3 Risks for My Favorite Biotech Stock in 2015

Image source: Amyris.

I recently labeled synthetic biology pioneer Amyris (AMRS) my favorite stock to buy in 2015. That may catch a lot of people by surprise, but I believe investors have good reason to be optimistic that the company is finally finding stable footing. Production costs have fallen nearly 77% since early 2013, which opens up more markets for profitable entry. Meanwhile, successful market development efforts will begin to allow larger production volumes; with sales not far behind. Knowing what I know now -- which includes management's tendency to set expectations too high -- I don't think it's crazy to say that 2015 might be the last time investors can acquire Amyris stock for less than $2, $3, or even $4 per share.

However, as with any investment, there are risks to being an Amyris shareholder. If management doesn't craft adequate strategies, then it will take even longer for investors to realize the growth potential promised years ago.

Flavors and fragrance sales could slump
The ability to engineer microbes, in this case yeast, to efficiently produce a diverse range of chemical products is one of the most enticing aspects of investing in industrial biotech companies powered by synthetic biology. Amyris is targeting diesel and jet fuel markets, performance materials markets, cosmetics markets, and flavor and fragrance markets with a single manufacturing platform. A large chunk of the company's future, especially profits, is heavily tied to success in that last category.

Amyris has over 20 flavor and fragrance molecules in its development pipeline with the industry's leading companies, such as Firmenich and International Flavors & Fragrances, which are hoping to acquire more stable and efficient supply of food and perfume ingredients that often come from difficult-to-harvest agricultural crops in challenging geographies. Take the company's first fragrance product, patchouli oil (a mixture of chemicals), as an example. It's marketed with industry leader Firmenich as Clearwood.

While growers of patchouli can enter long term contracts for selling dried leaves for about $300 to $350 per metric ton, purified patchouli oil can sell for over $100 per kilogram, or $100,000 per MT because leaves only contain about 3.5% oil. The low yields of agricultural patchouli sets a relatively low bar for Amyris that's accompanied by out-sized rewards.

Even if you buy in bulk, Clearwood costs $100 per kg through third-party distributors. Image source: PerfumerSupplyHouse.com.

But there's a catch. The patchouli oil that Amyris and its partner Firmenich sells, called Clearwood, isn't chemically identical to agricultural patchouli oil. That means it likely fetches lower selling prices than traditional patchouli oil, especially considering scent, not price, is king for perfumers. That may also make customers hesitate to use it as a direct replacement, instead choosing to use it in supplemental applications. To borrow a term more familiar to biofuels markets, Clearwood isn't a true drop-in fragrance. 

Amyris and its partners are aware of the complexities of agricultural flavors and fragrances, and the likelihood that early cultured products produced with industrial biotech will be relegated to supplemental applications, but it could lead to less ambitious sales for the high value portfolio. Unfortunately, this risk often isn't explained to investors.

Cash remains a persistent concern
This was the sole risk brought up in my prior article mentioned in the introduction above, but it's worth explaining again in more detail. Amyris will need to raise additional cash, likely more than once, before operations cover expenses and fund growth. Although the company is expecting to be cash flow positive within the next few quarters, there is some fine print to go along with statement that may go unnoticed by investors.  

Achieving "positive cash flow" means Amyris will generate enough cash every year to cover annual capital expenditures of about $8 million. While that's a step in the right direction, it's a pretty small one. There's a long way to go before the company covers its annual operating expenses, which have flat-lined at about $85 million. What's the difference? Operating expenses include the all-important R&D and Selling, General, and Administrative (SG&A) balance sheet categories. As defined here, capital expenditures only include "Investing Activities" on the company's cash flow statement.

Amyris debt by maturity date as of June 2014. Image source: Amyris. 

Here's some more worrisome math for investors: Amyris had just $67 million in cash at the end of the third quarter. That means the company will need to raise additional financing in 2015 just to continue operations, which means the already lofty debt mound will continue to grow. I'm optimistic the company can shakedown partners and existing investors for even more cash, but only if product revenue remains on track to double in 2015 compared to prior year watermarks. It seems that production costs are low enough to enable that to happen, but only real-life events will prove that thesis.

A dominating U.S. dollar
The lives of companies based in emerging markets are about to get exponentially more difficult in 2015 as the U.S. dollar has crushed global currency markets in the last year. Relatively strong economic growth in America, Russian banks scrambling to add to their foreign currency reserves, a stagnant Eurozone, a volatile Swiss Franc, and uncontrollable inflation in emerging markets, such as Brazil, are all contributing factors.

Sounds like good news for American citizens, right? Problem is, an appreciating greenback is horrible news for companies in Brazil that funded growth with dollar-denominated debt because That debt becomes more expensive to payoff in Brazilian Reals. This could place financial stress on companies in emerging markets and dilute overseas earnings once converted to U.S. dollars. 

While Amyris is based in sunny California, its sole manufacturing facility is in Paraiso, Brazil. A strong dollar will actually soften the company's losses (just as it would soften a company's earnings when converted to U.S. dollars) and make it a great time to payoff its $6.1 million loan to the Brazilian Development Bank, but it could have negative effects elsewhere. For instance, Amyris may have a difficult time selling renewable products to Brazilian customers dealing with the brunt of a stronger dollar and rapid inflation. It will also make it more expensive to import American equipment during its annual shutdown period early in the first quarter should the company need to do so. How management chooses to respond to changing currency markets remains to be seen. 

What does it mean for investors?
Amyris comes with above average risk in the near-term, which could cause the company's stock price to continue experiencing volatility in the next several quarters. Longer-term risks could develop if the huge bet on supplemental flavor and fragrance molecules fails to gain traction with customers. While it would only affect about 17% of sales in the next few years, the high profit margins on such products means any unraveling would have a disproportionate effect on profits. The need for additional capital and tricky circumstances for companies with global operations will also be worth keeping an eye on for investors.

However, in 2015 the company is poised to capture the broad array of market opportunities opened by lower production costs, stable production, and a relatively disciplined cash burn. If new products meet sales expectations and market development activities continue to prove successful, then Amyris will only need time (and the generosity of existing partners) to prove its growth potential to a broader investing audience. Just don't forget about the risks that lay ahead.