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$SZYM - Will Sugar Hold Solazyme Back?

http://seekingalpha.com/article/1754392-will-sugar-hold-solazyme-back?source=email_rt_article_readmore

For renewable oil producer, Solazyme (SZYM), there lies an ongoing critique that weighs on the minds of skeptics. Will the company's decision to base its technology on sugar-consuming heterotrophic algae constrain it's future outlook? The very notion of possibly utilizing "food for fuel" raises the reminiscent concern over unsustainable 1st generation ethanol, where rising feedstock costs eroded profit margins and elevated the price of food.

But as Solazyme brings online its first large scale commercial facilities with partners Bunge (BG) and Archer Daniels Midland (ADM), such fears ultimately remain unfounded. Multiple feedstock choices, selective product output, and enhanced yield improvements remain three noteworthy advances that further distance the renewable oil producer from its biofuel-constrained peers. Additional technological breakthroughs in unconventional feedstocks continue to also suggest that sugar may one day prove to be a critical component in the long-term goal of being less dependent on crude oil.

3 Reasons Why Using Sugar Is Not A Concern:

Multiple feedstock choices. Solazyme can convert carbohydrates to oils. This means it is not only able to utilize sugars from corn or sugarcane, but it is also able to use inputs such as glycerol, green waste, sorghum, and etc. The technology is not so much feedstock dependent as much as it is logistically constrained (i.e. aggregated material availability).
Selective Product Output. Solazyme harnesses unique tailoring capabilities, which allow for it to design new types of oil profiles. The company can modify the properties of how some oils and bioproducts function. This further uplifts the value of the company's output and broadens the profit margins. In some cases, it can even defy the "food-for-fuel" controversy by operating under the prospect of using "food-to-make-more-valuable-food." For instance, Solazyme's whole algal flour can cost-effectively replace the use of oil, milk, butter, or eggs by providing a healthier alternative.
Enhanced Yield Improvements. Because of its tailoring capabilities, Solazyme can dramatically increase the yields of the most valuable parts of a particular oil. This can significantly fortify the value of the oil itself by attaching a premium to it. In some cases, these yield improvements can exceed the highest natural occurrences several times over.

Because of Solazyme's ability to diversify between feedstocks, produce unique product properties, and exaggerate natural yields, the threat of using sugars as an input remains far from worrisome. The company can significantly expand its value range, thereby protecting itself from the encroachment of rising input costs. Nevertheless, there is still the issue of future capacity expansion.

Understanding The Capacity Limitation

While Solazyme is uplifting the value of sugar to the value of tailored oil, it would be misleading to believe that such technology will feasibly replace the immense demand for petroleum altogether. According to the U.S. Energy Information Administration, the United States consumed 6.87 billion barrels of oil in 2011. This roughly equates to a little under 1 billion metric tons of oil consumed annually.

According to Solazyme's S-1 filing found here, the company's technology can roughly support 400,000 metric tons of oil per year with a facility co-located at a sugarcane mill with 8 million metric tons of annual sugarcane crush. While Brazil does continue to expand its production of sugarcane, this does suggest that the leading producing country would only be able to support roughly 36.7 million metric tons of Solazyme's oil. Even then, it would require the nation's entire production to be devoted to the technology.

(click to enlarge)

The Future Of Sugars

This distant dilemma poses the question if Solazyme's potential is capped by conventional sugar's supply limitations. Yet the future of sugar stands to be much more promising than today's conventional supply would otherwise suggest. After all, carbon is very abundant. Simple sugars exist in all forms of biomass, and the technology to affordably unlock these sources is becoming more established by the day.

Consider a company like Renmatix, which utilizes supercritical water to isolate cellulosic sugars at a very low cost. The company expects to produce sugar for as little as $0.04/lb on an operating basis. The company is now working with Waste Management (WM) in a partnership that may one day turn our trash into low-cost sugars.

Then there is also the untapped supply of industry-produced carbon dioxide. A company like Proterro utilizes cyanobacteria and a modular photobioreactor in order create sugar (compared to extracting it). The company expects to use off-the-shelf materials and an efficient process that could lower the cost of sugar to $0.05/lb. Most interestingly, Proterro states that its system can produce sugars at a rate of 145 tons per acre per year, which is almost 30 times the rate of sugarcane.

(Proterro's efficient process)

With sugar futures currently priced at $0.19/lb, the promise of these unconventional sources of sugar aid on two fronts. They can dramatically lower the input costs for companies like Solazyme allowing them to pursue the more voluminous markets of low-value products, such as fuels. They can also significantly expand the supply of sugars by using unwanted materials such as municipal waste or the expelled carbon dioxide from a biorefinery, such as those used by Solazyme.

A Look At The Company

Solazyme currently trades with a market capitalization of $708 million based on the closing price of $11.37 as of October 17. The company currently trades in expectation of imminent growth as it supports a price-to-sales ratio of 20.48 and a price-to-book value of 4.93. The company's two facilities with Bunge and ADM are expected to grow the current production capacity by over 6,500%. For some time now, Solazyme has reiterated its confidence in its gross margin guidance shown below.

(click to enlarge)

Final Thoughts

Solazyme went against the grain of the industry direction when it decided to pursue the use of sugar rather than exploit the "free" nature of the Sun and carbon dioxide. The company's founders quickly realized that algae was a very poor creator of sugar and a very efficient producer of oil. By specializing in the oil production aspects of algae for over a decade, Solazyme now finds itself in a leading position when it comes to producing tailored renewable oils.

Skeptics may continue to view the use of sugar as a future pitfall for Solazyme. However, such a view fails to compare this cost to the amount of value produced in its use. Whether it be through increased product value, less land use, more process control, or more efficient operations, the reality of these costs will ultimately be reflected in the company's margins. For now, the expected margins appear favorable. Looking ahead, they only seem to improve as sugar production advances in light of ongoing innovation.