NEW YORK (TheStreet) -- One consequence of the extended bull market is that many investors have been ignoring catalysts which clearly indicate that a stock is facing an impending nosedive. These investors suffer significant losses which are entirely avoidable.
Gevo (GEVO) - Get Report has already plunged by 40% in the past two weeks, while the two-day 20% drop in Plug Power (PLUG) - Get Report may be just the beginning. For Renewable Energy Group (REGI) - Get Report, the expected drop could be far larger due to expiring government tax credits and a last minute distressed acquisition.
No one was surprised by a punishing financing from Gevo which saw its shares drop by 40%. The once $110 million company distributes isobutanol, but the filings show that as revenues dwindled to $1 million per quarter, gross margins swung negative and the company's cash balance fell by 70%. Gevo has burned $32 million in 2013 but had only $25 million left in cash.
The need for a financing was blatantly visible. Yet the share price recently rebounded by nearly 40% from November lows, looking to break $2.00. Gevo was smart and raised $22 million in stock and warrants on Dec. 16, at a price of $1.35 per share. But this sent the share price plunging to as low as $1.13. (Readers should note that as stocks fall below $1.00 they become considered "penny stocks" and are typically associated with greater risks and volatility.)
Yet why did investors keep pushing the share price up towards $2.00 when the impending plunge was so predictable?
Meanwhile, shares of Plug Plower more than tripled just in December simply based on a rare optimistic outlook from management. The shares rose from 70 cents in November to $2.24 last week. Earlier in 2013, it looked like it was game over when the stock traded as low as 11 cents. The company suffers from perpetual negative gross margins whereby it cannot ever sell its fuel cell systems even for what it costs to produce them. The company then incurs additional losses from SG&A and R&D.
If Plug were to suddenly become profitable at any level, it would be a dramatic departure from history. It is nearly inconceivable. The only reminder that investors needed was when Fuel Cell Energy (FCEL) - Get Report released disappointing results on Tuesday, quickly dropping by 25% to $1.41. Plug fell by 20% in sympathy.
Investors should have realized that the enthusiasm for Plug was entirely detached from reality. There was no rational reason for the stock to triple, and there is every reason for it to return to the 70 cent level where it was just 3 weeks ago. At present, Plug is still valued at nearly $200 million and trades at $1.80.
It is astounding that so many investors are willing to ignore obvious signs ahead of sharp declines in these new energy stocks.
Shares of REG are up by 80% YTD. The presumed catalyst has been that it is profitable and cash flow positive. Yet this biodiesel producer is massively dependent upon huge government subsidies which are set to expire on December 31st - just 7 trading days away. The tax credit has enabled REG to sell over $1.1 billion in biodiesel this year. Yet the last time this tax credit lapsed in 2009, the company was struggling to sell barely $200 million. The result was that the company had margins and cash flow that were both deeply negative. When the massive tax credit expires on Dec. 31, REG will immediately return to being a low volume, money losing company. The product simply cannot sell at price or volume without the subsidies.
Insiders are certainly well aware of this. As the expiration materialized, REG's major shareholder (USRG) quickly sold over 3 million shares (over $45 million) in heavy trading. West Central Cooperative also sold millions. USRG is headed by a former REG board member, so while independent investors have been slow, insiders have been liquidating before bad news hits.
A separate sign is REG's puzzling acquisition yesterday of Syntroleum (SYNM) . As with Gevo and Plug, investors were quick to bid up the share price of REG in after hours. Yet this acquisition makes very little sense and signals that management is expecting a very sharp decline in the share price of REG.
What investors are missing is that there are truly no synergies and there is no near term value to be realized. Syntroleum's only plant has been idled for over a year and there is no production activity whatsoever. Syntroleum's stock closed yesterday at $2.46, but this was only the result of a 1:10 reverse split that was completed earlier in 2013. So in reality, REG just bought a 24 cent stock which was facing delisting from the Nasdaq this year.
[Read: The One Thing Financial Advisors Want to Ask Clients]
Syntroleum's operations consist of a joint venture with chicken company Tyson Foods, Dynamic Fuels. From the 10Q, operations at Syntroleum's only facility were shuttered in October 2012 and no-restart date has yet been determined 14 months later. These facilities had once operated at substantial losses, which explains why they were idled. Syntroleum discloses that, "Primarily as a result of the extended period the Plant has been in standby mode, Dynamic Fuels determined that the carrying amount of the Plant may not be recoverable". Depending on whether or not the plant is restarted, the company will reassess potential for recoverability and any potential impairment.
Syntroleum is actually in the business "renewable diesel" not "biodiesel." REG is only involved in actual "biodiesel". Investors need to understand that these two products comprise entirely and radically different technologies which are in no way compatible. There are no synergies in the technology whatsoever.
From the 10K, "The Dynamic Fuels plant is operated at a single facility in Geismar Louisiana," Yet REG's operational facilities are almost exclusively located in the northern Midwest states. So in addition to the lack of technological compatibility, these facilities are also located on opposite sides of the country. There are also no production or logistical synergies.
Why would Renewable Energy rush to complete this seemingly worthless acquisition just days before the end of the year? The answer is that the acquisition was agreed via issuance of REG stock (NOT CASH) worth over $40 million at current prices. If REG knows that its stock is likely to fall by 50%-70%, then it is really paying around $15 million for these assets, which actually seems like a fair price.
Syntroleum's "renewable diesel" may ultimately turn out to be superior to biodiesel. REG is therefore buying a lottery ticket at a time when its share price remains high. As with Gevo, REG management is being smart. If REG management were to wait even two more weeks, the tax credit will expire and the share price is likely to head below $5.00 immediately. This would clearly make the purchase of the idled and unproductive assets far too expensive for REG to consider.
POSSIBLE TRADING IDEAS
Clearly there is not a long biased trade within any of these names.
For Gevo, there is not much of any trade to be had. The stock has already collapsed and Gevo is now relatively well funded, so further downside should be limited and the stock is likely to stay flat.
For Plug, the downside is likely just beginning and a short trade may make sense. The stock tripled from 70 cents just three weeks ago and there was nothing to justify it. As a result, the stock could easily be expected to simply return down to 70-90 cents. But predicting the timing could be difficult.
The best trade here is a short trade on REG due to the enormous valuation and two catalysts for almost immediate declines. The tax credits upon which REG heavily depends are set to expire in just days, sending REG back to being a cash burning and money losing company with low volumes. In addition, the acquisition of Syntroleum is only one day old and is not understood by the market. Over the next few days, broader analysis should reveal the value destruction involved here. As a result, REG could easily be expected to break below $5.00 by early January or before.
At the time of publication, Pearson ws short REGI, although positions may change at any time.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.