Kevin Quon: 5 ways that Solazyme’s food oils can attract large food manufacturers

[USA] Renewable food ingredients and tailored oils producer, Solazyme (NASDAQ:SZYM), continues to lead the race when it comes to introducing innovation through the microorganism of microalgae. In recent months, the company has reached a new commercial milestone with the first sales of its tailored algae oils as I reported in my articles found here and here. The company has begun to incorporate its high oleic algal oil into products offered by large food product manufacturers, and it has also launched its own brand of culinary algae oil with the test launch of Thrive.

In contrast to many of the company’s other products, food oils have very quickly risen to become a key focus for Solazyme. One concept that investors should understand is that this product segment stands in a sweet spot between having the potential for a large market size while also supporting higher profit margins in contrast to some of the company’s other divisions. This is important considering the delicate balancing act Solazyme needs to perform in order to maximize its profits while working through its current restraint on production capacity as its ramps.

Unlike the approximate 30% target gross margins for fuels and chemicals division, the company’s food business supports target gross margins in a range of 40-70%. For now, the company’s low-margin but high-volume business segments have largely been placed on a lower priority for the near term due to a rough commodity pricing environment.

Yet unlike the high-margin cosmetics business, which takes up a fraction of the small Peoria facility’s 2,000 MT capacity, food oil production can deliver oil sales of much larger quantities. It is for this reason that food oils will soon transition to Moema’s facility with its 100,000 metric ton capacity. It is also for this reason why food manufacturers will ultimately be relied upon to deliver the demand for these oils.

An Early Look At Market Response

For now, an early look at the recent introduction of Thrive gives a sense of how the company’s food oils may ultimately be perceived by the end consumer. The distribution of Thrive currently remains restricted to an online presence through the company website and on the shelves at the Gelson’s Markets supermarket chain in Los Angeles. The limited product launch represents an opportunistic channel to directly address the high-end consumer market. This follows alongside the company’s approach to market its high-end cosmetic line of Algenist, which quickly grew within a few years into the leading product line that now accounts for the majority of Solazyme’s product revenue.

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Despite this soft product launch, leading indicators already remain promising. According to Instantly, a market audience research firm, Thrive Culinary Algae Oil received a purchase intent score of 52% in its first month. This made it the #9 highest ranked consumer packaged good product for the month according to the firm’s metrics. This also placed the product’s purchase intent score right behind those of new products released by Dunkin’ Donuts (NASDAQ:DNKN), Campbells (NYSE:CPB), and Mountain Dew.

While these results are still premature and brand awareness is still far from being fully formed, the advantages of Solazyme’s food oils extend beyond that which appeal only to the individual buyer. While the immediate benefits of a new heart-healthy cooking oil with a neutral taste and a very high smoke point may or may not prove to catch on with consumers, it is also the benefits offered to the large food manufacturers, which should ultimately prove to be most valuable to the company.

Looking Forward Towards Larger Customers

In the company’s latest press release, Bunge (NYSE:BG) and Solazyme announced an extension of their joint venture to now cover oils for food, which will include the AlgaWise Ultra Omega-9 algae oil and the AlgaWise High Stability algae oil. Both of these oils carry similar properties to those offered under the Thrive brand with the largest distinction coming down to sales volumes and target audience. Maybe looking at their Contract lifecycle management will ensure consistent results. While Thrive is marketed directly to the end consumer, the AlgaWise product line will focus on bulk sales to large food manufacturers.

One key takeaway from the announcement of the joint venture’s extension now lies in the new role that Bunge will take on. According to the new arrangement, the expansion will lean upon Bunge’s global leadership in food and ingredients. As noted by Solazyme’s CEO, Jonathan Wolfson, the partnership will be able to utilize Bunge’s global food sales, marketing, and applications strength. This brings in much needed resources and expertise to further educate potential clients of these innovative oils.

Why this matters for investors lies in the fact that product quantities will play an increasing role over the coming quarters for Solazyme. Unlike Thrive, which continues to sell in small orders of half-liter bottles, large food manufacturers are capable of consuming AlgaWise oils on the scale of metric tons at a time. This is important when we consider the 100,000 metric ton nameplate capacity that Moema is expected to run at when fully ramped.

Under consistent and fully integrated operations, it was previously anticipated that the ramping process would take approximately 12 to 18 months until it was producing at full nameplate capacity. This would suggest that within a year, the company will need to source larger clients capable of ordering in higher quantities in order to prevent an inventory pile-up. It will only be through these future offtake arrangements that the joint venture’s ramping supply will be able to be met with increasing demand in this key market.

