Tuesday, June 23, 2015

Ceres Punts After Oil Price Drop

Last week Brazilian agriculture technology developer Ceres (CERE:  Nasdaq) made formal plans to shift its focus to seed traits and the food and feed markets and away from energy.  Ceres is not abandoning biofuels as such, but with oil prices at historic low levels, it is not economic enough to justify working capital not to mention new investments.   The company is restructuring operations and reducing personnel in both its U.S. and Brazilian operations.  Ceres management estimates the changes will save between $6 million and $8 million next year.

The question investors need to ask now is whether the shift in priorities can change the value of Ceres.

The company has a strong balance sheet with no debt and $4.8 million in cash and $9.9 million in marketable securities.  The cash and financial assets will come in handy over the months as Ceres tries to reinvent its business model.  Ceres has yet to post a profit on its various agricultural technologies.  Consequently, the company has required considerable investment in working capital.  Over the last year alone Ceres has used $23.9 million in cash to support operations.  Assuming the anticipated savings develops as planned, it is possible that Ceres might need another $16 million to $18 million to keep the wheels turning.  Still it looks like the company could be $2 million to $4 million short.

Thus the first hiccup in creating value is the potential need to raise capital.  That means either increased leverage or issuing additional equity securities.  For a company that is not generating profits or cash, debt can be troublesome.  For most investors, the dilution from new stock is anathema to creating value.

To be fair, Ceres has been making progress with its crop traits.  In March 2014, the company announced plans to accelerate development of its sugarcane traits after initial field trials found better than expected growth and biomass even under drought conditions.  The next stage of field research is expected to be completed by June 2016.  If the company is able to keep pace with the planned schedule, the sugarcane traits should be ready for commercial market introduction in 2018.

The company has made some progress that could bring in revenue in the near-term.  Ceres has licensed its homegrown bioinformatics software platform to HZPC Holland BV, a seed potato developer.  The license will allow HZPC to access DNA databases.  One software license is not material.  However, in my view, the fact that Ceres commercialized a technology that it has originally developed only for in-house purposes, is a plus for Ceres.  It is just the kind of creative management that is needed during adverse market conditions like those presented by weak price conditions in the energy market.

It does not look like there are any significant revenue and earnings generators in the wings.  The single revenue estimate that is published by Thomson Reuters for Ceres suggests revenue could ramp dramatically in the fiscal year ending August 2016.  That that analyst thinks there will be profits, he or she is keeping it a secret as they have not published an earnings estimate.    Of course, this estimate could be predicated on the old biofuel-centric business model.  Yet, I see little change in the potential for revenue and earnings in a ‘food and feed’ business model.

So if investors must wait for earnings to create value, the stock represents an option human or capital assets.  While I might like management’s style, Ceres stock price seems a bit steep for an option on management.  Its crop products, sorghum, sugarcane and switchgrass seem better suited to the energy market than to feed hungry mouths.  Thus the stock seems a bit overpriced as an option on the intellectual property if its application is to be limited to ‘food and feed.’

 

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

 

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