., had said late last year that the company decided to take advantage of its flexible technology and temporarily revert the Luverne facility to ethanol production with two goals in mind; demonstrate to partners that the company's plants can switch between isobutanol and ethanol production; and generate incremental cash flow.

In the third quarter of 2012, Gevo had reported revenue of $0.6 million, down from $17.5 million reported in the same period in 2011. The significant decline in revenue was mainly due to the fact that the company was engaged in start-up operations for the production of isobutanol at the Luverne facility. Once the facility starts full-scale production of isobutanol, one can expect a significant increase in revenue.

Another major development for Gevo has been a proposed bill in Minnesota that would enable isobutanol to be blended in Minnesota gasoline. The bill will be reviewed by legislators in the state today. The bill seeks to set an "aspirational goal" of displacing more petroleum use by calling for Minnesota gasoline to contain a 30% mixture of biofuels by 2025, according to Tim Rudnicki, who is the executive director of Minnesota Bio-Fuels Association.

The purpose of the bill is to increase the use of ethanol and also use more biofuels of all kinds. The bill would directly benefit Gevo as it is one the few companies that can distill a bio-based version of isobutanol from corn.

The Others in the Biofuel Space

Gevo certainly has the potential to become a major player in the biofuel space. However, it is worth looking at some other companies in the industry.

Renewable Energy is engaged in all aspects of biodiesel production. The company acquires feedstock, manages construction and operates biodiesel production facilities to market, sell and distribute biodiesel and its co-products.

Renewable Energy's strategy has been to increase production capacity through acquisitions. The company made two such acquisitions late last year. In November last year, the company announced the acquisition of a 15 million per year biorefinery located in New Boston, Texas. The company paid $300,000 in cash and also issued 900,000 shares of its common stock to North Texas Bio Energy to acquire the multi-feedstock biorefinery.

Also in November last year, the company announced the acquisition of a 15 million gallon per year biodiesel production plant near Atlanta, Georgia.

In the third quarter of 2012, Renewable Energy saw a 26% increase in its revenue to $322.9 million. Cash flow from operations for the quarter was $6.2 million. At the end of the third quarter, the company had more than $88 billion in cash on its balance sheet.

One of the biggest concerns with Renewable Energy in the past was the company's high debt levels. At the end of the calendar year 2011, the company's total debt was more than $160 million. However, since then the company has made efforts to bring down its debt level, and at the end of the third quarter of 2012, the company's total debt stood at $85.68 million.

In the fourth quarter of 2012, the company paid off long-term debt obligations of its operating biorefinery subsidiary in Seneca, Illinois.

Another biofuel company that is making efforts to bring down its debt level is Pacific Ethanol, the California-based marketer and producer of low-carbon renewable fuels in the Western U.S. In January, the company announced agreements to increase its ownership interest in Pacific Ethanol plants and improve their debt position.

At the end of the third quarter of 2012, Pacific Ethanol had total debt of $119.09 million, with long-term debt accounting for nearly $69 million. Meanwhile, the company had only $18.57 million in cash and short-term investments at the end of the third quarter.

Pacific Ethanol's net sales in the third quarter of 2012 were $215.9 million, down from $271.6 million. Total gallons sold for the quarter were 107.3 million, down from 122.6 million gallons. The company is also facing margin pressure.

Final Words

Gevo certainly is my top pick in the biofuel space, given the company's potential. The stock has been gaining momentum on expectations that the company might start production of isobutanol at its Luverne facility in the near term. It will be interesting to see if the company provides any update on the issue when it releases its financial results on March 5, 2013.

As I said, Gevo stands out from others in the biofuel space due to the fact that isobutanol can be easily blended with gasoline unlike some other forms of biofuels. In addition, the company has a relatively strong balance sheet.

Renewable Energy is another good pick in the sector right now, given the fact that the company is reducing its debt level and has been making strategic acquisitions.

Corn ethanol producers such as Pacific Ethanol and BioFuel Energy are perhaps the weakest links in the biofuel space.

Disclosure: I am long GEVO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.