Biofuels Learn From Failure, but Is It Enough?

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Biofuel companies may be getting it right this time, learning some lessons from ethanol's failures. When I say that, what I mean is they're not focusing on fuels at all. Companies such as Amyris (Nasdaq: AMRS  ) , Solazyme (Nasdaq: SZYM  ) , and Rentech (AMEX: RTK  ) are often lumped into the biofuels category because that's what people understand, but that's probably not where their future is.

Each company, in its own way, is finding ways to diversify their potential products beyond biofuels. Since biofuels will likely suffer from the same problems that ethanol did, a lack of feedstock or an increase in feedstock prices if biofuels became successful, this is a wise move for these companies.

A new business model
The new model these companies are using focuses first on making high-value products instead of trying to take over the world with volumes of biofuels.

Amyris says it is focusing on existing scale and high-value products made from current strains, which includes cosmetics, plastic additives, and flavors and fragrances. This will allow the company to diversify into higher volume lubricants and fuels in its new plants. The problem right now is that increased volumes of diesel and other high-volume products have put a damper on margins.

Rentech, which has its sights set on biofuels as well, actually makes most of its revenue from nitrogen fertilizer. It's the fertilizer business that drives results right now and keeps the company solvent.

Solazyme's products can be used to make everything from makeup to food products to jet fuel. This is a diverse base that the company hopes to draw a number of product lines from. Dow Chemical (NYSE: DOW  ) and Unilever have partnered with the company to make products such as soap, detergent, and de-icing materials. These products have higher margins than fuel, but will they grow fast enough?

Why I'm cautious
Unlike many of my Foolish friends, I'm much more worried about these biofuel stocks, in particular Solazyme. The company makes oil from algae using a variety of feedstocks. It is very proud of powering a U.S. Navy destroyer, a Maersk cargo ship, and the first U.S. commercial flight on biofuels with United Airlines. But what's to keep this company from going to way of ethanol?

Solazyme uses "low-cost plant sugars" such as sugarcane, switchgrass, corn, and forest residue. I feel like I've seen this movie before. Sugarcane and corn are already used for biofuels, so why reinvent a failed square wheel? A number of other feedstocks are named, but these sources of energy must grow from somewhere, and ethanol showed that a cheap feedstock can become expensive when you try to scale up production.

You would think a company like this would at least be growing like a weed, like Amyris is. But Solazyme saw revenue fall 35.7% in the fourth quarter. Product revenues are barely big enough to mention. Yes, the company has a joint venture with Bunge (NYSE: BG  ) , which could produce a massive amount of oil, but the financial terms aren't known so it's hard to judge the impact.

Some will say that I don't understand the model, just like I didn't understand Energy Conversion Devices, Ener1, or A123 Systems. All of these companies relied on hope in their business plans, just like Solazyme does: hope that the market will grow quickly, hope that raw material costs won't rise, hope that production plants aren't more expensive than planned, and most importantly hope that they won't run out of cash before all of these things take place. Hope is a tantalizing thing, but it doesn't often make a good investment.

Foolish bottom line
It's far too early to say that any of the emerging biofuels companies will be successful or even survive. Losses have been piling up, and the companies face a lot of the same challenges that ethanol faced in its early days. Without government support long term, I don't see this ending differently unless these companies can make nutritionals, health sciences, or lubricants a big market in a short amount of time.

I've watched too many companies built on cool technology and a lot of potential fail to make it over the last few years to buy into biofuels stocks right now. My contrarian view even leads me to make an underperform call on Solazyme over the next three years. I just don't think the company will ramp as quickly as expected and its big cash cushion will burn up quickly.

If you are looking for a stock that is a strong buy, check out our report on The Motley Fool's best stock for 2012. The report is free and it can be found here.

Fool contributor Travis Hoium does not have a position in any company mentioned. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings or follow his CAPS picks at TMFFlushDraw.

The Motley Fool owns shares of Solazyme. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (4) | Recommend This Article (5)

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  • Report this Comment On May 14, 2012, at 9:05 PM, wesevans wrote:

    How are bio-fuels going to compete with fossil fuel? The fossils are going to be around for 300+ years. The only way the bio's can compete for 200 years will be government intervention. With the world becoming more economically competitive I doubt the citizens will continue to support this agenda. ie The bio fuels have their own environmental problems when scaled to replace fossil fuel.

  • Report this Comment On May 14, 2012, at 9:50 PM, Cake123xyz wrote:

    I will definitely attest to the idea that you don't understand the model.

    Your first mistake is in assuming that the company is even primarily a biofuel maker to begin with.

    Of all the production capacity being made, fuels makes up the smallest portion of the company's plans. Dow is buying millions of gallons off of the Moema facility, Roquette is using SRN's facilites for food, and the Integrated refinery is really being used primarily for the cosmetics line.

    I actually thought you knew what you were talking about when I first started reading this, but I was sorely disappointed when your conclusions neglected the value of the oils being made. Like the rest of your Foolish writer peers, you're missing the point of what this company is even doing as you focus on biofuels.

  • Report this Comment On May 15, 2012, at 3:20 AM, BillStacker wrote:

    I agree with Cake. Did you copy someone else's homework for the first paragraph? Because everything you wrote after that affirms that you have fallen into the same trap of "lumping into the biofuels category"

    And even as you lump in with the other lumpers, ignoring the many high margin products Solazyme is already producing, you reveal that you know very little about Solazyme's fuel products or the process used to make them. You're whole premise is to lump all biofuels together as if they were the same thing. Solazyme is not distilling alcohol (ethanol) from sugar cane, they are feeding it (among other feedstocks) to their patented super strain of algae to make hydrocarbons. So just because you saw the same "actor" (sugarcane) in another "movie" (ethanol), it is NOT the same movie at all. Not even close.

    "what's to keep this company from going to way of ethanol?"

    Umm, the fact that it doesn't produce ethanol!

    When was the last time you saw a comercial jetliner fly on alcohol?

    "Why re-invent a failed square wheel?" has got to be the dumbest line in the whole article. Answer: Because there is a better wheel that will not fail. Edison "failed" to perfect the lightbulb over 1000 times. I guess he should have just given up on the whole electric light thing, huh? Convert the world from gas lamp? Preposterous!

  • Report this Comment On May 16, 2012, at 7:25 PM, tkell31 wrote:

    ("what's to keep this company from going to way of ethanol?"

    Umm, the fact that it doesn't produce ethanol!)

    Lol, if you don't understand a simple analogy it's hard to take any of your other points seriously. Ie when someone says it went the way of the dinosaur they don't mean that "it" was therefore also a dinosaur. You don't even try to touch the 37% decline in revenue or comment on the contracts that are in place. Pretty poor comment for supporting a speculative company.

    That being said I saw this on Mad Money at $15.24 or so when Cramer said he liked management and thought it would be a decent spec play. At the time it had run up from $10 and now that it's back to near a historical low I feel better about buying some. Not that it can't go lower, but I figured the general market would take it down at some point.

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