What’s up with Gevo?

| September 25, 2012

Amyris redux, or fiscal caution in the ramp-up process?

We look at the data, as the advanced isobutanol pioneer switches Luverne from isobutanol to ethanol amidst production shortfalls.

In Colorado, Gevo announced that, while making significant progress towards economic production levels, the company does not now expect to achieve its desired year-end run rate – instead it has delayed hitting that target into 2013.

“While we have made significant progress towards economic production levels,” said Gevo CEO Pat Gruber, “we have decided to optimize certain specific parts of our technology to further enhance bio-isobutanol production rates.  Implementing these adjustments while trying to produce product in a plant the size of Luverne makes no sense from a business or technical point of view, particularly when we have better options available.

“In order to maximize cash flow, we believe it makes more sense to temporarily shift to ethanol production. This optionality is a result of Gevo’s patented retrofit design that allows for switching between isobutanol and ethanol. It’s very important to us to introduce this technology to the marketplace in the most considered and responsible way, and do what’s right for our customers, our shareholders, and the long-term needs of the business.”

“In five short years, we have gone from start-up to commercial-scale production at the world’s first commercial bio-isobutanol production facility,” Gruber added. “Production start-ups are never easy, but we are years ahead of our competition and well on our way to realizing economic production levels during 2013.”

Why the switch?

Bottom line, isobutanol has been produced, but not at economically viable yields. The process needs improvement, at scale, which leaves the company with the choice of producing isobutanol at suboptimal yields and losing money – or switching back to ethanol and conserving cash. Since the company had not made any formal performance targets aside from a commitment to reach a 1 million gallon per month throughput by December – which is clearly out the window anyway – the option that offered the lower cash burn clearly looked more attractive to management.

Rob Stone of Cowen and Co writes: “Railcar quantities [of isobutanol] have shipped, and additional inventory should enable customer testing. However, throughput is too low, so continued production while working on the fix would consume cash. Specific issues have been identified, but were not disclosed for competitive reasons. Timing for a solution is uncertain, and Redfield is likely on hold.”

“This is a slightly positive cash margin business under current commodity prices, commented Raymond James energy analyst Pavel Molchanov, “so it’s preferable than the alternative, i.e. making isobutanol at suboptimal rates and generating negative margins.”

Amyris redux?

“Investors who got burned on Amyris over the past year may see this news as a repeat of that company’s initial guidance cut in November 2011 (which was followed by a full-fledged guidance withdrawal in February 2012),” commented Raymond James energy analyst Pavel Molchanov.

“There is a parallel here, of course, in that both companies experienced, in their own ways, the fermentation scale-up issues alluded to earlier. We don’t see the Gevo announcement as a carbon copy of what happened at Amyris. In retrospect, Amyris had laid out production and financial targets (including positive cash flow in 2012) that had been far too aggressive.

“Gevo’s only formal target previously had been the year-end 2012 exit rate of one million gallons per month, and at this point the company is (wisely, in our view) staying away from providing a specific timeline for resuming isobutanol output. Our prior assumptions didn’t show positive EBITDA until well into 2014, although that may need to be pushed out further depending on the progress in optimizing Luverne. We plan to update our near-term estimates for Gevo as part of our 3Q12 alternative energy earnings update next month.”

Molchanov added, “The other important difference compared to Amyris is their relative valuation. On November 2, 2011 – right after its initial guidance cut – Amyris was trading at 85% of our discounted cash flow (DCF) per share estimate. By contrast, Gevo as of yesterday was at only 35% of our DCF estimate – as shown on page 2, the lowest multiple in the peer group. In other words, Gevo is by no means priced for perfection, and while we expect some weakness today, we think it will be moderate.”
The fiscal impact

Rob Stone of Cowen & Co writes: “We believe it may take six months before isobutanol production resumes, and more time will be needed to prove economic viability. This raises uncertainty and likely pushes out future projects. Depending on the length of the delay, additional funding may be needed to reach cash flow break-even. Trading at about 1.2x BV looks fair, given a deteriorating balance sheet and no visible triggers. We lower our rating from Outperform to Neutral.

Impact for Gevo customers

“This delay does not endanger any of Gevo’s offtake agreements with its customers,” said Molchanov.

The Redfield impact

Gevo’s second project is at the Redfield ethanol plant in South Dakota. Analysts are expecting a 6-month delay in that project coming online.

Can Gevo make money producing ethanol?

It appears to be a breakeven.

“Rather than try to solve problems while in production, or idle the plant,” commented Cowen & Co’s Rob Stone, “the decision was made to switch Luverne back to ethanol. This is good for labor, local suppliers, and offtakers, while demonstrating the value of the reversibility feature for potential future partners. If favorable regional prices for corn and animal feed persist, management believes it should at least be able to run the plant at break-even cash flow.

The view from management

Gevo has likley said all it is going to say on the matter. But Molchanov notes, “in mid-August – only a month ago – Gevo’s CEO [Pat Gruber] made a $49,000 purchase. We are always fans of insider buying, particularly at early-stage companies such as this.”

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