But what will be the key selling points for these future customers found in large food manufacturers? Whereas the superior health angle may be persuasive for individual customers of Thrive, large manufacturers are often more concerned with the pragmatic benefits found in economic advantages, more efficient processes, and greater quality of the end product.

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A new patent application filed by Solazyme continues to offer insight into just why food manufacturers may soon be compelled into buying Solazyme’s high-stability oils. The following are some of the intriguing details about these advantages:

Removing EDTA and other chelating agents.

Ethylenediaminetetraacetic acid is not a word one would want to repeat five times as fast, and as such, it also remains a target ingredient that manufacturers would like to remove in order to simplify their nutrition labels. EDTA is often used in prescription medicines, but is also used as a preservative in food and can also be used as a color, texture and flavor promoter. Some of the dangers of the preservative are further detailed in this short article found here. In general, chelating agents can often be found in salad dressings, spreads, sports drinks, cheeses, and other foods in order to minimize oxidative degradation. Yet as Solazyme’s high stability oils are far more stable than other commonly used vegetable oils, the need for these agents can be eliminated or severely reduced. Two examples of a potential market found in products from Hampton Creek and Unilever demonstrate the abundant use of such agents.

Replacing metallic films and nitrogen sparging for fried foods.

Ever wonder why chips come in bags made out of metallic films rather than in less expensive bags made out of cheaper materials like plastic? Because of their airtight properties and ability to block out light, these expensive packaging materials are required in order to optimize the flavor and texture of the chips. The bags are also pumped with nitrogen for the same reason of preventing oxidation, which occurs when the oils in the fried foods begins to break down. Because Solazyme’s algal oils can far exceed the properties of conventional oils, the longer-lasting stability of fried foods made with these algal oils can eliminate the need for more expensive packaging materials and processes.

Replacing mineral oils for food processing equipment.

While far from ideal, many food producers continue to use mineral oils in food manufacturing because of the superior properties that these oils have when compared to conventional vegetable oils. Mineral oils are derived from petroleum, and when applied to equipment surfaces in a food-based environment, these oils can sometimes come into contact with food. Often used as lubricants in gears or for spraying heated surfaces, the vastly improved stability and high temperature nature of Solazyme’s algal oils can eliminate the need for such mineral oils in a food-based environment.

Removing partially hydrogenated oils for coating and spraying applications.

Oils that are low in polyunsaturates are often used as a coating for many foods including nuts, dehydrated powders, dried fruit, crackers, etc. These oils protect the foods from oxidation, which occurs over time based on the nature of an oil’s stability. While many conventional vegetable oils are unable to offer the level of desirable protection, partially hydrogenated oils are typically used for these circumstances. However, given the superior stability of Solazyme’s algal oils, such algal oils carry a top of the line capability to protect such foods and can even be used to replace partially hydrogenated oils altogether.

Offering an improved carrier for food flavors and colors.

Flavorants and colorants are expensive ingredients in foods that often require a carrier like an oil in order to be applied. How effective these agents are is dependent upon the stability of the carrier. As such, the high stability nature of Solazyme’s algal oils can aid in creating improved mediums for these agents and simultaneously remove less desirable oils such as partially hydrogenated oils. As a result, high stability oils can help improve the taste and shelf life of the prepared food item itself.

Overall, what stands out the most about each of these benefits to manufacturers is the fact that they address many of the problems now facing the industry. Food manufacturers are increasingly looking for cleaner food labels that appeal to a more cognizant consumer desiring simplicity. The dangers of trans fats has also led to a mandate by the FDA to remove partially hydrogenated oils from food products over the next 3 years. Additionally, finding safer production processes and cost-saving efficiencies in a competitive environment with tight profit margins is also an ongoing pursuit for manufacturers who must simultaneously protect product quality.

As Bunge begins to take a lead on marketing Solazyme’s high stability algal oils, these comparative advantages are likely to play an increasing role in the marketing to interested food manufacturers beyond the sustainability appeal already associated with oils derived from algae. Investors should also keep in mind that Bunge itself can serve as a buying customer and demand driver as well as a key production partner for the consumption of these oils. As one of the Big Four in agribusiness (Archer Daniels Midland Co. (NYSE:ADM), Bunge, Cargill, & Louis Dreyfus), Bunge’s own demand for food oils far exceeds the capacity that the joint venture’s production facility is able to provide.

