In one of the first tangible confirmations of product demand, renewable tailored oils producer, Solazyme (SZYM), executed a defined commercial supply agreement with leading consumer products giant, Unilever (UL). Shareholder confidence quickly rose on the news as shares of Solazyme rose 7% to $11.51 by the end of the day on September 25.
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The supply arrangement covers the first jointly developed tailored oil profiles between Solazyme and Unilever. For the past five years, the two companies have maintained an active partnership for the purpose of developing oil profiles uniquely customized for Unilever's needs. Through this latest development, investors have now learned that these first oils are intended to be used in Unilever's personal care products. Specifically, they will be incorporated into Unilever's popular brands of Dove and Brylcreem according to the New York Times in an article found here.
Why It Matters
Solazyme's algal technology platform utilizes heterotrophic algae (grown in the dark) in order to produce tailored oils with a wide range of characteristic flexibility. Having spent the past decade fine-tuning this technology to work on a large commercial scale, the company is now finishing construction of two large plant facilities based in Brazil and the United States with its partners Bunge (BG) and Archer-Daniel-Midlands Company (ADM).
Using its novel technology platform, Solazyme is able to introduce valuable properties into its tailored oils. In designing a new oil profile, the company can control carbon chain length, saturation level, and the positioning of fatty acids. In doing so, it is able to produce large quantities of customized oils in a manner unable to be commercially replicated elsewhere. Yet as innovative as the technology may be, the market has remained skeptical about its market acceptance.
Leading this bearish sentiment is Piper Jaffray analyst, Mike Ritzenthaler. As the company expanded its relationships with Bunge and ADM in late 2012, Ritzenthaler criticized Solazyme for its lack of meaningful offtake arrangements as seen in the article found here. He was quoted as saying the following:
"The only thing that matters is selling product, and they (Solazyme) have no offtake agreements. Having capacity built before there is demand for the product only serves to squeeze the margins as it gives their customers the upper hand in contract negotiations."
However, Solazyme is now proving that this was never truly a concern. In the last two months, Solazyme has announced two offtake agreements with significant players within their respective industries. The company announced that petrochemicals leader, Sasol (SSL), signed a multi-year supply of high erucic algal oil in August. Now, Unilever has agreed to buy roughly 3 million gallons of algal oil over the next 18 months.
5 Key Takeaways
- Defined Contract Terms. The specific term of "10,000 metric tons [MT]" represents the first tangible point of reference as to how large these offtake agreements can be. This represents 10% of the Moema plant's full capacity. However, it likely represents a significantly higher percent of the production expected to be produced in 2014 as the company ramps up its production capability over the 12 to 18 months.
- High Margins. In noting that these oils will be used for its personal care products, prior guidance would indicate that investors should expect higher margins for these sales.
- Long-Term Partnerships. The conversion of Unilever from a development partner into a purchasing client remains highly indicative of the Solazyme's capability to renew such results with its other long-term partners. [i.e. Dow (NYSE:DOW), Mitsui (OTC:MITUF), Chevron (NYSE:CVX), etc.]
- Brand Integration De-risking. The willingness of Unilever to integrate Solazyme's algal oils into its leading brands of Dove and Brylcreem remains highly indicative of Solazyme's ability to penetrate other leading product brands. This shows confidence on the part of the customer to introduce these unique oils.
- Consistent Timeline. The terms of the agreement state that validation trials will begin in Q4 2013 which falls in line with prior construction guidance. The additional condition of a 12 to 18 month delivery also suggests that Solazyme's timeline remains accurate and on schedule.
Keeping It All In Perspective
It would be a mistake to see this initial deal with Unilever as being pretty small. Indeed, it would be very foolish to believe this 10,000 MT bar is the upside potential of Unilever's demand or capability. More so, it would also be foolish to believe that the Moema facility needed to be entirely booked prior to coming online.
Through the eyes of Solazyme's management, it is important to recall that the company is currently capacity constrained. The addressable market of the company's oils far surpasses the ability of Solazyme to supply this need. A look at the first developed oil profiles shown in the graphic below already illustrate this dilemma. This is before considering the vegetable oil market itself where Solazyme could technically deliver oil replicates.
Likewise, it is important to remember that Solazyme plans on addressing multiple customers through its upcoming facilities. This helps to diversify their revenue streams and gain an additional foothold into its various markets. Additionally, by ensuring that capacity is not fully booked, Solazyme is able to utilize its competitive advantage in logistics. Because the company's technology can quickly adjust to the market's needs, allowing for some capacity to remain open will allow for Solazyme to capitalize upon favorable market prices as they evolve.
A Look At The Company
Solazyme now trades with a market capitalization of $717 million at its latest price of $11.51 as of September 25. The company carries a rather high price-to-sales ratio of 19.16 and a high price-to-book ratio of 4.61. However, Solazyme remains a promising development company now transitioning into a commercial operations. The latest sales figures fail to reflect the upcoming growth in production capability. This is expected to rise from 1,800 MT to over 120,000 MT by 2014.
All the while, there are signs of significant profitability to come. Much of the company's revenue is currently derived from high-margin research and development. However, the company's product revenue to date also continues to meet Solazyme's margin guidance. In the six months ending in June 2013, product revenues averaged a gross margin of 67%. Skin & personal care sales, including those now announced by Unilever, are expected to achieve target gross margins of more than 60%.
While the relationship between Unilever and Solazyme is far from something new, it is the cleaner visibility of Solazyme's business plan that continues to push share prices higher. Solazyme remains a leading company in a frontier industry subject to risks found in uncertainty. Nevertheless, the company continues to execute by proving its ability to attract and retain lasting business partnerships. Unilever's new arrangement with Solazyme helps to introduce a new level of commitment between the two companies. For Solazyme, the agreement marks another validation of its technology platform as it enters into a global marketplace.
Disclosure: I am long SZYM, BG. 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.