The appeal of biofuels is self-evident. Producing fuels from natural substances such as algae -- instead of crude oil -- can help wean the country's dependence on imported oil. And many biofuels hold the promise of lower costs than oil-based fuels. That was the lesson brought home on Sept. 24 when biofuels firm Gevo (Nasdaq: GEVO) announced it would shift production at a key plant from making isobutanol to ethanol. It may seem like a subtle shift, but it has major implications.
Holy Grail no more
Butanol is something of a wonder drug in the field of petrochemicals. It can be blended with gasoline (with much higher energy density than ethanol), or it can be used as a building block for a number of processed goods such as plastics, jet fuels, fibers and others. Its relatively high-energy density along with its multi-use quality make it quite valuable, currently trading at $2,800 per metric ton (or twice the price of plain old gasoline or ethanol).
Although Gevo has shown great promise in producing smaller batches of a biofuel version of isobutanol -- bio-isobutanol -- the company announced in September that larger batch sizes weren't yielding the desired output. Contaminants were getting in the production process and some batches had to be tossed out. Getting consistently good batches proved to be more difficult than first thought.
The company characterized the problem as a matter of getting the kinks out, yet it announced at the same time that its Luverne, Minnesota, plant would no longer make bio-isobutanol. Instead the plant will make ethanol, a commoditized product that fetches lower prices. Trouble is, the company isn't financially structured as an ethanol producer. Ethanol gross margins are currently around zero, implying negative operating margins. And if you read between the lines, then you can see that Gevo may never be able to realize its goal of being a leading bio-isobutanol producer.
Gevo, which remains unprofitable, could be out of money by early 2014 -- even if it is able to fix the isobutanol production glitches. Let's assume for a moment that Gevo can get back on track by early 2013. The company will still be burning cash as it produces negative EBITDA far into the future. In fact, it would take two plants working full-time producing isobutanol just to hit break-even, according to analysts at UBS. And this is not likely to happen before 2015 -- if at all. This means Gevo will need more money.
And this is where it gets tricky. Until and unless Gevo can get its isobutanol production back on track, the company will be hard-pressed to raise more money. Ethanol producers are a dime a dozen these days -- especially with mandated ethanol production quotas at risk of being eliminated in next year's Congress. Gevo is now racing against the clock.
Can Gevo work out the bugs? Well, it's not a hopeful sign that the company's chief technology officer, David Glassner, decided to resign on Oct. 1. This may have been a sign that a technology fix is neither imminent nor feasible.
We'll get an update on Gevo's technology issues and its cash burn rates when the company delivers quarterly results on Oct. 30. Look for discussions around the current quarterly burn rate of about $15 million. Management may also provide a look at 2013 financial projections. Gevo raised $98 million early in the third quarter, and likely ended the quarter with roughly $120 million. By my math, cash will be around $100 million at year-end and less than $40 million by the end of 2013. These forecasts assume that the isobutanol bugs will be worked out. If not, then that burn rate may be even faster.
For now, I give this stock "4" bankruptcy rating, which means that bankruptcy concerns aren't imminent, but the company may need to sell stock in the next 12 months. However, if the technology update on Oct.30 proves disappointing, then I may be inclined to move the rating up to "6," which implies that bankruptcy is possible within the next 12 months.
The company announced in the past week that its leading sales executive has resigned and that Nasdaq issued the company a warning that it is now out of compliance with its regulatory filings. I noted on Oct. 12 that the company hoped to restate its recent filings, but it subsequently announced that it needs more time to address the scope of the accounting problems. Shares continue to trend lower, so a 2013 bankruptcy filing can't be ruled out.
Risks to Consider: Upside risks for Gevo? A fix for the isobutanol production glitches would help the company, though the near-term switch to the production of ethanol would make it hard for the company to pivot right back to isobutanol production.
Action to Take --> Even if Gevo is able to sell more stock in 2013, then it would still likely force shares well lower just to line up sufficient investor demand. So even though this is not yet a "terminal short," it still has ample downside from here.