Although my investment approach tends to yield more mid- and small-cap investments, I don't recommend many stocks trading on the bulletin board. When I do recommend one, I do so with the expectation that it will soon graduate to a real exchange because the company has executed a turnaround. This is just what I expect from NutraCea (NTRZ - commentary - Cramer's Take - Rating) in the coming year.

NutraCea produces food additives and health-oriented nutraceuticals that incorporate the company's proprietary stabilized rice bran. The ramifications of commercializing this process are exciting because of both the profit potential it provides NutraCea and the humanitarian benefits of finally getting one of the biggest agricultural waste products on this planet into the human food chain.

Wasting Not

About 65% of the nutritional value of rice is contained in the rice bran, the brown outer layer of the rice kernel which is removed during the milling process. But raw unstabilized rice bran deteriorates rapidly, which has kept it from being a widely accepted component of nutrition, health and beauty products, despite its health benefits.

With tens of millions of tons being sold for a pittance or just thrown away, many firms have attempted to develop a viable high-volume process to stabilize it, and tiny little NutraCea appears to have one. It is this process, protected via a mix of patents and trade secrets, that is the main value behind this firm.

I became interested in the stock over a year ago due to a number of insider purchases and the announcement that Monsanto (MON - commentary - Cramer's Take) held an 8% stake.

Still, at the time, NutraCea had more promises made than kept. Since then, however, the company has executed impressively. Revenue has increased exponentially, totaling $12.9 million in the first three quarters of 2006 vs. just $1.1 million the year before. This was done with price increases alone. The company also became slightly profitable starting in Q2.

Right now the company's annual production capacity has remained at a mere 10,000 tons, but two new plants will come on line this year, one by Q2, the other by Q4, adding an extra 60,000 tons of production capacity.

This should produce revenue of at least $50 million next year and $80 million in 2008, which should translate into EPS of at least 14 cents and 26 cents, respectively. More aggressive assumptions (such as a higher price for the stabilized rice bran) could add a nickel per share to either year.

Considering that NTRZ still trades for just 18 times this low-end 2007 EPS estimate and less than 10 times my expectation for 2008, the stock can still be deemed attractive for having growth at a reasonable price.

While my revenue expectation of $50 million for 2007 has limited room for upside given that it takes a solid nine months to build a new bran-stabilization plant, my top-line estimate of around $80 million in sales for 2008 has tremendous room for improvement.

In Demand

The justification for such an extreme capacity expansion seems solid. At this point, NutraCea is already in the enviable position of having more demand than it can satisfy. Besides its legacy pet-food-additive business, the company has also incorporated its rice bran into niche nutraceutical products. Plus, it inked a deal with StoneBridge Pharma to sell rice-bran-fiber wafers, and several Fortune 100 companies are presently trying to determine how rice bran can be incorporated into some of their food products.

Also, NutraCea has signed agreements to supply feeding programs in eight countries with its RiceAde beverage. This in not charity work. Just because RiceAde appears to be both more nutritious than what feeding programs now supply to children, as well as cheaper to supply, doesn't mean NutraCea won't be able to make a fair percentage. And "doing well by doing good" is never a bad thing.

The real problem for NutraCea is that it cannot produce enough stabilized rice bran right now to make it a commodity, like wheat or corn. But therein lies the enormous upside potential. "We are looking forward to aggressively pursuing and executing on many diverse opportunities that exist worldwide," said CEO Brad Edson in the Q3 earnings press release. He further specified that "at some time in 2007" he hopes to "appropriately access the capital markets in a way that is accretive to shareholders to service 2008-2009 capacity expansion".

It is this potential to go global that is really behind its pop over the past six months. Judging by the tremendous increase in its average trading volume, there appears to be a growing acceptance that NutraCea's prospects are worth betting on. The important thing for this stock will be anything that keeps the "story" of the company's open-ended growth potential alive. If and when such news hits, NTRZ could garner a story-stock multiple in a hurry. It is news along these lines -- not more quarters of positive financial comparisons -- that investors should be keeping their eyes out for.

Risky by Definition

However, there is an obvious risk to investing in NTRZ. The stock has been extremely volatile over the past year. There is just no guarantee that this "story" has matured sufficiently to discount more severe price swings in the future.

Fueling this risk is the fact that NutraCea had to resort to extremely dilutive PIPE offerings over the past year to clean up its balance sheet and fund its 2007 capacity expansion. While this allows the company to boast over $13 million and no debt, the PIPEs got some institutions into the stock at prices much lower than NTRZ is today. I'd like to think that the increased trading volume over the past year has allowed the notoriously unloyal PIPE investors to take their quick profits in an orderly fashion. But there is no way to tell for sure if a large block of NTRZ won't suddenly be dumped on the market.

This makes NTRZ's technical health particularly important. Right now, the stock is testing important support in the $2.40 area. With NutraCea's fundamental prospects, I would expect the stock to pass this test. But if it doesn't, it's a long way down to the next support level.

There is also the risk that another, larger firm could break the rice-stabilization code and enter this market, but being the first to do so will likely still prove a distinct advantage for NutraCea. And even if a competitor were to arise, only NutraCea's bran has proved to stay stabilized for up to two years while keeping its high nutritional profile.

So it seems to me that if a large firm were really interested in this market, it would simply buy out NutraCea instead of trying to attack the market itself.

Despite the fact that NTRZ has risen sharply from some recent insider buying points, NutraCea's potential upside still seems attractive for investors with a little money to speculate with.

This article originally posted at TheStreet.com - RealMoney 

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