This time last year, Renewable Energy Group (NASDAQ:REGI) and Codexis (NASDAQ:CDXS) were each valued at around $500 million. While both businesses sport a market cap in excess of $1 billion today after an impressive rise last year, they're still considered small-cap stocks. Judging from recent and expected full-year 2018 operating results, both would make great additions to your portfolio in March.
The nation's largest biodiesel producer hit its stride last year after achieving profitable operations without the help of federal subsidies. Significant projects with the likes of ExxonMobil and Phillips 66 promise to keep growth humming along for the foreseeable future. Meanwhile, Codexis is a diversified biotech with several high-value shots on goal in a range of businesses including food ingredients, pharmaceutical manufacturing, and biopharmaceutical clinical trials. It delivered a solid year of operations in 2018 and expects the momentum to accelerate in the year ahead.
Here's why each company is worth a closer look -- and perhaps a spot in your portfolio.
Diesel fuels are about to see a surge in demand
Renewable Energy Group doesn't report full-year 2018 earnings until March 5, but investors don't need to wait to see the results to know the business turned a corner last year. It had struggled for years under the perpetual uncertainty of a specific biodiesel subsidy called the blender's tax credit (BTC). Earned by the first company to blend biodiesel with petroleum-based fuels, the BTC was allowed to expire in 2010, 2014, 2015, 2017, 2018, and now, 2019.
Although it has been retroactively reinstated each year prior to 2018, the credit's "on again, off again" nature injects a lot of uncertainty into the business. That's why investors breathed a sigh of relief last year when it became obvious that Renewable Energy Group had reached sufficient scale and operating efficiency to report profits without the BTC. What's more, the business will receive an estimated windfall (read: 100% profit) of over $200 million if the BTC is retroactively reinstated for 2018.
That newfound profitability significantly de-risks the company's operations going forward. Considering Renewable Energy Group is diversifying its core biodiesel business by expanding into renewable diesel (chemically similar to petroleum-based diesel) and petroleum-based diesel, the momentum is likely to continue. The timing couldn't be better.
A new rule requiring low-sulfur fuels to be used in the global marine shipping industry starting on the first day of 2020 is expected to increase worldwide demand for diesel fuel -- an inherently low-sulfur fuel -- by 12 billion to 30 billion gallons per year. Meanwhile, increasingly strict air-pollution and carbon-dioxide emissions rules go into effect in California and other West Coast states in the coming years, which is expected to increase demand for ultra-low sulfur diesel fuel, including renewable diesel products produced by the company.
Those catalysts should put upward pressure on the price of diesel fuel, which would provide a tailwind for the company's bottom line and expansion efforts. Renewable Energy Group and Phillips 66 intend to build a large-scale renewable diesel facility in Washington state by 2021, while the company is working with ExxonMobil and Clariant to develop genetically engineered microbes capable of churning out next-generation biodiesel and renewable diesel fuels.
Now that the business is comfortably profitable, even without federal subsidies, investors can feel confident that Renewable Energy Group can fund more ambitious expansion and research and development (R&D) projects -- and perhaps even accelerate those efforts. Considering the stock is trading at a PEG ratio of just 0.28 and 0.4 times sales (without accounting for possible windfalls from a reinstated BTC), that growth potential could be a bargain.
A diverse biotech company on the rise
Codexis is another small-cap company beginning to hit its stride. The company engineers biological molecules called enzymes, which allow chemical reactions to occur faster, at lower temperatures, and produce fewer byproducts (read: waste). Enzymes power all living things, and when applied to industrial processes ranging from manufacturing food ingredients to pharmaceuticals, can save millions of dollars per year.
The company's expertise in engineering enzymes allows customers to tap into the money-saving power of the biologic molecules. Codexis counts 21 of the world's top 25 pharmaceutical companies as customers, in addition to food leader Tate & Lyle. It generates revenue from enzyme supply agreements, licensing its software platform to large customers, and collaborations for various projects. The business isn't profitable yet but it's on a promising trajectory.
Codexis reported full-year 2018 revenue of $60.6 million, representing 21% growth compared to the previous year. Product revenue was generated at a gross margin of over 50%. Importantly, the business reduced operating loss to just $11.3 million on the year, compared to $22.9 million in 2017. Management expects the momentum to continue this year.
Full-year 2019 guidance calls for total revenue in the neighborhood of $70.5 million, representing year-over-year growth of 16%. That comprises expectations for roughly $27.5 million in product revenue, which is somewhat disappointing but reflects a shift in supply agreements.
Nonetheless, the business could come close to break-even operations in 2019, which would significantly de-risk future expansion efforts. Codexis is developing its own pipeline of therapeutic enzymes with Nestle Health Science. The first drug candidate, intended to treat a rare disease called phenylketonuria (PKU), is now in the hands of its partner in a phase 1b clinical trial. The enzyme engineer could receive milestone payments of $336 million on top of royalties if the product hits the market. Considering the only other treatments for PKU have significant side effects and still net BioMarin Pharmaceutical over $400 million in annual revenue, the potential is intriguing for the early-stage pipeline asset.
It's important to note that the biopharmaceutical pipeline is not the core business -- that title belongs to the much less risky enzyme supply segment. That alone makes Codexis a compelling growth stock to watch for investors with a long-term mindset, especially if product and collaboration revenue continue growing at a handsome clip.