Sorry to paste all of it on here but it's the only way I could do it I couldn't copy the link.
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Fuel Cell's Future Looks Bright But Buying The Shares Is A Leap Of Faith
Jan. 19, 2018 4:06 AM • FCEL
Summary
The company is experiencing an impressive acceleration in business development.
The market opportunities for Fuel Cell are potentially tremendous.
However, its finances are murky and it isn't at all clear when the cash bleed is going to stop, at least not to us.
So investing here constitutes a bit of a leap of faith.
Lately, there has been a resurgence in the interest and uptake of fuel cell-based energy projects, as we discussed in articles on Ballard (NASDAQ:BLDP), Plug Power (PLUG) and Hydrogenics (HYGS).
All these companies experienced a significant rise in revenues, and the company we're going to discuss here, Fuel Cell (FCEL) isn't an exception. Fuel Cell services four segments:
Distributed generation increases grid resiliency and reliability.
Emissions, reduction, and de-carbonization for power generation.
Distributed hydrogen to reduce transmission emissions.
Long duration energy storage to support the increased penetration of intermittent renewables.
From the Q4CC slides
Korea
The company has completed the delivery of a 20MW power plant for South Korea in December, a first for the company in this country. Management believes that this will lead to more opportunities here and it is a "large near-term market opportunity" per Q4CC:
We see sizeable opportunities for multi megawatt fuel cell parks with the country's top utilities. Our customer for this first project, Korea Southern Power Company or KOSPO owns nine gigawatts of generation assets alone, and this is their first fuel cell project. The government's renewable portfolio standard or RPS obligates the country's 18 largest power generators to achieve the RPS requirements in their generation or purchase offsetting renewable energy certificates, which is driving increased activity in our direction. Our team is actively pursuing many opportunities in this market.
US projects
Projects in the US are somewhat different from those like the Korea project, according to management during the Q4CC:
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The business models for our markets in South Korea and the U.S. are complementary. In Korea, the transactions tend to be outright equipment sales with short execution cycles and long-term service agreements. The KOSPO project used existing inventory and generated near-term cash flow. In the U.S., we financed projects with long-term power purchase agreements, and either retain them in our generation portfolio or sell them to investors. These projects provide consistent long-term cash flows.
One of these projects, a 7.4MW power plant for CMEEC, a utility in Connecticut, was executed in October.
Earlier in the year, there were 40MW of awards from LIPA (Long Island Power Authority). Here is management again (Q4CC):
The company does have optionality in whether we retain or sell these projects, the financial profile of the projects are very strong with good, long term cash flows. It's obviously been an objective of the company to retain -- selectively retain projects on balance sheet to have those long-term cash flows.
Good cash flow is what they urgently need, that's for sure but building these LIPA projects will only take place in the 2019-2020 time frame.
Tri-generation
The company has also developed something promising, a fuel cell power plant that generates excess hydrogen which can be used in transportation, its so called SureSource Hydrogen tri-generation solution. From the Dept of Energy:
Fuel Cell recently accomplished an offtake agreement with Toyota (NYSE:TM) from its Port of Long Beach tri-generation plant. Management noted during the Q4CC:
Our multi megawatt SureSource hydrogen solution will be supplying Toyota with affordable renewal hydrogen and is a template for future projects. The roadmap for mass deployment of these tri-generation systems in the hub and spoke fuelling infrastructure is gaining global interest from utility companies and others. Spending for these systems will accelerate to match the demand for fuel cell electric vehicles.
The 2.5MW plant produces roughly 1200kg a day, which would serve 300 cars a day. A little later management had this to add:
There is other people that are in the fuel cell electric vehicle business clearly supporting it, such as Honda and Hyundai. But the true leader in this is clearly Toyota. Having close the first project with Toyota, I think it's safe to say that we are working closely to them on a global deployment strategy here. And I don’t want to say anything more than that.
That sounds pretty promising, and it is an interesting concept, we have to admit. And the involvement of Toyota, the leading fuel cell car manufacturer in the world, gives it added credibility.
Energy storage
Reliable energy storage is the holy grail in alternative power generation as it is necessary to overcome the intermittent nature of alternative sources like wind and solar.
The company has developed a long-term storage solution for this market, from Q4CC:
Based on the reversible solid oxide fuel cell technology, our solution converts excess power during periods of low power demand into hydrogen and energy carrier, stores our hydrogen onsite for long periods of time and then uses this as a fuel source to generate clean power when needed during times of high power demand.
Battery storage is usually short-term storage, so this is a different market proposition as it covers both short-term and long-term storage, an advantage in situations where longer-term storage is warranted, not only to cover night time (when solar panels do not generate power) but cloudy days.
