Waiting For Capstone Turbine: Breakeven Is Here

Feb.14.14 | About: Capstone Turbine (CPST)

It's not too often that an ethical investing stock has the potential to change an industry. Thirteen years ago, the market thought microturbine maker Capstone Turbine might be that stock, but the management couldn't deliver profits. The stock soared to 94 in late summer 2000, shortly after its IPO. Everyone's car was going to be a Capstone-powered batmobile, every investor would be rich. Capstone didn't turn cars into batmobiles after all, and a year later, the stock was below four. It's struggled since, and the company has yet to turn a profit. Many may remember being burned.

Capstone's products solve genuine problems. Ironically enough for the alternative energy investor, Capstone's biggest current hit is in the fracking fields, where it supplies remote power to rigs and pipelines that are far from grid power. But Capstone's turbines are a beautiful fit for a technology that should be a no-brainer in today's world -- combined heat and power. Burning fuel to generate power also generates a lot of waste heat. Then, transmitting power over long distances wastes a lot of the generated power. By installing a refrigerator sized turbine right at your building, you eliminate transmission losses and get to use what would otherwise be waste heat to heat your hot water and warm your building. It's even possible to turn that heat into air conditioning. And because the turbines are highly reliable, with just one moving part floating on air bearings, your building still has power even when the grid goes down.

Fossil fuel power plants deliver about 30-50% of the energy in the fuel they burn. By putting the power plant right in the building, you get total efficiency into the 90s. By putting the power plant out into the gas field, you get to burn free flare gas and eliminate the major problem of emitting methane, a climate change gas.

Capstone's flagship, the C200 200kW generator, now has four years of in-the-field experience, and customers have been coming back for more. The company has distributors world-wide.

What if Capstone is STILL an ethical investing stock that will change an industry, making its investors a big profit at the same time? The current CEO, Darren Jamison, came on board in December of 2006. Let's see what, if anything, has changed in the seven years he's been in charge.

The 10-K financials published just after his arrival (FYE 3/31/2007) look like this: $21 million revenue with a $26 million COGS and $34 million for SG&A and R&D. A loss of about twice the revenue. Share price hovered between $0.75 and $1.25 and there were about 100 million shares outstanding.

To see the trajectory, we'll need to look not just at the recent quarters and the last fiscal year, but also at the two years before that. Revenue 2011/2012/2013: 82/109/128. Revenue after COGS (gross) 2011/2012/2013: (-1)/5/14. R&D and SG&A: 33/37/37.

Which leads us to the operating losses for 2011/2012/2013: 34/32/22.

The company has been losing money hand-over-fist and, until recently, this stock was among the most beloved if you were a short. All you needed to do as a short was bet on bankruptcy. For much of Capstone's history, it was absolutely true that every turbine they sold cost Capstone more to make than they sold it for. The shares outstanding has risen from 100 million to 300 million.

But this is the breakeven year. Following the quarterly announcement, the stock is being punished for coming in with the following numbers: quarterly revenue of $37 million, a gross margin of 20% (up from 14% one year ago!), and a quarterly loss of $2 million (down from $4.5 million one year ago). The company's book to bill ratio is 1.4 to 1. It needs a gross margin of 22% on revenue of $40 million to be at breakeven. It has $30 million in the bank. It will be generating cash: possibly in the current quarter, if not, then certainly within the coming year.

Breakeven is nice, true, but high profitability is better. Is there reason to believe Capstone can continue to increase its margins? The good news is yes, there are very good reasons to believe Capstone will become very profitable, very soon.

First, it is now testing an upgraded version of the C200, the C250, which produces 250kW of power compared to the C200s 200kW. The C250 uses mostly the exact same bill of materials as the C200, meaning it will not cost much more to produce. The company sells a configuration of five C200s in a box, calling it the C1000. The C250 will mean four in a box, and while the price of the box remains the same, the cost of producing that box will drop substantially.

Second, Capstone has lots of room to grow its production without needing new capital investment. It's been running on one shift.

Third, the company has been involved with a federal lab, Argonne, in researching less expensive materials for one of its product's major parts, the recuperator. Replacing the current alloys with a less expensive alloy gives still more room for margin improvement, and an improved alloy may allow higher temperature operation, which will increase the system's efficiencies.

No doubt, long term investors in Capstone have been long suffering. But the company has recovered from $0.84 back in spring of 2013, and is running at $1.50 today. Sure, it will be competing with fuel cells. But it has very happy customers today, with a long-term proven product, a built-out distributor base worldwide, a new higher margin product nearly popping out of the pipeline, and the probability of new customers buying banks of C1000s, rather than individual C200s.

The company has a lot of videos of its installations at its video gallery. My favorite is this one, from the Colombian Chamber of Infrastructure, where they just decided to go standalone with their Capstones because connecting to the grid was such a time-consuming bureaucratic mess. But check out Wrightspeed as well.

It's difficult to value the company based on its past. It is more expensive on a price/sales basis than old tech competitors, and its price/earnings is still negative, since it has been losing money. But the company has gone from $21 million revenues when current management came aboard (FYE 3/31/2007) to $128 million in FYE 3/31/2013 to a likely $137 million in FYE 3/31/2014. Growth did slow this year due to problems in Europe, but Capstone is still growing and, critically, is now showing that 1.4:1 book to bill, promising rapid growth in the near future.

Does it continue at its past rate of growth? Impossible to know. The management's January presentation talks about capturing 10% of a $15 billion market, with 1/3 of revenues coming from combined heat and power, 1/3 from oil and gas fields, and 1/3 from landfills, wastewater plants, and digesters, each of which now emit dirty methane-rich gas that could be used as free fuel in a Capstone installation. Critical power for data centers is another large potential market for Capstone, Syracuse University and IBM opened a Capstone powered, heated and cooled data center in 2010 and report $500,000 annual energy savings. The good news is the company has been getting reorder after reorder from oil and gas companies, some of the customers who have the easiest time getting capital.

It's not hard to imagine oilfields worldwide installing Capstone units to generate on-site electricity from "free" gas they now flare. Capstone has had units at Kenworth and Peterbilt trucks, is part of the truck electrification platform Wrightspeed is introducing, and is inside Russian buses (not to mention the hard luck Designline bus, which may yet rise again). Capstone advertises a four to five year breakeven against reciprocating engines. Without the subsidies given to fuel cells and solar, that's been a difficult sell throughout the recession. If it has grown 700% through these last seven years, how will it grow when the world economy recovers, and managements once again invest in future savings? How will it look to companies that have begun seeing climate change under their noses?

Five years from now, if you are willing to accept that reorders become easier for a new technology once it has demonstrated itself for a few years, it seems reasonable to expect Capstone will have annual revenues of $500 million or more. Given a successful introduction of the C250 and the successful introduction of less expensive alloys, gross margin in the 35% range is reasonable. That future Capstone would be earning $100 million a year, by going to three shifts with its existing equipment. The company's market capitalization is now in the $500 million range. So at today's stock price, that's a five year forward P/E of 5 on a company with a sustained growth rate of better than 10%. How much you discount that will depend on how substantial you think the risks are. But the track record of the past seven years would look pretty brilliant if the starting gross margins had been zero, instead of deep into a hole. How many companies deliver an improvement in margin of six percent per year, three years in a row? Or 700% growth in seven years?

It's incredibly hard to transition from an R&D story stock to a company that mints money, and most teams fail. Capstone's past looks bleak; sure. Capstone's future looks bright. Investing is about the future.

Disclosure: I am long CPST. 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.