In my previous coverage of Solazyme (SZYM), I reviewed the company's earnings results while offering insight into the company's pursuit of whole algal products such as Encapso and AlgaVia. In this article, I want to focus on the company's high-oleic oils which serve as some of the first algal oils now selling out of the recently-launched Clinton facility based in Iowa. While most investors would fail to distinguish between oils for their properties, it stands as a bold statement that Solazyme has chosen to produce these oils now.
In many ways, Solazyme's high-oleic oils help to further validate the novel technology to future partners who are capable of expanding the company's objectives. High-oleic oils have large volume markets and widespread application. They represent the latest achievement in oilseed technology, having taken nearly two decades of development to reach the consumer. Yet within ten years of being founded, Solazyme has managed to create an alternative source of high-oleic oils that can be rapidly produced and easily scaled. Above all, these oils rank on the highest end of quality, showing properties that exceed that which is now produced by the more established competition.
Solazyme Brands Its Industrial High-Oleic Oils
As the initial production out of its Clinton facility continues to ramp, Solazyme is beginning to develop its first commercial markets. Recently released product information found here suggest that the renewable oils and bioproducts producer has now branded its industrial oils under the trademarked name of Soleum. First out of the gate is the company's high-oleic oils which are expected to be used in a variety of ways including lubricants and dielectric fluids.
While initially geared towards metalworking lubricants, the same high-oleic platform used to create these oils is also expected find its way into food-based applications as well. In Solazyme's Q1 2014 earnings call, management noted that the company recently completed the U.S. self-affirmed GRAS (generally recognized as safe) process allowing it to commercially sell the oil for food applications in the United States.
But what is it about a high-oleic oil profile that is so ideal? In many ways, the question can mean several things to several industries. However, one such way to answer this question is to consider that the profile offers some of the highest oxidative and thermal stability properties found in an oil. This directly translates into product shelf life and functionality.
For industrial purposes, it might mean greater fire resistance properties and overall duration of product use. The same goes for food applications when we consider oils used for packaged baked goods or frying oils. When food manufacturers began to shift away from the use of trans fats, they sought to use high-oleic oils to preserve their food longer for customers. When it came to frying oils, high-oleic oils provided additional frying life which directly resulted in cost savings from longer use.
The Search For High Oleic Oils Heats Up
In November 2013, the U.S. Food and Drug Administration announced a progressive step in the journey to eliminate trans fats in processed foods. This preliminary declaration served as a strong signal to the industry that trans fats were on the way out. Trans fats are the artificial fats found within any product using partially hydrogenated oils. As a result, this suggested that the well-established manufacturing process of hydrogenation would also be facing a significant decline.
The reason that trans fats are used is because they give foods a desirable taste and texture. They are easy to use, inexpensive to produce, and preserve well. Restaurants and fast-food outlets often use trans fats to deep-fry foods because oils with trans fats can be used many times over in commercial fryers. Foods such as French fries, doughnuts and almost all pastries often include some amount of trans fats.
Yet in recent years, many manufacturers and retailers have voluntarily taken action into their own hands by reducing the level of trans fats in their foods and products. Many food companies have already proven that most of their products can be made without trans fats. Yet certain foods, like baked goods, also require solid fats in order to function. This requires particular oils and fats that share texture properties only partially hydrogenated oils were best fit to provide.
As a result of this search, partially hydrogenated oils will have to be replaced with another solid fat such as those made from palm oil. However, this search for an alternative also raises an issue of increased health risks. This is according to research by the Agricultural Research Service, a intramural scientific research agency of the U.S. Department of Agriculture. Their research concluded that palm oil is simply not a healthy substitute for trans fats.
In The Pursuit Of A Solution
Ultimately, one source of oils which are becoming increasingly looked upon as a potential solution are high-oleic oils. Oils like Cargill's Clear Valley brand of canola oil have helped lead the way in replacing trans fats for frying and food manufacturing. For instance, Clear Valley 65 (which has 65% oleic acid) has been the dominant high-oleic canola oil in food service for the past 20 years. Standing as a testimony in itself, fast-food giant McDonald's (MCD) stands as one such loyal customer to Cargill. The company got rid of its trans fats in 2008 and continues to award Cargill for its contribution in high-oleic canola oil.