A problem is that storage isn't usually financiable, that is, utilities have to keep the plants on the books. The company is working on a solution with partners.
And needless to say, the hydrogen produced can, instead of being used as storage, also be used for the transport sector, lowering the cost of storage. So this could be an attractive proposition for utilities, it's like the tri-generation model.
Carbon capture
The company is initiating a carbon capture facility in Alabama with Exxon Mobil (XOM). This is a fairly small pilot project of some 2.7MW, but the company expects this to lead to other, larger projects.
The "end game," as management called it would be projects of a much larger size between 100MW and 300MW per site. Here is Exxon describing the technology (also see the video in the link):
ExxonMobil scientist Tim Barckholtz thinks so. Along with FuelCell Energy, Barckholtz and his team at ExxonMobil are tapping the power of utility-scale fuel cells to capture carbon emissions. The process is promising because, unlike other carbon capture technologies, the fuel cells would capture the emissions from a natural gas-fueled plant and generate additional power, rather than consume it.
On paper at least, this is a brilliant idea, Fuel Cell management has this to add on the Q4CC:
Concentrating carbon dioxide is a normal side reaction for our proprietary fuel cell’s electrochemical generation process. Because it simultaneously captures carbon dioxide and generates power, ours is a truly affordable capture solution and a potential game changer in the industry. Our system can capture 90% of the CO2 and destroy 70% of NOx from a plant’s emission stream.
The endorsement by Exxon is of course a huge boost and the project should be up and running in 2018/19. And here is Cowen spelling out the opportunities (from Bloomberg, our emphasis):
Cowen researchers don’t include it in revenue forecasts for FuelCell because they “always assumed it was one of many futuristic growth options,” Osborne said. For FuelCell Energy, the market opportunity could be huge. Capturing 90 percent of the emissions at just 1 percent of U.S. coal plants would require 2,160 megawatts of fuel cells, equal to about $6.5 billion in sales and $9.7 billion in service revenue, Osborne estimates. The company posted sales of $108 million in fiscal 2016.
Huge indeed.
Growth
As you can see below, the company has had some quite difficult years:
But in the second half of 2017, a recovery of sorts is taking place as Q4 revenue was a whopping 95.7% higher compared to Q4 2016. This looks set to continue, if not downright accelerate, from management during the Q4CC (our emphasis):
In the last six months since July, FuelCell Energy has been awarded approximately $1.2 billion worth of projects. Only a portion of this amount has been recognized as part of our backlog. The remainder, comprised of more than $1 billion worth of project awards has not yet been recognized as backlog. We're currently working with these customers on finalizing contracts and expect them to be converted to backlog in 2018.
If they can indeed convert these projects into backlog, or even half of it that would be quite a turnaround. For 2018, management is optimistic, from the Q4CC:
Near term opportunities for 2018 include RFPs in Connecticut with the potential procurement of over 100 megawatts as well as RFPs and projects in Korea and California, totaling tens of megawatts. Global demand for emissions reductions and decarbonization solutions is growing.
Finances
Whilst revenues were 95.7% higher in the quarter than those a year ago, operating cost were unchanged. Still, despite this remarkable feat, there was nevertheless a substantial loss of $10.8M or $0.17 per share, a decline from the $13.7M loss in Q4 2016.
Adjusted EBITDA improved from -$9.5M to -$5M. There are several reasons to expect near-term improvements though:
Continued revenue growth.
The company at present has 11MW of projects on its balance sheet, but this is going to rise to 30MW (see quote below).
The increases in working capital will reverse in Q1 2018, as these were due to the Korean project.
Operating expenses will remain in the $11M-$12M quarterly range.
The company will shift its fuel cell module conditioning activities from Danbury to Torrington, Connecticut, which will result in lower manufacturing cost.
Their production facility suffered from low utilization and only recently ramped back up to 25MW (from 15MW).
All of their project going forward are calculated without the Investment Tax Credit, which actually survived the recent tax reform.
Management about those projects on the books in 2018 (Q4CC):
we have 11.2 megawatts of operating assets. We currently have 19.5 megawatts under construction in various stages of construction. As I mentioned, we have coupled it and we show the picture of the SureSource 4000 in Danbury, that’s very close to being commissioned. That’s our first 50% efficient fuel cell write down the street from here. So that’s close to being done. We have a project in California, Tulare, which is close to being done and then other projects in various stages of construction. So yes, if you add up the 11.2 and the 19.5 that’s in the 30 range, as you mentioned.
However, the company doesn't provide any guidance for revenues or profits (losses, more likely) because they do not know whether to keep projects on the books or to sell them.
