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More Ugliness at Pretty Woman's Pet Project

I've already given investors plenty of good reasons to stay away from what one Fool community member dubbed "the Planet Hollywood" of energy companies: Earth Biofuels (OTC BB: EBOF.OB). As I noted then, this tiny, unprofitable firm has somehow earned a seal of approval from celebrities like Julia Roberts, Willie Nelson, Rusty Wallace, and Morgan Freeman.

Anyone who touts this company is clearly more interested in looking "green" than in helping investors hang onto their greenbacks. Earth's latest earnings report only confirms it.

For the third quarter, the company sold $9.4 million worth of fuels, which is a lot more than the $393,000 it moved last year. But that's no reason to celebrate, because the more fuel it sells, the more money it loses.

Earth's cost of sales for the quarter was $9.8 million. The only reason it could report a gross profit at all was thanks to government handouts, in the form of $920,000 worth of energy production credits.

That's right -- without federal incentives, Earth Biofuels spends more on making its fuel than it can recover selling the stuff in the market. And things only get worse as you travel down the income statement.

After taking into account $13 million in compensation costs, plus selling, general, and administrative expenses, Earth posted a loss from operations of $12.7 million.

So how does the company show net income of $3.4 million ($0.01 per share)? Because it booked a $22.8 million "gain on derivatives."

Lest you think that sum reflects anything substantive -- say, clever cost-hedging in volatile commodity markets -- the reality is this: It's entirely owed to changes in the value of the varying bits of convertible debt that Earth has resorted to in order to fund its cash-burning operations.

In other words, these earnings are about as meaty as a tofu burger.

The cash flow statement makes this all (horribly) clear. So far this year, Earth has burned $18.6 million in operations, and spent another $31 million on "investments" and capital expenditures.

And that's the big problem here. Anyone can build a biofuel plant, or two, or 10. And everyone is doing it. That means the game will go to those with experience and scale, like Archer Daniels Midland (NYSE: ADM  ) . And I firmly believe that if there's any real money in it, you'll see traditional, integrated fuel giants like Exxon Mobil (NYSE: XOM  ) and BP (NYSE: BP  ) climb in and clobber the pipsqueaks. Investors in the likes of Pacific Ethanol (Nasdaq: PEIX  ) , Xethanol (AMEX: XNL  ) , and other micro-players are, I believe, likely to suffer the same fate as the innocents who piled into long-term losers in the fuel-cell industry.

So while the entire hyped-up biofuel industry looks bad, Earth looks like one of the crummiest runts in the litter. You buy this, and you buy stock in a money-incineration machine run by a CEO whose past enterprises include a defunct undersea ship-salvager and a flop wireless company trading for pennies.

So don't be fooled by celebrity hype. Roberts, Freeman, Wallace, and Nelson ought to get away from this outfit before the reality comes back to haunt them -- them, and any unwitting members of the public who get fooled into buying these shares because of short-sighted celebrity do-goodery.

Earth Biofuels is one of the lowest-rated stocks in our new stock-rating service, CAPS. Got a different opinion? Bring it to CAPS. You pick, we keep score, and it's free to use.

At the time of publication, Seth Jayson had no positions in any company mentioned here. View his stock holdings and Fool profile here. Fool rules are here.

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