# Why Solazyme Will Impact The Food Industry, Part 2

As an innovator and manufacturer of renewable oils and bioproducts, Solazyme (SZYM) now finds itself set to shake up the food industry as its first large scale commercial facilities come online. The company can cost-effectively produce healthier replacements for eggs, milk, and butter in a wide variety of products varying from baked goods to ice cream. Its ability to design uniquely tailored oils unable to be made elsewhere also gives the company a helping hand when it comes to carving out a niche in the field of nutritionals. This article is the second of a two-part series highlighting the impact Solazyme can have on the food industry. The first article can be found here.

Efficiency In Production

By creating more cost-efficient alternatives for milk, eggs, and butter without sacrificing the integrity of taste or quality, Solazyme can not only improve the health profile of processed foods but it can also simplify the food resource chain. Moving beyond just the algal "flour" product, the same can be seen in oil production. The company's process is simply more efficient. This can be illustrated through the rough calculations of the following example.

Consider for a moment that the average California cow produces just enough cream per year to produce 838 pounds of butter, or 3,352 sticks of butter per year. This is based on the assumption that it takes 11 quarts of milk to make 1 pound of butter and that the average cow produces 2,305 gallons of milk per year. On the other hand, there is 1/2 cup of vegetable oil in 1 stick of margarine and each cup of vegetable oil conservatively equates to 8 ounces.

According to Solazyme's Form S-1, there are approximately 290 gallons in a metric ton [MT] of Solazyme's oil. This suggests that 1 MT of oil is capable of generating roughly 9,280 sticks of margarine. Therefore, we see that the 100,000 MT facility now under construction for the joint venture between Solazyme and Bunge (BG) could roughly support the production of 928,000,000 sticks of margarine in a given year. Assuming sticks of butter are equal replacements to sticks of margarine, we see that this one facility could theoretically displace over 275,000 cows and their related costs.

That's quite impressive when one considers that there are roughly 60,000 dairy farms in the United States with the typical dairy herd averaging 135 cows per farm according to Purdue University. While this example may be a bit of a peculiar comparison, the point illustrates the efficiencies of utilizing Solazyme's technology in relation to the current food system.

More so, Solazyme is capable of creating food materials that are simply healthier than their alternatives. Seen above, the company can extend the usefulness of less expensive ingredients as I asserted in my other article These benefits are demonstrated by the reduced use of cream. All of this is done while still retaining a similar taste and texture profile to their original products.

Meeting Tomorrow's Food Oil Demand

There is a growing problem when it comes to the global supply of oils and fats. To understand why this is important, it is necessary to understand that there is an increasing demand for food oils. As seen in the chart below, the world market for vegetable oils has grown dramatically in the past few decades. Driven primarily by population growth and rising incomes, the accelerating trend remains set to continue even as the amount of arable land remains relatively the same.

Palm oil and palm kernel oil supplies remain one of the more at-risk crops for the foreseeable future. Both of these oils are derived from the same plant, whose production has far outpaced the other crops. Unfortunately, the supply for tropical oils such as palm oil and coconut oil can only grow so much larger as the habitat for either remains limited to a few particular areas. In 2012, the neighboring countries of Indonesia and Malaysia accounted for 86.6% of the world's total production of palm kernel oil according to the website found here.

What makes palm oil and palm kernel oil so useful also comes down to simple math. The palm tree is capable of yielding significantly more oil than any of the other commonly grown oilseeds. This is shown in the yield chart found below. The chart may seem deceptive at first until you realize that only crude palm oil and palm kernel oil [CPO + PKO] yield is being measured on the right in comparison to the other oilseed crops. Therefore we see that the palm tree yielded almost five times more oil than that of rapeseed plants (ie. canola), the next highest yielding oil seed crop.

The productivity of the palm tree remains unrivaled. Should its growth be stifled, the oil demand other crops will be expected to meet may prove to be a tall order to fill. In order to compensate for the volumes needed, less efficient crops such as soy or rapeseed may have to expand production. This will require significantly more land and resources (ie. water and fertilizer) in order to make up for the volumes that palm trees may otherwise have been able to address with far less. Therein lies a problem with vegetable oil production. The amount of choices available to be produced at scale remain limited. Likewise, those that are viable are simply inefficient in light of rising demand.