That is a bit of a tricky question, management argues that these projects generate good returns and cash flow, but they tie up capital and financing. They could be choosy here, and keep the best projects on their books.
But their books are still in a bit of a mess. While the company has $87.4M in cash, cash equivalents and restricted cash on their books, they also have $78M of debt and $29M in short-term debt (plus the current part of their long-term debt). Their GAAP margins are pretty poor:
And the company is still bleeding cash:
Which is why the company had to rely on large debt and equity financing:
Last year only the share count almost doubled.
Then there are the preferred shares (FCELB), which pays a 5% coupon, but a double-digit yield now. See SA contributor Norman Roberts for a discussion of these preferred shares. From the 10-K:
We have 105,875 shares of our 5% Series B Cumulative Convertible Perpetual Preferred Stock (Liquidation Preference $1,000.00 per share) (“Series B Preferred Stock”) authorized for issuance. As of October 31, 2017 and 2016, there were 64,020 shares of Series B Preferred Stock issued and outstanding.
A dividend of $50 per share a year amounts to $3.2M a year. Then there is more. Recently, the company issued preferred stock (Series C), from the 10-K:
We issued an aggregate of 33,500 shares of our Series C Convertible Preferred Stock ( “Series C Preferred Stock” and, such shares, the “Series C Preferred Shares” ), $0.01 par value and $1,000 stated value per share for net proceeds of $27.9 million on September 5, 2017. Each share of Series C Preferred Stock was sold at a price of $895.52 for gross proceeds of approximately $30.0 million. As of October 31, 2017, there were 33,300 shares of Series C Preferred Stock issued and outstanding.
These shares pay a 15% coupon and are convertible at $1.84. Then there are these:
We have 1,000,000 Class A Cumulative Redeemable Exchangeable Preferred Shares (the “Series 1 Preferred Shares”) issued and outstanding. The Series 1 Preferred Shares were issued by FCE Ltd., one of our wholly-owned subsidiaries. We have guaranteed the obligations of FCE Ltd. under the Series 1 Preferred Shares.
The terms of the Series 1 Preferred Shares require (i) annual dividend payments of Cdn. $500,000 and (ii) annual return of capital payments of Cdn. $750,000. These payments commenced on March 31, 2011 and will end on December 31, 2020. Dividends accrue at a 1.25% quarterly rate on the unpaid principal balance, and additional dividends will accrue on the cumulative unpaid dividends (inclusive of the Cdn. $12.5 million unpaid dividend balance as of the modification date) at a rate of 1.25% per quarter, compounded quarterly. On December 31, 2020, the amount of all accrued and unpaid dividends on the Series 1 Preferred Shares of Cdn. $21.1 million and the balance of the principal redemption price of Cdn. $4.4 million shall be paid to the holders of the Series 1 Preferred Shares. FCE Ltd. has the option of making dividend payments in the form of common stock or cash under the terms of the Series 1 Preferred Shares.
The company paid $9.2M in Q4 in interest expense, from the 10-K:
Interest expense for the years ended October 31, 2017 and 2016 was $9.2 million and $5.0 million, respectively. The increase results from borrowings under the Company's Loan and Security Agreement with Hercules and interest expense related to sale-leaseback transactions recorded under the finance method. The interest expense for the years ended October 31, 2017 and 2016 includes interest for the amortization of the redeemable preferred stock of a subsidiary fair value discount of $2.0 million and $1.8 million, respectively.
Instead of a buyback plan, the company has a sales plan where it is authorized to sell shares at the open market, from the 10-K:
There has been some uptick in its valuation multiple recently:
But two times sales for a company that is still bleeding large amounts of cash isn't cheap.
Verdict
There can be little doubt that the company is turning the corner in terms of sales. We also have little doubt that they are faced with tremendous opportunities, not only in power generation, but they have some innovative solutions with tri-generation, carbon capture and storage. The company already has a tremendous amount of backlog and even much bigger project wins.
There are (at least) two big caveats though. One is the scaling up necessary to service that backlog, let alone the ramp necessary if the $1.2B in project wins are actually converted into backlog.
The second is the continued cash bleed. On the one hand, this is likely to reduce given the acceleration in business development, but on the other hand, they are likely to need more cash in order to be able to deliver these.
That is, further dilution still seems very likely to us in addition to the dilutive instruments already out. It's likely that this is going to subside at some stage, and that could very well be sooner than many people might think. But without even the company guiding, it is pretty hard to make any firm predictions.
Taking a position here could be very lucrative, given the distinct business acceleration, but it's a bit of a leap of faith.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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