Plug Power: Sorting Through The Noise

Apr.15.14 | About: Plug Power, (PLUG)

Summary

Short sellers using PLUG's historical results as an indicator of future performance are misguided in their approach.

Disappointing financial results and initial struggles to gain meaningful market share are not uncommon for companies offering disruptive products or technologies.

Based on a recent Department of Energy study, fuel cell forklifts are superior to traditional battery forklifts in medium to large-sized facilities operating 2-3 shifts a day.

The total addressable market for PLUG's fuel cell system is large. In the US alone, Class 1, 2, and 3 electric forklift factory sales were over 105,000 units per year.

Recent momentum indicates that adoption of PLUG's fuel cell systems is accelerating. Thus, I believe that PLUG is an attractive investment at the current share price levels.

Plug Power (NASDAQ:PLUG) has had quite the year so far. On February 26th, the Company announced it had signed a contract with Wal-Mart (NYSE:WMT) to provide 1,738 GenDrive fuel cell units, as well as infrastructure and fueling services for six of Wal-Mart's distribution centers. Although Wal-Mart has been a PLUG customer since 2007, this contract is perceived to be a potential game changer. The order is estimated to be worth ~$50mm, and is by far the largest order that PLUG has ever received from any single customer. To add to the bullish sentiment, PLUG CEO Andy Marsh stated on the Q4'13 earnings call that PLUG had received its first order from a large automobile manufacturer. Many investors have interpreted the recent wave of positive news as a strong indication that the adoption of PLUG's fuel cell systems for forklifts is accelerating. As a result, PLUG's stock price has increased over 200% since the beginning of the year.

The meteoric rise in PLUG's share price has made it one of the most divisive stocks in the market today. When a stock increases so much over such a short period of time, it tends to attract a lot of skeptics to go along with the believers. As a result, PLUG's short interest has increased from 7mm shares at the beginning of the year to over 30mm shares today. The increase in short interest has been accompanied by frequent publishing of articles on Seeking Alpha and other websites by short sellers. In these articles, short sellers argue that PLUG's stock has run up too far, too fast, and that the market is overreacting to PLUG's recent deal announcements. Most prominent among these short articles was a report released by Citron on March 11, 2014. On the day Citron's report was released, PLUG's stock declined ~42%, from $10.31 to $6.03 per share.

Although I am a current holder of PLUG shares, I find it helpful to hear differing opinions on PLUG, as long as they are well-reasoned. That being said, I believe that Citron's report and many of the other short articles written on PLUG contain a lot of misguided noise. More specifically, these articles place too much of an emphasis on analyzing the Company's past performance. In the next section, I will summarize why analyzing the Company's past performance to gauge the future prospects of the business is a largely meaningless endeavor. Following this, I will highlight the key aspects of PLUG's business that an investor should consider before purchasing shares. At the same time, I will provide reasons for why I think PLUG is an attractive investment at the current share price levels

Past Performance Is Not Indicative Of Future Results

As a growth company, it makes little sense to analyze PLUG's historical performance to gauge the future viability of the business. Yet, for some reason, many short sellers have focused a large portion of their articles to do just that, while giving little to no credit for the Company's recent significant contract wins. For example, in Citron's report, the author states the following:

"…Well over a decade as a public company, during which they have lost close to $850 million, while developing no IP or meaningful revenue growth. Profitability? Forget about it!"

As another example, in a more recent article posted on Seeking Alpha by Weighing Machine, the author commented:

"If PLUG is such a fast-growing company (as implied by its huge valuation relative to sales), why hasn't PLUG been able to grow revenue for the past three years?"

To repeat, PLUG's merits as an investment should not be based on its past performance. In order to illustrate my point, I will briefly discuss the history of the tablet computing industry. In the 1980s, 1990s and early 2000s, both Apple and Microsoft invested a significant amount of money developing tablet devices. In 1993, Apple released the Apple Newton, which did not incorporate a fully-responsive touchscreen and achieved only limited success. In 2000, Microsoft released its Microsoft Tablet PC, which also failed commercially due to its heavy weight, cumbersome interface and lack of necessary application support. In addition to Microsoft and Apple, numerous other companies throughout that same time period invested a significant amount of money in tablet development and failed. Eventually, however, improvements in tablet technology, lowering of production costs and the emergence of wireless data networks converged to make tablets a more commercially viable product. Finally, in 2010, Apple released its iPad to much success, and the tablet market hasn't looked back since.

