What Happened To Biofuel 1.0?

by: Randy Lewis

After being in investment management and being a trader for years, I have seen the "green" fad come and go several times. Another craze, though, just before the recession, seemed like something that would stick around for a while. I remember in 2008, when the world economy was in the throes of crises and gas prices sky-rocketed (not unlike today, incidentally), and the green stocks were doing phenomenally well. Of course, in 2009, you could have thrown a dart and made money, but still, the valuations on some of the eco-friendly stocks, were astounding. Solar (especially), wind, biofuels - all were showing great promise. Just like the previous decade of dot-coms, companies could just put "bio", "eco" or "green" in their names, and speculation ran.

I am not an industry expert, but do keep abreast of news and have maintained a cursory view of the sector. Years ago, I was an unfortunate investor in Xethanol Corp., and after losing my shirt, decided my money was best placed elsewhere. But now that gas prices have gone through the roof again, and knowing the hardship ethanol companies have faced in recent years, I decided to revisit this sector to see what was going on.

I first visited a website that has not been updated in four years but is still live. It lists many biofuel stocks, all of which I remembered after seeing them again. I'm glad the site has not been updated, because most of them are not around anymore. In addition to many OTC stocks, there were several AMEX plays, like Xethanol, Nova Biosource Fuels and New Generation Biofuels. All gone.

Certainly I knew this was a tough industry. On one side you had the technology developers that were trying to convert some kind of organic matter, or biomass, into fuel. On the other you had the producers that were attempting an extremely capital intensive, volatile and low margin business model, which is still the case. And on the third side was big oil, which was always trying to make itself the "good guy" by pumping millions of dollars into green energy R&D.

So I asked myself, "Are there any pure play (or close enough) biofuel stocks left?" I certainly know about BioFuel Energy Corp. (NASDAQ:BIOF), which seems to be about the only remnant of the first generation left. I've been watching this stock for a while, including its rapid rise recently - but I wanted to see what else was out there in the so-called "second generation".

First, there's GEVO Inc. (NASDAQ:GEVO), which went public in February of last year. The company is currently earning all of its revenue from ethanol and related products that are derived from the process. A smart move to show revenue, but in its last reported quarter, its COGS was more than its revenue. GEVO is banking on its other business, which is interesting and the apparent reason for the negative gross margin. Originally, the focus was on producing the solvent, isobutanol, which can also be a fuel additive, and eventually making it from non-food sources. Isobutanol can be made through a biomass fermentation process, which now seems to be the company's primary focus, having recently been awarded a patent on its process. It hopes to convert existing ethanol facilities to make the product and in turn sell it to a wide variety of potential users.

Next is Solazyme, Inc. (SZYM), which went public a few months after GEVO. While not a pure biofuel play, the company engages in the production of renewable oils made from algae and plant sugars, and in addition to chemicals and fuels, is pursuing the nutrition, and skin and personal care markets. In fact, its sole commercial product line to date, Algenist, is in the personal and skin care market, and the company's strategic partnerships range from Chevron to Sephora. But sales are growing and product revenue (vs. R&D revenue) is a greater percentage of total sales - two things analysts would undoubtedly want to see. The company expects more sales from industrial markets next year, but it remains to be seen what role it will play in the biofuel industry.

Interestingly enough, we came across another stock that seems to be making headway in the biofuel market. The company, Eco Ventures Group, Inc., (OTCPK:EVGI) is currently on the OTC, but might not be there for long. While not the purest of pure plays either, unlike other smaller first generation upstarts, the company has some meat behind it while it pursues its own plants and use of new technology to improve margins. This is not uncommon, as seen above with GEVO making ethanol. We also failed to mention the newest kid on the block, Renewable Energy Group, Inc. (NASDAQ:REGI), which went public on January 24, because they have a lot of chatter and I figured most people are familiar with them. Like EVGI, it is a middleman on related commodities as well as a producer, and provides facility services to others as well.

The meat for EVGI is rapeseed oil (which is what canola oil is made from and often used synonymously). Rapeseed oil still seems to be the preferred stock for biodiesel production in most of Europe, having better properties and better unit production qualities than soybean oil, which REGI seems to be using mostly - though it continues to explore alternatives. Rapeseed oil accounts for about 80% of the feedstock. About 2/3 of total rapeseed oil supply - of which Germany was the fourth largest producer in the world in 2009 - in the European Union is used for biodiesel production.

Earlier this summer, EVGI signed a definitive agreement to acquire Energiepark Süptitz GmbH, a German rapeseed oil producer ("EPS"). EPS is also involved in brokering rapeseed oil and has some interests in solar and wood chips as well. What was 75% ownership, will now be 100%. According to my initial calculations, consideration to EPS will be 15 million shares of EVGI stock and a $7 million cash infusion into EPS. The company is looking to raise $10 million total. The combined entity will consist of two divisions - a European ("EPS") and a U.S. division ("EVGI").

Of course, the deal is predicated on the company raising the capital and issuing the shares, but it has hired a respected investment bank to help with this. I do not have information on exactly when the deal is expected close, but will find out and update readers.

Regarding revenue, management is talking some big numbers, which include primarily EPS. FY 2013 revenue will be derived from:

· EPS operations which include the aforementioned

· A 3.6 million gallon biofuel facility to begin operations Q1 2013

· Another five million gallon facility to begin operations around the beginning of Q4 2013

Things look more promising especially with the announcement last week of an expanded EPS deal for $121 million over the next 15 months. The contract with this existing customer was slated to account for about $15 million this year.

According to my calculations, the company is slated to do about $202MM in revenue next year and, according to management presentations, EVGI expects an EBITDA margin of just over 10%, which is about double what REGI has reported for the first half of the year. EBITDA, which I define as income from operations as a proxy, is a better comparison than net earnings because of gains/losses on investments (primarily derivatives) and other factors that are just accounting treatments, the gains and losses of which flow to the bottom line. "Adjusted EBITDA" is a common measure for these companies, but the "adjustments" seem to vary a bit and I didn't want to turn this write-up into a thesis.

As we break out the calculator, I see it's still tough to compare apples-to-apples in this industry, so for simplicity let's ignore any seasonality and just double REGI's EBITDA for the first half of the year. I get an EBITDA multiple of about 3.3X. REGI's margin and multiple seem reasonable for this industry to me, even though some stocks are higher.

So if we apply these figures to our EVGI revenue estimate we get:

· EBITDA = 202,000,000 x 5.29% = $ 10,685,883

· Market Cap based on EBITDA multiple of 3.3 = $35,263,414

· Current Estimated Market Cap (based on 41 million shares @$0.39) = $15,990,000

So we have a lot of room to play with here even at these multiples. Applying the same methodology to FutureFuel Corp. (NYSE:FF), for example, we get an EBITDA multiple of over 11X, with a reported margin of almost 12%. Though I know some allowance certainly has to be made for deal risk in EVGI's case, it still seems like the math for Eco Ventures that I did above is pretty conservative. Furthermore, the balance sheet - read, "net assets" - acquired from EPS might make the company ready for a senior exchange almost immediately.

Anyway, while there are no absolute pure plays that I found - for example, for its last reported quarter, FF derived about 77% of its revenue from biofuels, but that number is growing - it sure seems the industry is making a comeback. I know new mandates across the globe and rising petroleum process have a big part to play in that, but I look forward to getting a better grasp on renewable energy 2.0 and following this industry more closely, especially as these companies look to improve margins on production and materials.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.