Gevo Stock Is A Buy For The Long Term (NASDAQ:GEVO)

Gevo (NASDAQ:GEVO) offers a rare long-term buying opportunity. The company had a very impressive first half of the year. The business negotiated supply agreements with many companies and has taken huge steps towards supplying fuel.

The stock is currently down 62% year to date at its lowest point since December 2020. Furthermore, Gevo trades at a P/B ratio of 0.64, putting the company firmly in the value range. With just two years from running its Net-Zero 1 plant, the company could see a significant lift-off in the next 2 to 3 years.

Finance and agreements

I have covered Gevo on two separate occasions, once in February 2021 and another in July 2021. The first time I covered Gevo was also my first-ever article on Seeking Alpha, so it is fair to say it has a special place in my heart.

In the first half of 2021, the stock was riding on the hype for green energy and the need for sustainable fuels. At that time, I compared the stock to one of the biggest biodiesel producers, Renewable Energy Group, before Chevron took over the business.

In February of 2021, Gevo’s valuation looked excessive as the company had a market capitalization of $2.06 billion and was trading at 15.5 times the projected sales for 2024, way higher than Renewable Energy Group’s 1.8, with barely any fuel supply agreements and a lot of things still very uncertain.

On my second dive in the stock in July, the company was still expensive, with a market capitalization of $1.34 billion and a P/B value of 2.3 compared to Renewable Energy Group at that time, which traded at a P/B of 1.58. Both times Gevo was overpriced at periods when the renewable energy industry resembled more of a tech bubble from the late 90s. The company had tiny production facilities for its size and, with more than $500 million in the bank, looked more like an overpriced fund than an energy company.

However, things are different now. The company has way more going on, which makes me believe that now is the time to buy the stock.

What is the difference now?

From the operational side of things, the business is the same. The company has generated $0.3 million of revenue in the third quarter of 2023 compared to an even more humble $0.1 million during Q3 of 2021. The difference comes from the initial sales of RNG from Gevo’s RNG project.

The business has recorded an operational loss of $43.7 million for the quarter, including a $24.7 million impairment loss, with earnings per share also coming negative at $0.19.

The company continues to burn cash. The firm used $36.8 million for operating activities for the first nine months, compared to $28.7 million the year prior. Furthermore, during Q2 of 2022, the company used $5 million for research and development expenses and general administrative expenses. Much of this expense was related to strategic new hires, stock-based compensation and professional fees.

Although the cash-burning of the business is unlikely to take a dramatic U-turn in the next three years, I believe the bleeding can be eased from now onwards as a new facility has started operation since September.

Gevo’s Developments

Gevo’s new renewable gas plant in northwest Iowa is finally generating biogas and pumping it into the network. The project is an integral part of Gevo’s vision and fuel production. Furthermore, it will be a remedy to cash-burning until Net Zero-1 comes into operation.

The management expects to ramp up biogas production to its full capacity of approximately 355,000 MMBtu through the second half of 2022. The project consists of three dairy farms with over 20 000 milking cows. The facility will use the manure and sell renewable natural gas in California. The venture is expected to generate between $16 and $22 million in EBITDA by 2023.

However, Net Zero-1 remains the central jewel in the crown. The project is the first step toward the commercial-scale production of sustainable aviation fuel, and Gevo has already purchased approximately 245 acres of land near Lake Preston in South Dakota. The preliminary cost is expected to be $850 million, including on-site renewable energy generation. The management currently has the cash for 100% of the equity investment for the project.

If everything goes well, the company could see its first production in 2025, when it will fulfill part of the contracts already signed. The facility is expected to produce between 55 MGPY of sustainable vacation fuel or 62 MGPY of total hydrocarbon volumes with 420 million pounds of high-protein animal feed as a byproduct.

One thing investors might have missed and is still more reflected in the share price is that the firm has improved the plant’s operational efficiency by transitioning from isobutanol-to-SAF to ethanol-to SAF design. Those changes promise to increase the projected EBITDA of the project by 56% or from approximately $200 million to $300-$325 million per year, therefore, improving the ROI of the project substantially.

Outlook & Valuation

The company’s income statement is unlikely to improve dramatically in the next couple of years as the Louvern facility is currently used for demonstration operations and additional support for further advancing the technology. However, the built RNG facility is expected to reduce the cash-burning and bring more trust from investors.

In one of my previous articles on the 6th of July, I mentioned that the company resembled more of an overpriced fund than an energy company in its current state. However, the company’s shares were trading between $6 and $7, with a market capitalization of about $1.34 billion and net equity of just $595 million, or a P/B value north of 2.2.

Since then, a lot has changed. The P/B ratio has only decreased, making the company a far more attractive investment. At about $1.8 a share, Gevo has a market capitalization of roughly $427 million and net assets of $664 million, resulting in a P/B ratio of 0.64, putting the company firmly in the value range.

Furthermore, on the 22nd of July 2021, the company signed its most significant contract with American Airlines (AAL) to supply 100 million gallons of sustainable aviation fuel (or SAF) for five years. As of Q3, Gevo has accumulated more than 375 million gallons of SAF supply agreements per year. Depending on the time horizon of the contracts, it could mean that the company may need up to 5 Net-Zero plants to meet its obligations, given the capacity of 55 million gallons per year each one of them has.

According to the management, these contracts are expected to generate approximately $2.3 billion annually and potentially over $1.5 billion of EBITDA. If so, it is not unrealistic for investors to expect that the company will be worth far more than $500 million, but how much? The day Renewable Energy Group was acquired by Chevron for $3.15 billion or $61.50 a share, the company was trading at a P/S ratio of 0.84 and forward P/E ratio of 17.4.

Yet, it is still unknown when and how many Net-Zero 1 plants Gevo will build. However, at a P/S ratio of between 0.5 and 0.75, just like REGI’s, the company could be worth anywhere between $1.15 and $1.73 billion, or an upside potential between 150% and 280% in the next 2 to 3 years.

Gevo has nowhere near the financial capacity nor a defined plan for raising money for more projects, whether through issuing new shares or taking on debt. However, these supply agreements will surely come in handy when speaking with banks for finance.

Whatever the management chooses will impact the price per share, which is why valuing the company could be tricky.

Risks

Just like with any other stock, this one has its risks too. The company has issued a huge number of shares in the past two and a half years. The total shares in issue have increased from 50 million shares in May 2020 to 237.22 million shares based on their report on the 8th of November 2022. Although the company has about $546.8 million in cash and marketable securities, which should be enough in combination with debt to ensure the completion of Net Zero-1, the timing of raising debt could not have been worse. The rising inflation has led to FED increasing the rates at an incredible pace. This has pushed the 10-year U.S. treasuries to 3.5% compared to about 1.5% at the same time last year.

Conclusion

The current situation of the company is not ideal. Suppose the management wants to fulfil their supply agreement, the company will have to construct several projects just like Net Zero-1. The firm does not have the cash for more than one project, so it will most likely resort to issuing more shares or raising debt on not-so-favourable terms.

However, I believe the company has probably done the most difficult part, finding a market for its product which is why I believe the stock is a BUY. As soon as the NZ1 is complete, the market could become more favourable towards the share of GEVO, taking the stock way higher.