Yet advancements and alternatives are beginning to enter the industry as well. For example, Cargill recently launched its Clear Valley 80 high-oleic canola oil in 2011, after more than 15 years of development. As the name suggests, the oil contains 80% oleic acid.
Additionally, high-oleic soybean oils are also on the cusp of entering the marketplace. Monsanto (MON) has its brand of Vistive Gold soybeans and DuPont Pioneer (DD) has its Plenish soybeans. At least in the case of Plenish, it has taken 20 years of research and development for this new soybean oil solution. Both of these brands are high-oleic varieties but have had a rough start to date in expanding their acreage.
Nevertheless, the soy industry has remained optimistic about its potential impact and outlook in the race to replace partially hydrogenated oils. The American Soybean Association requested the FDA not withdraw its GRAS status on trans fats. They cite that current projections from QUALISOY suggest that approximately 1.3 billion pounds of high oleic soybean oil can be ready for use by the food industry in 2017. This amounts to nearly 590,000 MT of soybean oil. According to their estimations, there are approximately 0.9 million MT to 1.15 million MT of partially hydrogenated oils that are still on the market.
A Look Solazyme's High-Oleic Platform
This ultimately brings us back to Solazyme's High-Oleic oils platform for several reasons. First, it shows the near-term need for high-oleic oils in just the nutritional markets alone. Second, it's important to realize just how long it has taken for these new high-oleic commodities to be developed and put into the marketplace. Last of all, it's ideal to see just how Solazyme's platform compares against the competition in this evolving field of high-oleic oils.
Investors should remember that high-oleic oils can be used in both industrial and nutritional applications. Therefore, while the following profile is geared towards industrial purposes it is reasonable to expect very close similarities (if not the same properties altogether) in a nutritional oil profile as well. Solazyme's release of the Soleum product data sheets gives us an insight into just how far the company's technology has progressed.
In the profile noted above, one key attribute to focus on is the fatty acid composition. We see that Soleum Very High Oleic Oil is composed of more than 88% C18:1 (oleic acid). This is ideal when we consider the direct correlation oleic acid has to an oil's oxidative stability index. Taken from the article found here, we see that a greater percentage of oleic acid directly correlates into a higher oxidative stability index. For a simpler understanding of this, it might be best to consider an increase in the percentage of oleic acid to mean a greater duration of product functionality or shelf life.
The following graphics shown below represent the oil profiles of the competition. What we see is that Cargill's top-tier and latest oil profile is only able to achieve 80% oleic acid while Dow AgroSciences' (DOW) oil profile only has 73% oleic acid. Additionally, Monsanto's brand has 72% oleic acid while Plenish has 75% oleic acid. Even before considering Solazyme's top-tier product, the Soleum High-Oleic oil already has 82% oleic acid, placing it on the highest end when compared against the competition.
What is more surprising is just how fast Solazyme was able to develop this first generation oil profile. Whereas Cargill took 15 years and DuPont took 20 years in order to develop these oils, Solazyme was just founded as a company less than 11 years ago. The two co-founders started in a garage in 2003 and eventually developed the technology platform to even create these oil profiles over the next decade. It's important for investors to see that what distinguishes Solazyme now is just how fast it can move in relation to the competition. The graphic below taken from my article found here demonstrates this advantage.
A Quick Look At The Financial Picture
Solazyme now trades with a market capitalization of $715 million based on the closing price of $9.41 as of May 24. As of the end of April 2014, the company now has over $310 million in cash and cash equivalents according to the Q1 2014 earnings conference call. The company has more than enough cash on hand to scale its first two commercial plants with a total nameplate capacity of 120,000 MT. It also has enough capital to further expand its manufacturing base as these two plants ramp up to their nameplate capacity over the next 18 months.