An Efficiency Solution Found in Solazyme's Algae

In my other article found here, I show that Solazyme is able to produce 864% more oil per acre utilizing Brazilian sugar than current PKO production is able to yield via the palm tree. When accounting for both CPO & PKO combined, Solazyme comes in second place as it roughly produces 1.59 MT/acre compared to palm's 1.73 MT/acre. The sheer productivity of Solazyme's process increases its usefulness for addressing world oil demand. Large quantities of oil can now be produced where sugar sources (ie. cane, sugar beets, corn, etc.) are grown. The solution helps address the immediate need for more oil.

Further down the road, there is still the promise of one day being able to utilize sugars derived from unconventional sources. Today, companies continue to refine their ability to extract cellulosic sugars from various forms of waste biomass. One company is even proving the concept of creating sugars out of waste carbon dioxide from industrial plants. Therefore, we see a transition away from the idea that sugar can only be grown on arable land.

Solazyme stands directly on the path of closing this futuristic loop of converting waste into practical food utilizing non-arable land. With its unique ability to replicate existing food oil profiles and create functional food replacements, Solazyme may be one of the few names capable of converting these elementary sugars into substantially meaningful food products. Solazyme itself has filed a patent to utilize waste glycerol in order to run its process.

The Priceless Immeasurables

Above all, there are the incalculable advantages to Solazyme's technology that are beginning to add significant weight to the company's value proposition. Take its logistical efficiencies for example. Because of the rapid growth of Solazyme's heterotrophic algae, the company is essentially able to provide significantly more "harvests" of per year than any other crop. For producers, the supply chain advantage is noteworthy. Rather than locking up capital or making decisions months in advance, clients are now able to improve cash flow while adjusting to market conditions. These thoughts are expressed by CEO Jonathan Wolfson during the Q1 2013 earnings call found below:

Today, formulators make financial decisions months or even years in advance on inventory and supply-chain management. Shortly, our customers will for the very first time, have a reliable commercial supply of valuable oils, with the added flexibility to react quickly to changing market demands. This is oppose to locking in full supply needs months or years in advance. The implications of this versatility are vast, for our customers and the specialty oils markets generally, and they provide unique margin capture opportunities for Solazyme.

Other priceless benefits of Solazyme's process can also be seen in the increased control that comes about from utilizing a fermentation facility. Weather no longer jeopardizes a crop's survival or dictates the quality consistency of Solazyme's output under these controlled conditions. Likewise, the harmful effects of pests and invasive species are practically nullified once procedures are established and optimized.

The same is unable to be said of current agricultural crop production. Droughts continue to be a nuisance driving the volatility of commodity prices. Decades of tackling weeds and insects utilizing genetically modified crops have also been met with problems. The introduction of "super-weeds" and "super-bugs" have shown Nature's knack for adopting to its environment. This thought is captured in the article found here:

The question is how much longer those benefits will last. So far, farmers have dealt with the proliferation of resistant weeds by using more glyphosate, supplementing it with other herbicides and ploughing. A study by David Mortensen, a plant ecologist at Pennsylvania State University in University Park, predicts that total herbicide use in the United States will rise from around 1.5 kilograms per hectare in 2013 to more than 3.5 kilograms per hectare in 2025 as a direct result of GM crop use.

Conclusion

There are very few oils and fats utilized within today's food industry which are able to be produced in significant volumes and at the right cost structures necessary to address the growing demand for vegetable oil. The most productive of these crops, found in palm, remains habitat-constrained and incredibly concentrated around two key countries. For these reasons alone, there is a growing need for a productive crop capable of further diversifying the portfolio selection now in existence.

Now trading with a market capitalization of \$703 million as of July 29, Solazyme stands as a developing company on the brink of addressing a vital market for sustainability. The company is able to convert low-cost sugars into viable food alternatives without significantly altering the taste of these products. The industrial biotechnology company is also capable of introducing new food oils that significantly improve the health profile of existing foods.

Solazyme presently trades 37% below its IPO price of \$18 per share in 2011. The company now carries more cash on hand than it did at its IPO and stands just months away from commercial production at its new facility in Moema, Brazil. It is here at this plant that investors continue to pin their expectations as to the direction of Solazyme. The company's target margins have yet to be proven.

Yet even as skeptics continue to debate the near-term profitability outlook of the company in light of its limited sales information, long-term investors should continue to focus on the viability of the technology. Solazyme can improve logistical efficiency just as it also increases quality consistency. In the area of food, the company's oil replacements should be able to easily integrate into existing supply chains. Above all, the company is introducing to the world a new source of oils with a wide range of functionality and flexibility. Such an opportunity does not present itself often to this stable industry.

Disclosure: I am long BG, SZYM. 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.