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No Eeyores for KiOR

| August 16, 2012

Analysts are bullish as KiOR’s drop-in biofuels technology transitions to commercial phase – what factors are driving all the good vibes?

There are a lot of Eeyores around the advanced biofuels space these days – well, around the United States and to a great extent the EU as a whole, really. Gloomy, pessimistic, chronically depressed.

Investors have been, in a similar mood, hammering advanced biofuels and biobased material stocks – in some cases to within a few bucks of cash on hand.

KiOR, by contrast, has been generally able to create and sustain its own weather, and has become a rare oasis for analyst optimism. In today’s Digest, we look in depth at the data behind the cheers.

In Texas, the company this week announced a second quarter 2012 net loss was $23.0 million, or $0.22 per share, compared to a net loss of $16.8 million, or $0.16 per share, for the first quarter of 2012 — but it was hardly the financials that prompted a wave of bullish reports from a once-bitten, twice-shy set of equity analysts who rarely hand out lollipops these days for early stage, publicly-held, advanced biofuels companies.

More about KiOR

KIOR has developed a proprietary process, biomass fluid catalytic cracking. BFCC rapidly produces renewable crude oil, which is converted via standard refinery equipment (hydrotreating) into gasoline, ultra low sulfur diesel, and low sulfur fuel oil.

In many ways, KiOR’s technology resembles a time machine – compressing the timeline by which Mother Nature accomplishes the transformation of biomass into fossil crude oil over millions of years, into a couple of seconds.

As a thermochemical technology, it has optionality on feedstock – initially, the plant will use southern yellow pine, which according to analyst option has a sustainable surplus at this time of 59,000 tons per day – enough at 90 gallons per ton to support – all by its onesey – 1.9 billion gallons of fuels. The other main input? Abundant (and highly affordable) natural gas.

Moreover, the Renewable Fuel Standard (RFS2) mandate of 36B
gallons by 2022 should support premium pricing. Scale is up 400x, to 10 TPD, and a 500 TPD plant should be on line in H2:12. We model thirty six 1,500 TPD plants from 2014 to 2021, and licensed partners should add 12 more.

A next-generation catalyst – boosting nameplate capacity by up to 20 percent?

The process produces liquids – which are hydrotreated into fuels; gases, which are burned to help provide process electricity; and coke, which is burned to provide process heat and regenerate the catalyst. However, a new catalyst, KiOR, said, may change the ratios and allow plant to produce up to 20 percent higher throughput. More about that before year-end.

Yields, now and later

In early 2009, yields were in the 17 gallons per ton range, but have improved to 67 at the present time and are targeted to reach the high 80s by 2014 en route to an eventual target of 92 gallons per ton.

Costs, now and later

For 2013, feedstock is modeled by analysts Rob Stone and James Medvedeff at Cowen & Company at $0.29 for natural gas (per gallon produced), with an expected price of $0.52 per gallon by 2022. Yellow pine is modeled at $1.07 per produced gallon in 2013, dropping to $0.89 per gallon in the long term – that equates to a $70-$80 range in the per-ton cost of wood.

Bottom line – today at plant #1 with 250 tons per day of wood biomass arriving at the time of commissioning, costs will be in the $16.27 range per gallon, according to Cowen & Company, of which the marginal costs are $8.97 per gallon.

With scale-up, total cost per gallon drops to $5.95 by 2013, $3.73 per gallon in 2014, and the magic sub-$3.00 figure in 2015 when it is expected to reach $2.62 per gallon at full-scale.

Scale, now and later

For now, KiOR is commissioning its first commercial-scale facility, which each ultimately have a 62.5 million gallons capacity (based on 1500 tons per day).

Production this year is expected to be in the 800,000 gallon range as plant #1 commissions, rising to 10.2 million gallons in 2013, and rapidly scaling up to 273 million gallons by 2016 en-route to 2.3 billion gallons by 2022, according to Cowen’s ramp-up thesis.

When will we know?

There are three key inflection points for KiOR to watch.

This year – plant #1 is expected to complete commissioning this year – watch that for a confirmation that the technology works as planned at scale.

2014 – plant #2 is expected to be up and running by the end of 2014 – watch that for confirmation of the company’s proposed timeline for new plant construction and financing, and ramp-up towards the 2 billion gallon marks by the early 2020s.

2016 – the company is expected to go sub-$3.00 in terms of cost per gallon for its fuels – thereby reaching the expected parity point with fossil fuels. If it reaches that milestone – essentially, as an infrastructure-compatible, made-at-home, drop-in fuel it should be fully independent of the Renewable Fuel Standard in terms of needing a mandate to assure a market.

Analyst opinion

Rob Stone and James Medvedeff, Cowen & Co.: “A next-generation catalyst may boost nameplate capacity up to 20%, reducing future fixed and operating cost. However, potential start-stop operations and ASP discounts during the initial ramp reduce our estimates. First Columbus revenue, more yield details, Natchez capex and offtake agreements should provide substantial triggers to support fundraising in Q4. We see 80%+ upside potential in KIOR rel. to the mkt in 12 months.”

Mike Ritzenthaler, Piper Jaffray. On the call, management stated that they expect Columbus to cost ~$213 million, 4% below the estimate on the 1Q11 call in May. The company has set its sights on completion of the design package for Natchez by the end of FY12, and has set aside $13 – $14 million for that purpose. Management affirmed that Natchez is tracking for a late 2014 startup. In addition, management announced that they expect lower coke production with improved catalysis, enabling 20% more throughput and lower capital intensity. We maintain our Overweight rating and $20 price target.

Pavel Molchanov, Raymond James: “Within the context of our broadly favorable view on Gen2 biofuels, KiOR provides investors with a pure-play on cellulosic biofuels. As such, KiOR is well-positioned to address the “food vs. fuel” concerns and price volatility surrounding sugarcane and corn. We also like the versatility of KiOR’s biocrude – the ultimate “drop-in” biofuel. Balancing our positive view on the company’s technology platform with scale-up and project financing risks, we reiterate our Outperform rating. Shares are currently trading at 63% of our DCF estimate, and our target price of $11.00 is based on a 90% multiple of DCF. Despite the more than 50% upside to our target, KiOR’s distant outlook for profitability (late 2014 at the earliest) keeps us from a Strong Buy rating.

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