With Plenty Of Cash, Hydrogenics Is A Buy

| About: Hydrogenics Corporation (HYGS)

On Monday Hydrogenics Corporation (NASDAQ:HYGS) announced that it:

intends to offer common shares in an underwritten public offering. The offering is subject to market and other conditions, and there can be no assurance as to whether or when the offering may be completed, or as to the actual size or terms of the offering.

Despite Hydrogenics closing out 2012 with $16.8 million of cash, almost no debt, and a record backlog of orders over $60 million (all with deposits), it has arranged to raise more cash.

Hydrogenics cash burn was $11.2 million in 2012, and it is now on the cusp of profitability for the very first time - per management's repeated comments profitability will come at about $50 million in revenue. CEO Daryl Wilson on the Q4 conference call:

We remain on track to become profitable at around $50 million of revenue run rate and believe that 30% gross margins are clearly achievable as we reach that revenue level. We have the facilities in place to support our rapid growth and we expect stronger margins and economies of scale as we achieve operating level at higher output levels.

So it is a fair question to ask why it would raise more cash now, and the answer is that Hydrogenics is growing quickly across all of its businesses. Mr. Wilson on the Q3 conference call:

In the hydrogen area we are already seeing other players in the sector faltering because they can't deliver operationally or they don't have the financial means to deliver. I don't want to see that kind of situation here and I think that the credibility and the delivery capability that we have shown over recent years means that we can endure this growth and be on top of it so we will only take in whatever capital is absolutely required to fund the growth plan but sitting where we are today, we are in very good shape, better shape than we have been in a long time and with the prospects that we have in the near term I think we are in a good balance.

Everything is coming together for Hydrogenics at once, and it does not want to miss its chance. Hydrogenics has three businesses, all of which are growing quickly. They are:

  1. Hydrogen Generation
  2. Fuel Cells, also known as Power Generation, and
  3. Energy Storage

Let's look at them:

1) Hydrogen Generation

Hyrdrogenics' biggest revenue generator heretofore has been on-site hydrogen generation. It is a leading provider of hydrogen globally, partnering with industrial gas giants Air Liquide and Linde.

Hydrogenics' electrolysers isolate hydrogen from water. The hydrogen is used industrially for production of many things including steel, glass, solar products, silicon, uranium, and fertilizer. It is also used to re-fuel hydrogen fuel cells for vehicles and small scale energy storage.

2012's revenues in this segment were $27.5 million per the latest annual report, up 35% year-over-year. That represented almost 90% of Hydrogenics revenue last year, as in years past. CEO Daryl Wilson on the latest conference call:

Revenue grew 35% within this segment during 2012 and we see continued robust demand going forward. Our backlog at year end was approximately $19 million.

This business is growing fast, but is not the reason Hydrogenics is making sure it has enough cash.

2) Fuel Cells

Hydrogenics produces fuel cells in two business segments: propulsion and backup power.

In September of last year Hydrogenics got its biggest order of all time - a $90 million propulsion order. It received a $10.4 million deposit for the order - this is part of the reason it ended the year with $16.8 million in cash. The customer, an original equipment manufacturer that Hydrogenics has worked with for 8 years, has required that management not reveal the name of the company or the product. Mr. Wilson on the Q3 call:

due to the extremely sensitive nature of the customer and sales process, we cannot say anything more about this program, and I wish I could as it's the most exciting thing that's ever happened in Hydrogenics' history but unfortunately it's just not appropriate at this time per the customer's request.

That said, we did receive 10.4 million as an initial upfront payment related to the award just this week in recognition of the long term nature of the contract and the confidential technology that's being supplied to the OEM in question. We expect to finish the first phases of the product development in 2013 with a good portion of the revenue related to the initial 36 million contract being reported in the next year as well.

General Motors (NYSE:GM) thought enough of Hydrogenics' fuel cell technology that it partnered with HYGS and took an ownership stake - GM owns 6% of Hydrogenics. The propulsion fuel cell segment is growing quickly for the first time in its 16 year history, right at the same time that the backup power segment is coming alive.

