KiOR Goes Double or Nothing on Platform

Cellulosic gasoline and diesel manufacturer KiOR (NASDAQOTH: KIORQ  ) shocked shareholders on a hope-dashing, enthusiasm-smashing second quarter conference call weeks ago by lowering production guidance for its first commercial-scale facility by 60-67% for 2013. Shares followed production projections and sank more than 60% with many leaving the company for dead. Until management shocked the investing world again on Thursday.

KiOR announced plans to double nameplate production capacity to 26 million gallons at its Columbus location with a second facility. Management believes it will result in enhanced operations, enable the company to achieve cash flow profitability in 2015, and allow higher initial margins for product sold. Mr. Market liked the sound of that and sent shares more than 60% higher in intraday trading.

KIOR Chart

KIOR data by YCharts

So let's get this straight: KiOR encountered start-up problems at its first facility and wants to fix it by building another facility? Is it really that easy? Believe me, I want the technology to work, too, but I have serious doubts about holding shares in my portfolio.

Double...
KiOR will spend approximately $225 million to build Columbus 2, which will take 18 months to construct and begin operations. Vinod Khosla and Khosla Ventures are committing $50 million to that total with the balance coming from debt offerings and loans. Since the company just built Columbus 1 it should have a very good grasp of costs and scheduling for the project -- so hopefully no surprises are in store for investors. Similarly, by incorporating the latest technology improvements to Columbus 2 the company aims to reduce start-up problems that plagued Columbus 1 this year.

At their peak (nameplate) both facilities will convert 500 tons of biomass per day into annual production of 13 million gallons of product -- a combination of cellulosic gasoline, diesel, and oil. That means the company's catalyst will need to yield about 80 gallons of product per ton of biomass, which is Vinod Khosla's 2015 goal. The company last announced yields of 72 gallons per ton.

Assuming operations at Columbus 1 ramp smoothly from now on and Columbus 2 begins ramp-up by the second half of 2015 KiOR will have approximately 15 million gallons of production from the Columbus site in 2015. If every ton of biomass produces 80 gallons of product then production costs per gallon drop to about $3 per gallon, perhaps lower (compared to about $6 per gallon now). It seems unlikely that gasoline costs will drop below that in the future, so KiOR would achieve cost parity with fossil fuels before accounting for subsidies. Adding the credits pushes the selling price up considerably. In fact, KiOR realizes average selling prices of $5.49 per gallon from current production.

There is no shortage of customers, either. KiOR is partnered with Catchlight Energy, a joint venture between Chevron (NYSE: CVX  ) and Weyerhaeuser (NYSE: WY  ) , and sells product directly to the company. Chevron leverages its vast refining expertise and distribution network, while Weyerhaeuser provides feedstock to support KiOR's production. The JV hasn't quite taken off as originally envisioned in the Pacific Northwest, but the pine-rich Southeast and KiOR's platform offer a new opportunity. It could be a highly profitable win-win-win for the trio, especially given the low price of wood pulp compared to other popular feedstock.

Source: KiOR, Credit Suisse Small & Mid Cap Investor Conference presentation

Chevron and other refiners will benefit tremendously from buying KiOR's fuel, especially in the volatile ethanol blending credit market. Why? KiOR's gasoline and diesel count for 1.6 times the standard first-generation ethanol credit and don't face blending constraints (it is drop-in gasoline and diesel, not ethanol and biodiesel).

Or nothing
Financially speaking, KiOR should give you pause. A lot of pause. Sure, the potential exists for a profitable future with high demand for products and incredible growth. But are you willing to bet the technology platform will work as expected? Can it remain afloat to realize that future? Don't forget, KiOR recently admitted "substantial doubt about the ability to continue as a going concern". Thursday's announcement doesn't change that. 

There are multiple red flags in the company's finances.

Financial Metric

2Q13

4Q12

% Change

Cash

$11.5 million

$40.9 million

(71.9%)

Total debt

$154.7 million

$126.0 millon

22.8%

Debt to assets

56.6%

42.6%

32.9%

Source: SEC filings

First, the company's cash burn rate has been incredibly high. That can be attributed to start-up operations at Columbus 1 and capital expenditures related to its larger planned facility in Natchez. KiOR can continue to take on debt to fund operations and expansion, but it may be walking a tightrope with its future. Will taking a "double or nothing" attitude now limit growth opportunities in the future?

Even if things go perfectly at Columbus 1 investors shouldn't bank on KiOR being in existence to see expansion through. Consider that if the facility began producing at full capacity and optimal yields  tomorrow -- rather than 2015, as expected -- it would generate sales of roughly $70 million in the next 12 months. Take out the cost of revenue as illustrated above to arrive at a profit of just $33 million -- hardly enough to fund expansion, much less interest on its debt. Management estimates a combined price tag of $825 million for Columbus 2 and Natchez, while interest payments tallied $7.2 million in the second quarter alone. Can a company that generates a few million dollars in revenue attract enough investors to fund $825 million in debt? I'll bet not -- certainly not in an investor-friendly manner, anyway.

Too much risk
It seems counterintuitive to take a struggling platform and make it better by increasing production, but new manufacturing facilities almost always encounter problems. While that may provide a perfectly adequate explanation for a slow start at Columbus and seem to support further expansion, it is just one piece of the puzzle for investing in the company. KiOR is extremely dependent of debt to finance its current operations and its future. The potential may be enticing, but trust me, KiOR is too risky for you. 

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