Gevo (NASDAQ:GEVO) is a Colorado-based renewable jet fuel company. The company is building a huge green plant in South Dakota to make fuels from non-carbon sources. The problem is the plant won’t be online and producing cash flow until 2024. That’s a long wait for GEVO stockholders.
The plant will use cow dung to make the fuel, which it refers to as “biomass.” The bottom line is that the fuel will not come from carbon-based sources.
Right now GEVO has over $525 million in cash in the bank that will be more than enough to cover its plant buildout expenses. This can be seen on page 7 of its 10-Q in the balance sheet for the quarter ending March 31.
On June 24, the company released an updated presentation about its projected plans. On page 24 the slide deck indicates that right now GEVO has $1.6 billion in “take or pay” contracts in place.
In addition, it is in negotiations for another $13.4 billion worth of deals
Estimating the Value of GEVO Stock
Analysts estimate that the revenue will kick in by 2023 with $39 million in sales and $108.75 million by 2024, according to Seeking Alpha. From there the estimates move up consistently each year.
As of June 29, GEVO had a market capitalization of $1.47 billion and GEVO stock is up 72% year-to-date. This puts it on a forward price-to-sales (P/S) multiple of 13.5 times sales. That’s a pretty high valuation.
And it’s even higher than that if we discount the future sales forecasts by the time value of money. For example, using a 10% discount rate for 3 and a half years in the future to 2024 year-end, the discount factor is 71.635%. So the $108.85 million in 2024 forecast sales has a present value of $77.98 million (i.e., .71635 x $108.85m). This raises the P/S multiple to 18.85 times (i.e., $1.47 b/$77.98 m) from 13.5 times.
I think that makes GEVO stock fully valued right now. That implies that there might be little upside for the stock at this time.
What Analysts Say
TipRanks.com reports that 2 analysts that cover the stock have an average price target of $17.00 per share. Given that GEVO stock presently trades at $7.44 per share, that implies potential upside of 128% for GEVO stock from here.
These analysts are putting a higher multiple on prospective sales years in the future. It’s good that they have so much confidence in the company, but I’m unconvinced that they are adequately accounting for all of the risks.
In cases like this, I like to use a probability matrix to help me assess the real upside for the stock.
Probability and Expected Return
Here is how this works. Let’s say that there is a 40% chance that the Wall Street analysts are correct and the stock will rise 128%. That implies an expected return of 51.2%.
Next, let’s assume that there is a similar 40% chance that I am right and that GEVO stock will not rise at all. That gives it a 0% ER. Lastly, let assume there is a 20% chance the stock could fall 20%. That is an implied ER of -4.0%. Note that all three scenarios add up to 100% (i.e., 40%+40%+20%).
So in total, all the three scenarios have the following ER: +51.2% + 0% -4.0%, or 47.2%. Therefore, the total expected return is over 47%, even if my expectation of a 0% return is possible.
Moreover, think of it this way. Even if there is as little as a 20% chance that analysts are correct GEVO stock has a potential upside of 21.6% (i.e., 20% x 128%-4%, or 25.6% -4% = 21.6%).
In other words, analysts are so much more positive on GEVO stock that it appears that GEVO has a good chance of still rising from here.
On the date of publication, Mark R. Hake did not hold a position in any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.