In 2010 Commscope, a leading manufacturer of cell tower equipment, partnered with Hydrogenics and took a 28% ownership stake. Since that time the two companies have been demonstrating the ability to use Hydrogenics' fuel cells for back up power in cellular towers - the advantages being longer life and longer replacement cycles. Now they have moved from deploying trial sites to the first commercial orders. Mr. Wilson at the 2013 Needham Growth Conference:

This is a major transformative event for our company. When we think about our historical revenue in power systems around $4 million - in a single first commercial order that we'll produce in a single quarter for the company, we'll double the revenue in this division.

Customers for Hydrogenics' fuel cells include many prestigious names including NASA, Airbus, the Canadian Space Agency, and BAE Systems.

The fuel cell segment had revenue of only $4 million dollars in 2012, but now it is growing very quickly in both propulsion and backup power.

With the financial arrangements, Hydrogenics will not risk being caught in a situation where it cannot meet all of its clients' demands.

3) Energy Storage

The energy storage segment of Hydrogenics' business is the biggest market by far, and is unfolding quickly.

Renewable energy is an enormous trend globally, but there is a major problem - wasted surplus energy. The idea is that a windmill spinning at 4 am produces energy that is wasted - no other way of storing the energy can scale for use by utilities besides hydrogen. What Hydrogenics does is use the energy from renewable sources to power its electrolysers, splitting water into hydrogen and oxygen. The hydrogen is then injected directly into the natural gas system. This provides not only a nearly unlimited capacity for storage of carbon-free energy, but a delivery method that is far-reaching and fully constructed.

Hydrogenics is already doing this in the leading market of Germany, where it has won 5 of the 7 contracts that have been awarded, and it is competing for 11 more contracts there currently. These 18 contracts are just the tip of the iceberg - Germany is closing all of its nuclear facilities and is mandating renewable energy as a major constituent of its national energy policy. There are parts of Germany now that have 30% - 50% renewable energy.

The missing link in renewables has been storage, and Hydrogenics is winning the most contracts, and the largest contracts - despite the fact that the projects are sponsored by the German government and there is German competition. This is not an aberration - Hydrogenics has the best patented intellectual property for this.

Its most recent award is for the world's largest single PEM electrolyzer stack for 1 megawatt of storage. This is the technology that will allow HYGS to produce storage upwards of 50 - 100 megawatts per installation. Per the Q3 conference call Hydrogenics' competition would need 5 - 15 stacks for one single megawatt of storage.

This award, along with the first ever to market hydrogen storage project delivered in December, are both for E.ON, one of the largest utilities in the world.

Per management's comments 1 megawatt of storage equals roughly a little more than 1 million dollars. Germany alone will need about 6,000 megawatts of energy storage to satisfy its Energiewende energy policy - about 1.2 months worth nationwide. This market is a huge one, and being strapped for cash will not stand in the way of Hydrogenics capturing it.

"Power-to-gas" is a major trend coming into being wherever wind and renewable energy is prevalent. There are already projects announced in Belgium and elsewhere in Europe. Per management's comments there is real interest in this technology in Norway, Spain, Italy, Japan, Hawaii, and California. Most importantly Enbridge (NYSE:ENB) - the largest distributor of natural gas in North America and a major wind energy producer - recently partnered with HYGS and took a 14% ownership stake.

The energy storage market is coming quickly for Hydrogenics, and this is most definitely an enormous opportunity. This market is one of the main reasons management has prudently arranged to make sure it has enough cash to quickly deliver on its opportunities.


While the cash raise is not definite to happen, the arrangements Hydrogenics has made should ensure that it has all the resources it needs to continue growing quickly and meet its demands. Hydrogenics has a lot of exciting things happening all at once. Though it is not in danger of bankruptcy without raising cash, the capital raise is prudent to take full advantage of the inflection points in its businesses. Mr. Wilson again on the Q3 call:

the balance sheet is now very strong but we don't want to miss out on the momentum that's here and we talked also this morning about the growth in power to gas and the growth when it comes to our opportunities and telecommunications with CommScope. So we need to fund the working capital for those projects. We will be doing our best to do that without raising additional capital in the markets but if additional capital in the market is the right way to go then that's something that we are willing to pursue.

Disclosure: I am long HYGS. 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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