The world of vegetable oils is marked with numerous susceptibilities when it comes to controlling output. Beyond insects and invading plants, there is the daily fluctuation of weather conditions for optimal growth. For renewable oil producer, Solazyme (SZYM ), the ability to create tailored oil replacements in standard industrial fermentation vessels stands as a key advantage when it comes to controlling oil output. The recent disaster caused by Typhoon Haiyan represents a clear case study in how Solazyme's technology could one day be used to stabilize vegetable oil markets.
How The Market Can Change Overnight
On November 8, Typhoon Haiyan swept across the Philippines with winds topping 195 miles per hour. While the human death toll still continues to rise today, the economic consequences are also gradually being realized. The Philippines remains the world's largest producer of coconut oil as seen in the graph below. However, initial reports have shown that more than 3 million coconut trees have been destroyed by the typhoon while also disrupting approximately 300,000 metric tonnes [MT] of coconut oil supply.
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In less than two days, this single event temporarily disabled approximately 8% of the world's coconut oil production. The strong storm had cut across the very heart of the Philippines affecting some of the country's most abundant coconut-growing regions. While the full extent of the damage remains unknown, the effects of the typhoon provided enough pressure to significantly move commodity markets.
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As of November 18, coconut oil prices (c.i.f. Rotterdam) rose to $1075/MT. As seen in the chart below, this steep increase continues a volatile trend that has continued to plague geographically-restricted oilseed markets. For coconut oil alone, the commodity has seen average price fluctuations of more than 400% over the past decade. The rise of coconut oil prices after Haiyan also pulled up the prices of palm and palm kernel oil as suppliers sought viable alternatives.
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The Problem With Geography
The inherent supply problem with coconut oil lies in the constrained geographic regions in which coconut trees naturally grow. As shown in the graphic below, coconuts naturally grow in an area with very limited land available for agriculture. As a result, the top four coconut oil-producing countries supply nearly 88% of world supply. All of them reside in Southeast Asia.
To further complicate this issue is the most compatible replacement to coconut oil. This is found in palm oil and palm kernel oil, two products made from the same plant. Yet the same geography issue exists for palm as well. By themselves, Indonesia and Malaysia account for 86% of world production. As a result, the global supply of these popular oils are confined to a very narrow region of the world. Additionally, it is a part of the world that annually vulnerable to adverse weather conditions.
A Look At Solazyme's Technology
Solazyme uses proprietary heterotrophic algae strains that convert low-cost carbohydrates into high-value tailored oils. Beyond merely replicating the oil profiles of commonly used oils (ie. petroleum, vegetable oils, & animal fats), the company can control carbon chain length, saturation, and structure when it comes to oil design. This allows for the creation of novel oils with unique properties that far exceed the capabilities of natural oils.
One relevant example of this tailoring capability can be found in the creation of an oil with high yields of myristic acid. The highest concentration levels of naturally occurring myristic acid can be found in coconut oil and palm kernel oil as seen in the chart below. However, through a joint development arrangement with Mitsui & Co., Ltd. (MITSY ), Solazyme's technology has produced an oil that can create more than four times the amount of myristic acid within its oil.
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But beyond this breakthrough technology's capabilities, the most fundamental advantage of Solazyme's platform lies in its ability to expand the geographic production range of its target markets. For example, intermediate companies based in the United States that would otherwise be dependent on coconut oil from the Philippines can now use improved oil alternatives produced in the heartland of America. Additionally, Solazyme's process effectively produces an oil "harvest" every week compared to the 2-3 harvests per year when it comes to traditional crops.
This is exactly the situation we see brewing in Clinton, Iowa, where Archer Daniels Midland Company (ADM ) is partnering with Solazyme for renewable oils. Among the possible products to be produced is the creation of a cocoa butter replacement. Bound by similar geographic restrictions around the Equator, cocoa supply has notoriously faced a large degree of price volatility. By partnering with Solazyme, Archer Daniels Midland can theoretically source multiple oils throughout the year with significantly less expenses when it comes to transportation, storage, and capital allocation.
A Look At the Company's Financials
As of its last closing price of $8.20 on November 22, Solazyme now trades with a market capitalization of $559 million. The company carries total current assets of $219.9 million with current liabilities of only $20.4 million. This gives the company a working capital of $199.5 million. Total liabilities and equity equate to $278.8 million.
In the last quarter, the company carried a total loss from operations of $24.1 million. However, $17.6 million of this amount was dedicated to research and development expenses. As a result, we see that Solazyme continues to invest into the improvement of its technology despite already having a viable platform capable of being implemented in its first large-scale commercial facilities now under construction.
Opening its first plants in the United States and Brazil, Solazyme will expand its manufacturing capacity by 6,500% with its partners Archer Daniels Midland and Bunge (BG ). Over the coming months, this will raise Solazyme's production ability from 1,800 MT to over 120,000 MT. After nearly two years of construction, the first newly constructed plants are expected to start producing commercial quantities of product in Q1 2014.
Analysts currently expect for Solazyme to produce revenue of $194.8 million in 2014. This represents 315% growth off of the revenue expectations of $46.9 million in 2013. Since Solazyme's IPO in 2011, the company's stock has fallen 60% despite significant improvements to the company's outlook in terms of technological capabilities, market acceptance, partnerships, and financial strength.
Final Thoughts
Solazyme offers a unique technology capable of revolutionizing the procurement of supply-constrained oils. More specifically, it can radically improve the supply efficiency of yield-restricted fatty acids based on its tailoring capabilities. The company's technology vastly expands the narrow geographic band in which production is possible. As a result, it is able to decentralize some of the world's most popular commodities away from some of the most vulnerable regions of the world.
Disclosure: I am long BG, SZYM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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