The recent excitement regarding Plug Power's (NASDAQ:PLUG) sales momentum with regard to fuel cell units that power forklifts for Walmart and other large companies has ignited interest in the shares of the other two fuels cell stock big boys, Ballard Power Systems (NASDAQ:BLDP) and Fuel Cell Energy Corp (NASDAQ:FCEL). Plug Power now sports a market cap of around $875,000,000. Not bad for a company that was a penny stock within the last year. The sympathetic move in Ballard shares has some logic to it, as Plug Power relies on Ballard for its fuel cell stacks as outlined in Plug's latest prospectus (that's right, PLUG does not make its own fuel cells):
We have certain key suppliers, such as Ballard and Air Squared, that we rely on for critical components in our products and there are numerous other components for our products that are sole sourced. A supplier's failure to develop and supply components in a timely manner or at all, or to develop or supply components that meet our quality, quantity or cost requirements, or our inability to obtain substitute sources of these components on a timely basis or on terms acceptable to us, could harm our ability to manufacture our products. For example, in the fourth quarter of 2012, Ballard had temporarily stopped shipping fuel cell stacks for our GenDrive product line due to a dispute with us that was later resolved.
However, the logic behind Fuel Cell Energy's sympathetic stock move is puzzling. Fuel Cell Energy recently sold 25.3 million shares in a public offering this past January at just $1.25 per share. This was before all the hoopla from Plug Power got into high gear. FCEL now trades at $3.53, almost triple its secondary offering price. Interestingly, some of the hype that got this ball rolling may have violated Section 5 of the Securities and Exchange Act of 1933 and put PLUG at risk of litigation as per the same prospectus:
We may have rescission liability from our offering in February 2013, in connection with the articles published in the Business Review on January 11, 2013 and January 16, 2013.
The statements made by our Chief Executive Officer in articles appearing in the Business Review were published within close proximity to the time that our registration statement on Form S-1 was filed on January 15, 2013. It may be determined that such statements constituted an offer to purchase our securities in violation of Section 5 of the Securities Act of 1933, or the Securities Act. As a result, we may be subject to contingent rescission liabilities from those investors who purchased shares in our offering in February 2013 and subsequently make a claim under Sect 12(a)(1) of the Securities Act alleging that we violated Section 5. If an investor was to successfully win such a claim, we may have an obligation to make a rescission offer to those investors. Although we believe the chances are remote, if rescission is required, we may continue to be liable for the original purchase price, plus interest, for a period of one year under Section 13 of the Securities Act. If all investors rescinded their securities, potential liability could amount to over $3.3 million plus one year's interest. In addition, investors that successfully make such a claim under Section 12(a)(1) of the Securities Act after already having disposed of the securities may be entitled to damages and interest. We are not able to quantify or project what such damages would be, but acknowledge that in certain situations, the damages could potentially be greater than the value of the purchase price of the securities in such offering.
With regard to Fuel Cell Energy, it is difficult to understand how any informed investor could somehow assume that success by either Plug Power or Ballard Power Systems would correlate into success by Fuel Cell Energy. Fuel Cell Energy makes very large molten carbonate fuel cell stationary power plants that can be aggregated into megawatt class power plants with a very favorable environmental footprint. This market has nothing to do with Plug's focus and there are likely no Walmart like orders that are going to quickly ramp up sales. Getting approval for large power plants involves a long lead time process subject to complicated logistics.
One place to look for evidence of future growth for Fuel Cell Energy would be to examine product backlog. The last reports was not encouraging. While service backlog in the October 2013 quarter increased nicely, product backlog actually decreased by 25% to $170.1 million at October 31, 2013 compared to $228.2 million at October 31, 2012. This is also down from $381 million on July 31, 2013 and $410 million on April 30, 2013. Product backlog in megawatts (MW) decreased by 29% to 107.3 MW at October 31, 2013 compared to 150.7 MW at October 31, 2012. This is also down substantially from 123 MW on July 31, 2013 and 140MW on April 30, 2013. Not a pretty picture.
