Gevo: Not A One-Trick Pony

Oct.28.13 | About: Gevo, Inc. (GEVO)

Gevo (GEVO) makes isobutanol, a known molecule with a known market of about 1 billion gallons a year, most of which is made from petroleum. Dr. Patrick Gruber, the Chief Executive Officer says "Gevo's corn-based isobutanol will be 36%-40% cheaper to produce in a commercial production facility than the oil-based version." In mid-June Gevo announced the commencement of their first full-scale commercial production run at the biorefinery located in Luverne, Minnesota. In August Gevo announced that it had brought a second million liter fermenter online which validated the technology and that two additional fermenters would be brought online before the end of the year.

Gevo will host a conference call to report the third quarter financial results on November 5, 2013, which is when an update on the progress of isobutanol production is expected to be announced. That catalyst is certain to have an impact on shareholder value since the timing for ramping up production of isobutanol at other facilities depends on a full and successful production run at Luverne. Gevo currently has a short interest of nearly 8 million shares reported on 10/15/2013 with a short ratio of over 23 suggesting Gevo is ripe for a significant short squeeze.

Understanding how to maximize the value of isobutanol in co-products is key to Gevo's success. Gevo holds the rights to over 450 patents and patent applications for the economic production of isobutanol, process innovations, and downstream product applications.

Gevo will sell the isobutanol it produces in the specialty chemicals and specialty oxygenated fuel blend stock markets, and use it as a building block to make jet fuel and chemical products, such as paraxylene, which is converted into PET and used in the production of bottles and fibers.

Gevo markets include:

Solvents and Coatings. A solvent-grade renewable isobutanol can be used in the existing butanol market as a cost-effective alternative to petroleum-derived solvents with a lower carbon footprint.

Materials, Plastics, and Fibers. Isobutanol can be dehydrated to produce butenes, which are building blocks for the production of materials such as lubricants, synthetic rubber, PMMA, propylene, xylene, and PET. Gevo's isobutanol can provide chemical companies with an alternative to petroleum-based butenes with potential advantages in cost, predictability and life cycle profile.

Biojet Blend Stock. Isobutanol has been converted to kerosene, which is a drop-in blend component for petroleum jet fuel. Bio-based kerosene has the potential to provide a cleaner burning, renewable jet fuel with a lower carbon footprint. Working with the Department of Defense, they have validated that alcohol-to-jet fuel is a clean-burning, homegrown, drop-in option.

Specialty Fuels. For specialized uses, such as small-engine and/or marine fleet engines, it is important to have a fuel that does not cause shortened engine life or create operational safety issues, and can meet EPA emission targets. Isobutanol has a lower Reid vapor pressure value than ethanol and, with 30 percent more energy, generates significantly more renewable fuels credits. It has a lower propensity for phase separation in the presence of water and has no stress corrosion cracking compatibility or elastomer.

Burning Down the Rumor Mill

An article published on 10/24 impugning the viability of Gevo's business model caused a bit of a stir on Twitter and in internet chat forums as news spread of a proposed change to the EPA's renewable fuel standards mandate in 2014 that the article suggested would curtail Gevo's profitability. As any concerned investor would do I immediately set about the task of evaluating the effect this could have on shareholder value. After careful study I determined that even if the proposed changes do occur it will not have a negative impact on Gevo's future.

The article focused on a leaked draft document that indicated the Environmental Protection Agency is looking to cut the renewable fuels standard mandate for 2014 and 2015 by 6% from current levels, which would indicate a significant cutback in ethanol's corn demand. The proposal if passed would reduce the revised Renewable Fuel Standard's [RFS2] volumetric mandates for total renewable fuel and advanced biofuel in 2014; however there is good reason to expect that the changes may not even occur according to Bob Dinneen, president of the Renewable Fuels Association.

The impact of the renewable fuels standard mandate to Gevo was brought up and discussed during the 2nd Quarter's conference call on Tuesday, August 06, 2013, during the question and answer segment. The recording is still available on Gevo's website. The issue was addressed beginning at the 33rd minute into the conference call. It is clear that management has planned well ahead and made provisions in their marketing strategy to avoid any potential negative impact that something like a change in the renewable fuels standards mandate could have on Gevo's future.

It is worth mentioning that, should the EPA decide to change the mandate, a cutback in ethanol's corn demand could result in lowering the price of corn. That would have a net positive impact on Gevo as it would result in an increase to their profit margin. No matter what changes are made by the EPA for 2014 and beyond there will be no negative impact on Gevo, but a change could actually work in Gevo's favor. The same may not be said for most of Gevo's competitors who are still producing ethanol, some of whom are already knocking on Gevo's door about having their ethanol plants converted to produce isobutanol using Gevo's GIFT system.

The Gevo GIFT system

CFO Mark Smith explains:

We targeted commercial performance, then identified the process. We knew that we had to be cleaner and greener, but ultimately cheaper. What trips up renewable companies is capital intensity. Hence our retrofit strategy, which utilizes underperforming assets to produce higher value product, and allows us to scale up quickly.

Owners of existing mills producing ethanol get a higher value product with a lower volatility revenue stream by partnering with Gevo. Gevo scales up at a fraction of the cost of building new production facilities by retrofitting the mills with a bolt-on system, utilizing almost all of the systems of existing dry mill biorefineries that produce feed grains and ethanol. Capital cost estimates for a 22 million gallon retrofit is $17M, a 50 million gallon retrofit is $22M-24M, and a 100 million gallon retrofit is $40M-$45M.

On a closing note, CEO Pat Gruber was the winner of the 2008 Carver Award for Lifetime Achievement which recognizes significant contributions by individuals in the field of biotechnology and its application in biological engineering. Here is a short video of Dr. Gruber demonstrating how easily isobutanol separates from water.

Note: Edited, prior to submission to Seeking Alpha, by Michael LaRocca.

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.

Disclaimer: This article is for informational and educational purposes only and should not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.