A Look At Solazyme Now

Solazyme now trades with a market capitalization of $241 million based on the last share price of $2.99 as of November 24, 2015. The company continues to heavily rely upon its in-house cosmetic and skincare brand, Algenist, for the majority of its reported revenue, but over time, the company expects to see an improved contribution to the bottom line through its 50-50 joint venture with Bunge. The joint venture will revolve primarily around the bulk production and sale of ingredients and intermediates coming out of the joint venture production facility based at Moema in Brazil.

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However, until financial consolidation of the joint venture occurs, Solazyme’s reported sales will not reflect the progress now underway within the joint venture. The distinction may eventually be important as financial consolidation of the joint venture is not planned for any time in the near future. On the other hand, the majority of the company’s efforts will be focused on the facility at Moema controlled by the joint venture. Despite these efforts, revenue derived by the joint venture will not show up in Solazyme’s reported financials, which may mislead investors into believing growth at Solazyme has not improved as quickly as one would expect.

Recently, Solazyme also introduced its own branded product line of culinary algae oil called Thrive. The production of this branded product is also expected to be transitioned to Moema as production at its Clinton facility winds down. As such, it is likely that Solazyme will be buying its oil supply through the joint venture. Nevertheless, as an in-house brand, it is probable that sales of Thrive will be directly seen on the company’s financials over time. This remains in stark contrast to much of the high-volume food oil production (much of which will be of a similar nature to the Thrive cooking oil) which will contribute to the joint venture through Bunge’s lead on marketing.

Despite this complicated reporting process, progress at the joint venture can still be seen in a limited fashion through Solazyme’s reported quarterly reports filed with the SEC. The joint venture’s sales continue to be slow as the joint venture begins to ramp up its initial production at Moema. This is to be expected as the process follows an S-curve model in which low production is anticipated towards the beginning of the ramp but will rapidly increase towards the middle of the ramp and level out to nameplate capacity at the end of the ramp. Having only recently gained access to a fully integrated production facility (due to utility delays), a meaningful optimization process is now underway in which low-volume production can be tweaked for the ideal conditions before high-volume throughput is put into action.

Despite the expectation of these low initial production figures, the company’s filed SEC forms continue to show some promising progress. According to the company’s filed Form 10-Qs, net sales at the joint venture have increased from $257,000 in Q1 2015, to $401,000 in Q2 2015, and have now improved to $953,000 in Q3 2015. This represents consecutive sales increases of 56% and 138% for Q2 2015 and Q3 2015 respectively. Based on the normal business cycle, it also remains likely that these reported sales continue to trail actual increases to production over the same time frame. This was previously seen at the Clinton facility in which sales from product made in 2014 was still being sold and reported in early 2015.

It remains disappointing that much of the progress at the joint venture will ultimately remain masked behind complicated and less transparent financial reporting due to non-financial consolidation of the joint venture. This consolidation is not expected to occur until Solazyme gains greater control over the day-to-day decisions of the joint venture and meets other relationship conditions. Such conditions are not expected to be met in 2016.

However, as noted in the company’s filings, progress continues to be seen on a surface level as noted by the improving sales growth in consecutive quarters. When the production ramp reaches much higher volume levels, investors can anticipate for improved economies of scale to become meaningful.

Final Thoughts

Solazyme is well on its way making a meaningful impact in the food industry. It is doing so by introducing innovative food ingredients that not only replace conventional ingredients with more sustainable alternatives, but also offers improved benefits beyond what existing materials can currently provide. Most importantly, Solazyme’s products continue to align well alongside favorable trends now found throughout the food industry.

For some time, food companies have become hard-pressed to improve their environmental and health footprints, particularly when it comes to limiting the use of palm oil and eliminating the use of trans fats, which continue to be used prevalently throughout the packaged food industry. Yet with innovation perfected over the past dozen years, Solazyme’s algae oils can also do more than merely lift the sustainability profiles of large food manufacturers or provide viable alternatives to partially hydrogenated oils. Indeed, the increased stability of these oils can be used to provide additional cost savings, increase the appeal of a final product, or even allow the product to perform better than it could with the standard ingredients of today.

Investors in Solazyme now are holding onto a company with the intellectual property for some of the most stable foods oils in the world. The company is now beginning to sell its food oils to the public, and the targeting of large manufacturers is now in the hands of Bunge, a reliable and established partner with deep ties throughout the industry. Solazyme remains in a favorable position to benefit from this increased demand, and expectations remain high that food manufacturers will have much reason to embrace such innovation.

 

View original article at: 5 Ways That Solazyme’s Food Oils Can Attract Large Food Manufacturers

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