Gevo's Cash Flow, Small Cap Buying Back Shares

Key Points

• Shares of GEVO have been rallying for the past week after management announced a sizable share repurchase program, a sum totaling $25 million to be allocated. 
• By analyzing Gevo's financials, investors will find that delivering on these programs currently seems a bit of a long shot, as the company has yet to achieve economies of scale and positive gross margins. 
• Analysts see double-digit upside potential in the stock, which has been riding on a massive revenue growth report for the first quarter. The share repurchase program's likelihood is now in the hands of the company landing other deals and agreements to increase revenue and achieve positive free cash flows.

When investors typically refer to small capitalization stocks, those businesses that fall between $300 million and 2 billion dollars in market capitalization would enter this category, usually not known for consistent cash flows and profit margins. So it would come as a significant surprise when markets heard that Gevo NASDAQ: GEVO announced a sizeable share repurchase program, which is typically funded by the company's free cash flow levels, again not a metric that is mainly present within these small-cap businesses. 

The announcement on May 30 was such a surprising and unexpected move from management that GEVO shares have broken out in a 45.6% rally ever since. Considering that Gevo's market cap, as of its closing price on June 6, is a mere $365 million, the $25 million share buyback program announced would represent nearly 6.9% of the entire company's capitalization. The question investors must ask themselves now is, how could Gevo's financials play out to enable this program to be implemented in the first place?

Room to Deliver?

Gevo's Chief Executive Officer, Dr. Patrick R. Gruber, stated within the announcement that the repurchase program is not only a vote of confidence in the future valuation of the company but also a bet in "... the future of Gevo in light of what we believe to be the considerably undervalued price of our common stock,". These words, or at least words similar to the message, have been spoken by countless executives. Management can take on a sales role to boost investor and financial market morale, especially when a stock price has been compressed, as Gevo's chart would show.

However, it would seem a long shot to conceive of the possibility of Gevo's current financial state allowing for any buybacks. As of the first quarter of 2023, the company's press release would reflect figures needing a magic touch for positive cash flow. The business's core operations reported a net loss of $19.5 million and an additional $11.4 million in capital expenditures to deepen harmful free cash flow levels. The company is - and has been - funding its operations by issuing common stock, essentially diluting current shareholders. 

While revenue grew by an astonishing 1,650% yearly, the company's business model still has much work to do. With negative gross margins, Gevo still needs a profitable operation that could eventually trickle down into enough cash flow to start repurchasing shares. Management attributes the spike in revenue to sales within their renewable natural gas (RNG) segment, which came after the company was awarded a partnership by Zero6 Energy. This partnership gave Gevo the green light to develop a 20-megawatt hydrogen production facility in South Dakota.

What's the Consensus

Gevo analyst ratings suggest that the stock still carries room to move up by as much as 60.3%, according to the assigned median price target of $2.52 per share. Businesses with negative earnings and absent EBITDA (Earnings before Interest Tax Depreciation and Amortization) are typically valued on multiple sales. Today Gevo sells for 11.7x its last twelve months' sales. For reference, high-growth technology companies like Tesla NASDAQ: TLSA trade at only an 8.0x sales multiple. 

Tesla once traded at similarly high sales multiples, reaching a high of 29.0x during 2021. However, the company had successfully treaded through the challenging 'growth stage' most startups must overcome. By the time the sales multiples reached such exorbitant levels, Tesla was well into established positive net income and free cash flow.

Despite the two being a small universe of comparison, the logic behind valuation still stands. Only one thing can carry Gevo into profitability, eventually fulfilling management's promise to buy back shares aggressively.

Growing revenues at similar rates seen in the first quarterly results would not only justify the rich sales multiples but also begin to enable the positive effects of achieving economies of scale, where Gevo may finally see its first profitable quarter. While still a long way from consistent enough free cash flow, where share repurchases - instead of issuance - may be possible.

Growing revenues at this point would come from management being able to land more deals with consumers of Gevo's fuels, such as the recently completed first Indian commercial flight, which relied on Gevo's sustainable aviation fuel.

Nonetheless, it would benefit investors to remain wary of the company's financial situation. This would call for reacting to items further from just revenue growth. The cash flow statement will be a more fine gauge of the proximity of the promised buyback program, as increasing operating cash flows and controlled capital expenditures will be the foundational step into any such dividend or repurchase scenario.