By themselves, these first two large-scale commercial plants are expected to bring in annual revenue in excess of $240 million based on a minimum target oil prices of $2,000/MT. This alone sets Solazyme on a path of triple-digit revenue growth over the coming year. However, the introduction of additional product lines such as Encapso and AlgaVia are likely to boost the potential revenue higher than the figure stated above. These products incorporate the use of biomass and technical expertise that can command a higher value than what is only found in the oil otherwise.
My Take On The Company Right Now
Investors are accustomed to evaluating companies on the basis of earnings and revenue growth. However, Solazyme now exists as an early stage company that is beginning to ramp commercial production based on a novel technology with large upfront capital expenditures. As such, I find that the value of the company is best understood in light of its overall capability to continue to develop. Having enough capital, having an edge over the competition, and having the ability to bring product to market are essential qualities to consistently consider.
Solazyme now has $310 million as of the end of April, nearly double the cost of its largest facility found in Moema and one of the largest balance sheets for an industrial biotechnology specialist. The company also has a proven technology platform that has reached commercial scale. Solazyme's products can establish new markets or offer superior quality products in existing industries. Above all, the company now has two facilities that have proven to be operational and capable of being ramped to reach sustainable operations.
There are some uncertainties in the present. While operational, the Moema facility has not officially started producing commercially. This has led to investor fears which have only been spurred on by delays and speculation. The overall cost of production has also been difficult to determine. However, in my last article I showed that the company's latest results were more impressive than what I was expecting.
All things considered, for me it ultimately comes down to the technology. Solazyme is capable of creating superior products in several multi-billion industries. The company is the first name in a green field space of intellectual property, and it is quickly claiming significant ground to core technological pathways, processes, and products. Above all, Solazyme is now producing tangible products such as tailored high-oleic oils that bring theoretical concepts into reality.
In terms of valuation, I therefore believe that Solazyme should at least be trading at a value of its paid-in capital after adding back its accumulated deficit. After all, despite enduring increasing losses Solazyme's technology has continued to steadily advance. When one considers the $203 million raised on April 1 in a public offering, this would suggest a fair valuation would be $1.01 billion. This is upon considering that Solazyme had paid-in capital of $464 million and an accumulated deficit of $341 million as of March 31.
Altogether, for me this would suggest that Solazyme should fairly be priced around $13.27 based on 75.98 million shares outstanding. Analysts now have a consensus target prices on Solazyme of $13.1 according to the website found here. This is based off of nine analysts in which six gives ratings of buy or outperform, two give ratings of hold, and one gives a rating of underperform.
Final Thoughts
The FDA's push to eliminate trans fats gives a supportive lift on the side of high-oleic oil producers. These oils are likely to find much greater demand in nutritional applications even though they are just as versatile and desired in the industrial oil markets. For Solazyme, it positions the renewable oil company squarely in the middle of a growing opportunity.
Solazyme's high-oleic oil platform is able to create oil profiles that exceed the capabilities of the current competition now found in Cargill, Monsanto, Dupont, and even Dow. Indeed, Dow has even teamed up with Solazyme for the creation of advanced dielectric fluids. Investors should note that Solazyme has not only created oil profiles that are superior to the competition, but they have done so in a much shorter time frame and with much lower costs.
The market has often pegged Solazyme to the struggles of biofuel companies along with the woes of struggling fermentation companies such as Gevo (GEVO) and Amyris (AMRS). Yet in doing so, it has far overlooked the actual markets Solazyme is targeting. Solazyme is not offering the promises of a single target molecule, but rather improving upon the large volume vegetable oil markets already dominated by a few slow-moving agricultural science companies.
What investors need to understand is that Solazyme is progressing with much greater speed and with much greater efficacy than these companies have been able to do in comparison. Bypassing the slow growing cycles of seeds altogether, Solazyme's timely entry into the high-oleic oil markets appears to be just the beginning of where the company expects to go.
Disclosure: I am long 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.
Additional disclosure: I also have bear call spreads on MON