Another problem I have with Fuel Cell Energy as an investment is that the gross profit on its product and service revenues, even at substantial $188 million revenue run rate in its last fiscal year ended October 31, 2013, was only $7 million or 3.7%. The fourth quarter was slightly better with 2.6 million in gross profit on $55.2 million on sales. However, that still amounts to only paltry 4.7% gross margin. Gross profit comes before deducting R&D and G&A expenses that totaled $37.0 million and $7.0 million in for the year and quarter ended October 2013, respectively.
Fuel Cell Energy has made forward looking statements regarding its projected margins in its December 17, 2013 conference call:
We expect continued margin expansion, growing to the low teens in the second half of 2014, as we improve the mix and continue to reduce product costs. We are well positioned for 2014 in terms of our cost profile, including manufacturing efficiencies from process improvements, as well as decreasing product costs. As production increases beyond 70 megawatts, we see additional margin expansion coming with higher volumes, a favorable sales mix that includes complete power plants, plus EPC services and other revenues, as well as lower product costs from overhead and supply chain leverage. We will further benefit when POSCO Energy commences cell production in 2015. Increased production, whether it be in North America, Asia or Europe, will reduce product costs as we leverage our global supply chain.
In conclusion, revenue and incremental operating margins are strong compared to the prior year. And continued cost reduction at our current 70-megawatt production run rate will drive further margin expansion in 2014. We are targeting positive quarterly cash flow, as measured by EBITDA, by the end of 2014 based on anticipated order flow and continued cost reduction.
A couple of thoughts come to mind regarding this forward looking statement. First, with regard to EBITDA, I follow the views of Warren Buffet, so even if management is "targeting positive quarterly cash flow, as measured by EBITDA, by the end of 2014", EBITDA is not GAAP not as relevant as GAAP numbers. Secondly, Fuel Cell Energy may have problems meeting and sustaining its own EBITDA projections based on the declining product backlog. Since the last quarter there have been no new announcements from the company with regard to new project sales. One can logically expect that backlog will weaken further.
Fuel Cell Energy has history, going back at least 22 years, of failing to meet sales goals and as a result has accumulated an astounding $771,000,000 in cumulative losses for shareholders. Yet, after all this time and all that investment, it is still barely above breakeven on a gross margin basis. Even the great Northeast blackout of 2003 wasn't enough to spur enough business to bring this company to profitability and that event was one of the greatest examples in human history on why distributed generation makes sense. Just 10 months before the blackout, on December 9, 2002, CEO Jerry Leitman was throwing out numbers like 400MW in annual sales during an interview with The Wall Street Transcript:
TWST: What is it that sets the 50 megawatts per year target? Is that the ability of the market to absorb units? Is it manufacturing capacity versus the amount of money already invested?
Mr. Leitman: We have been developing our manufacturing processes for more than 12 years. We had three to five megawatts of manufacturing capacity, and last year we began to build that up to 50 megawatts capacity. That's the first step in commercial serial production, if you will. Step two is to go to 150 megawatts and step three is to go to 400 megawatts. The next step, which is 150 megawatts of annualized manufacturing production capability, will cost us about US$20 million in capital expenditures, and we will make that decision depending on how the market looks during 2003. But 50 megawatts gives us a serial production capacity. As I said, we have about 12 megawatts in our production backlog. So as we see new orders growing and depending on the success in the marketplace, we would look at expanding beyond the 50 megawatts to the next step at 150 megawatts.
Even the largest blackout in human history couldn't bring this company to profitability.
Short term investors who own FCEL as a momentum trade, God bless and good luck. I won't try to predict how long upside momentum will continue or whether it may violently reverse course. However, if one puts aside the hype and coldly looks at FCEL by the numbers... if one gives serious consideration to the backlog decline and continued weak gross margins... if one takes note of the dearth of new product order announcements since the end of the last quarter... then one had better have a hell of a lot of faith in management's ability to pull something out their collective hat at the upcoming conference call on March 10th in order to remain positive on the shares. Fuel Cell Energy now has a market cap of around $812 million, up from $287 million when it sold 25 million shares at $1.25 in January. It has no room for error.
Disclosure: I 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.
Additional disclosure: These are the personal views of Wall Street Titan and should not be used for your investment decisions. All readers should always do their own due diligence. I am long puts on FCEL.