We believe FuelCell (NASDAQ:FCEL) is a compelling short due to the steep cliff the company faces as POSCO, its dominant customer, transitions away from FuelCell. Since signing large one-time contracts from POSCO and Dominion in late 2012 and early 2013, FCEL has signed few orders of any size for additional fuel cells. With the POSCO order book running out, FCEL is at risk of missing estimates and seeing declines in sales and increased losses. Our price target for FCEL is $1.00/share, for a potential return of 60%.
POSCO is a major customer that is going away
Over the past three years, POSCO has accounted for 44%, 76%, and 54% of revenues, as per the latest 10-K (here).
When viewed in dollars, the amount from POSCO is striking.
Furthermore, we understand that POSCO accounts for essentially all of FCEL's remaining $144.6 million and 95MW of product backlog. Unfortunately, that's almost completely going away. According to the terms of the contract signed in 2012 (here), POSCO is building its own manufacturing facility in South Korea that is expected to be operational in 2015. Once open, POSCO will stop ordering from FCEL, start manufacturing its own fuel cell kits, and pay only a 3% royalty. In other words, if POSCO continues its current rate, FCEL's revenues from POSCO will go from $101 million today to only $3 million once POSCO opens its manufacturing plant! That is a 52% drop in total revenue from current levels!
Order trends are not encouraging
The only way FCEL can offset the steep decline from POSCO is through significant new orders. However, the volume of new orders over the last 4 consecutive quarters has been anemic, to say the least. As a result, product backlog (the lifeline of the company) has fallen nearly 45% since 1Q 2013.
Even if the company starts booking new product orders, they would have to be incredibly large in order to offset the looming POSCO declines. We think this is highly unlikely due to the high cost of FCEL's technology, which has only been implemented in areas with stringent renewable mandates. While sell-side analysts expect significant growth in revenues, we believe FCEL is facing dramatic revenue declines. Its order book and recent orders make this clear.
Negative cash flows will accelerate
To make matters worse is FCEL's consistent cash drain. As of January 31, 2014, FCEL had $104.6 million of cash, or only $0.41 per share. However, FCEL's cash drain over the last 3 years has averaged $32 million per year, or $0.13 per share.
During the most recent quarter, FCEL had negative Cash Flow from Operations of $5 million and spent another $1 million on capital expenditures for a total of $6 million in negative Free Cash Flow. On an annualized basis, this is another $0.09 per share of cash that FCEL will quickly burn from its $0.41 per share balance.
Once POSCO transitions to its own manufacturing plant, we expect FCEL's cash drain to become even more significant and put further strain on FCEL's share price.
Conclusion: 60% risk to FCEL share price
We think FCEL faces a significant risk once POSCO's current order backlog run outs. With no large orders added to its backlog, FCEL faces a steep drop in revenues, significant cash drain, and potential financial distress. We generously value FCEL at a more than 100% premium to its current cash balance of $0.41 per share and therefore give the stock a price target of $1.00 per share. This represents nearly 60% downside from today's price.
Disclosure: I am short FCEL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.