Back in December, fellow Fool Travis Hoium outlined why biofuels specialists like Amyris (Nasdaq: AMRS), Rentech (AMEX: RTK) and Solazyme (Nasdaq: SZYM) would eventually run into problems, and his argument that there are "way too many barriers in the way, barriers that we originally saw with corn-based ethanol" is convincing.
Specifically, Travis pointed out that while things initially looked good in the prototype labs for ethanol, problems galore started cascading when it came time to ramp up. Once everyone wanted corn for ethanol gas, the price of corn shot up -- and all of a sudden, the value proposition of ethanol wasn't so great anymore.
Today's biofuel producers can use everything from animal fats to wood chips to produce their oils. That type of diversity is great, but the fundamental problem still remains: Whether it's oil or wood chips, when demand outpaces supply, the price of a commodity skyrockets. If biofuels -- as the driver of our future cars, trucks, planes, and boats -- are our future, there is no doubt that animal fats and wood chips would become far more expensive than they are today.
One stock I'm singling out
Of the three biofuel specialists I mentioned above, I think Solazyme stands the best chance of outperforming the market. In the end, it doesn't even need its biofuels to succeed.
Though they have a partnership in place with Chevron (NYSE: CVX), and their fuels have been successfully used in a United Continental flight, on U.S. Naval Destroyers, and Maersk shipping boats, Solazyme has several other fronts on which it can succeed.
First and foremost is its beauty product line -- Algenist -- which uses tailored oils produced by patented micro-algae. The products have sold briskly over the past year. Solazyme's new plant in Peoria, Ill., is now focused on pumping out the algruonic acid used in Algenist. And the company has target gross margins set between 60%-80% for its skin and personal care products -- far better than they could accomplish by just focusing on fuels.
Furthermore, the company is also able to create healthy, tailored oils for use in food products. One brand -- Golden Chlorella -- is already for sale at stores and grocers now, but there are several more to come from the company's joint venture with Roquette Nutritionals. The latest product will be Whole Algalin Flour, and like the beauty products, these food offerings will likely sport better gross margins than fuel.
Though neither food nor beauty products will ever drive the kind of volume that biofuels would, that could be a blessing in disguise. If biofuels do become big, then the feedstock that Solazyme needs to give to its microalgae would become far more expensive. Therefore, the lower-volume, higher-margin food and beauty industries could be just what the doctor ordered.
Multiple futures
Fool co-founder David Gardner has a phenomenal track record, and part of the reason for that is because he likes to invest in companies with "multiple futures." What David means by this is that he likes to invest in companies that are innovative, and could end up dominating any one of a number of different fields.
In Solazyme, we have an excellent candidate with multiple futures -- food, beauty products, and biofuels. Though the company started off just focusing on biofuels, its leadership had the vision to expand its scope.
"In order to succeed, we had to pivot. It was adapt or die. We were right that algae was the best platform to make oil but wrong about how to do it," CEO Jonathan Wolfson said of his company's transformation. "It soon became clear we were making renewable oils."
I've backed up my belief in Solazyme with my own money, and I'm maintaining my outperform CAPScall on my All-Star profile, despite the fact that it's losing to the market right now.
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