SHEL - S&W Seed Posts A Better Quarter And Signs A Promising Biofuel Agreement

Summary

• S&W achieved better than expected sales in the seasonally weak second quarter, with $1M year-over-year growth from Double Team sorghum in the U.S. and improved gross margin.
• S&W formed a joint venture with Shell to develop and market oilseed cover crops for Shell's biofuel production facilities; the venture will initially focus on camelina.
• Shell is contributing cash to the JV, as well as paying $7M to S&W and paying off a $7M promissory note, helping ease the cash crunch at S&W.
• S&W remains a promising, but highly risky, opportunity in agri-tech on the potential of its Double Team sorghum, an established alfalfa business, and ventures in biofuels and stevia.

Turnarounds are a little like growing crops - you prepare the field as best you can, plant the seeds, and then you wait. I never expected the potential turnaround at S&W Seed ( SANW ) to occur in just one year (let alone just one quarter), but a solid result in a seasonally slow quarter and a promising and potentially significant biofuel agreement with Shell ( SHEL ) are both encouraging developments since my last update .

I'd caution readers not to get too excited too soon about the biofuel agreement. The idea of growing improved camelina as a cover crop and biofuel feedstock is a good one, but this is basically a pilot project for Shell and there's a long way to go before this is a truly viable commercial venture. By the same token, progress is progress, and I like the agreement, as well as the growth in Double Team sorghum in the U.S.

Fine Results In A Seasonally Slow Quarter

The December quarter, S&W's fiscal second quarter is never a particularly strong quarter, so I urge investors not to draw too many conclusions from the numbers. By the same token, outperforming in an off-season quarter is still a welcome development on balance.

Revenue rose 2% in the quarter, but revenue from the core seed business grew more than 8%, with $1M year-over-year growth in the North American sorghum business (Double Team) and $1.9M growth in the Middle Eastern alfalfa seed business. This was offset by declines in Middle Eastern sorghum sales and U.S. alfalfa sales, but S&W came out ahead on balance (and ahead of my expectations).

Adjusted gross margin improved almost eight points from the year-ago period, while adjusted EBITDA improved by $1.9M to a loss of $4.6M.

S&W ended the quarter thin on liquidity, which is an ongoing significant concern, but I'll address how this situation has improved recently in just a moment. Finding sources of liquidity is going to be crucial for S&W. There's an old cliché from auto racing that goes, "to finish first, first you must finish" and that's true here as well - it doesn't matter how promising Double Team sorghum or stevia or camelina may be if the company is forced to severely dilute investors to raise more capital.

A Biofuel Deal With Shell - Potentially Major, But It Will Take Time

Earlier this month, S&W announced that it had reached an agreement with Shell to develop novel plant genetics (seeds) for oilseed cover crops that can be used as feedstock for biofuel production. The venture will initially focus on a plant called camelina.

The two companies are forming Vision Bioenergy Oilseeds, with Shell initially owning 66% (and S&W owning 34%), but with mechanisms in place for S&W to potentially become a 50-50 partner over time. S&W is contributing its knowhow and technology, as well as its Nampa, Idaho processing and research facilities, while Shell is contributing cash and will also be responsible for producing biofuels at its North American facilities. The JV, VBO, will develop and produce seed, sell it to farmers, buy back the camelina, contract for crushing, and then send the oil on to Shell facilities.

In forming the JV, Shell is contributing $13M to the JV and will make an additional $12M payment of $12M in 2024. Shell also paid $7M to S&W directly, paid off a $7M promissory note, and will make an additional $6M payment in February of 2024.

I consider this a promising venture for S&W. Camelina is already used for biofuel production ( Honeywell ( HON ), among others, has turned it into jet fuel on a limited basis), as it has the advantages of relatively high oil content (around 40%) and low processing costs, as well as the ability to grow in pretty marginal soil and in colder climates. Growing it as a cover crop is even more appealing; farmers use cover crops to limit soil erosion and preserve soil quality and turning a cover crop into a potential source of profit has a lot of appeal, particularly in cases like this where the farmers are guaranteed a buyer for the crop they produce.

I do think it is important to keep the potential of this venture in perspective. For starters, and this may seem obvious but you'd be surprised how many people don't realize it, when you produce seeds you have to GROW them and that takes time and acreage. That limits how quickly S&W/VBO can scale up production. It's also worth noting that as much as farmers may like the idea of getting paid for a cover crop, they tend to be a conservative bunch, so it may take some time recruit farmers to participate.

Shell is a good partner and one that is committed to biofuel - the company has a large ethanol production joint venture ( Raizen ) with Brazil's Cosan ( CSAN ) that is one of the largest and most efficient producers of ethanol in the world. Even so, perspective is important - this is a small venture for Shell and while I'm sure they're serious about it, it's far from a needle-mover for them. To quote Raul Julia as Bison in Street Fighter , "For you, the day Bison graced your village was the most important day of your life. But for me, it was Tuesday."

The Outlook

The $7M payment from Shell and the payoff of the $7M promissory note do give S&W some much-needed breathing room, but the company is going to be liquidity-constrained for some time. That is a major ongoing operating risk, and it puts even more pressure on the company to execute on opportunities like Double Team sorghum (a non-GMO herbicide-resistant sorghum) and IQ alfalfa. While I've never been bullish on the company's efforts in stevia, this too is a growth opportunity given an ongoing pilot production agreement with Ingredion ( INGR ).

That major companies like Ingredion and Shell see S&W as a worthwhile partner is encouraging. These aren't make-or-break deals for the larger companies, but I don't think they'd bother at all if they didn't regard S&W as a credible partner with a future.

I continue to believe that S&W could reach $100M in revenue in FY'24 and generate long-term growth in the double-digits (off an admittedly low base), but positive free cash flow is still some way off. The VBO JV could help accelerate that some, but there are still a lot of hoops to jump through before S&W can be evaluated as just another company (in other words, where its ability to continue as a going concern isn't a significant factor in the risk analysis).

The Bottom Line

I continue to believe that 2x revenue is a reasonable valuation for S&W. While agri-tech M&A has seen 3x revenue or higher multiples, I believe a discount is in order given S&W's lack of profits and strained balance sheet. The elevated risk precludes me from openly recommending this name, but I do find it an increasingly interesting speculation for those investors who can accept the risk.

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