The evolution of the tablet industry is a clear illustration of the difficult path that disruptive technologies or products often take before gaining mass market acceptance. There are countless other examples that you can see in the market today. The recent emergence of the solar industry after years of unfulfilled promise is another good example. Another well-publicized example is the success of Tesla Motors, a company that was on the brink of bankruptcy before finally achieving commercial viability. Often times, the development of disruptive technologies or products requires significant investments in order to make them viable for mass-market consumption. At the same time, the timing has to be right for the product or technology to gain a meaningful amount of adoption. In the process, investors and businesses can, and often do, lose money. However, once adoption begins to accelerate, large profits can be made by the companies that are best-positioned to take advantage of the emerging trend.

As you can see, PLUG's long and arduous path over the years is not uncommon given the disruptive nature of its fuel cell products. Thus, investors would be wise to ignore the noise about PLUG's past and focus on the things that hold more weight toward the future success of PLUG's business. More specifically, investors should focus on analyzing the value of PLUG's fuel cell system versus competing products, as well as the potential size of PLUG's addressable market.

A Tale of Two Studies

During my research of PLUG, I came across two recent studies on the economic viability of fuel cell forklifts. To my surprise, these studies arrived at meaningfully different conclusions on the merits of fuel cells as a forklift power source. The first study was released in early 2012 by Colorado State University. In this study, it was concluded that fuel cell forklifts were a niche solution only viable in facilities with "extraordinary costs of facility space, labor, and electricity."

Although the report is well written, the accuracy and relevance of the study is questionable for a few reasons. First, the Colorado report claims that fast charge battery forklifts are more economical than both traditional battery forklifts and fuel cell forklifts in higher workload scenarios (generally meaning facilities with multiple shifts). Like the fuel cell forklift, the fast charge forklift meaningfully reduces labor costs in multi-shift facilities by eliminating the need to change batteries. This is because fast charge batteries take 75% less time to charge than traditional batteries. Thus, fast charge forklifts can be sufficiently charged during downtime at work (i.e. lunch breaks, coffee breaks, etc.). Conceptually, this makes sense and appears to make the value of a fuel cell system somewhat redundant. However, further research revealed that applying the fast charge system in a real world scenario is not as practical as it sounds. Fleetman Consulting, a Vancouver-based forklift consulting company, had the following to say about fast charging:

"Your company culture has to be the right fit for the technology…. ie the timing of when to charge, how to charge and how to properly maintain the battery has to be a priority in your organization with clear lines of responsibility. The operators, supervisors and management team all have to take ownership of the program if it is to succeed."

"Fast Charge chargers draw more current ( amperage ) than standard chargers and for this reason it would be important to make sure your facility has enough power available, especially if you need multiple chargers to satisfy a large fleet size."

Material Handling & Logistics also had the following to say about fast charging:

"….upper management must fully embrace this technology and be aware of the discipline required to properly water and charge batteries on a timely basis. They should also know that fast charging generally draws more current than regular chargers. If your company has a large fleet of trucks, you may need to upgrade the electrical service, which can be an expensive proposition."

Thus, due to the logistical hassles, fast charging only makes sense for a limited number of facilities whose managers can handle the extra planning and development of best practices that fast charging requires. You can read more about fast charging here and here.

In addition to the Colorado study's questionable claims about fast charging, the accuracy of the study's overall cost assumptions is also questionable. Consider the following quote in Section 2 of the report, which states that:

"The analysis models costs and capabilities for the year 2010."

Given the advances in fuel cell technologies relative to battery power since 2010, it is likely that the costs of fuel cell systems in relation to battery power are overstated. Furthermore, the study is not based on any real-world deployment of fuel cell systems. Instead, it is a compilation of information collated from personal discussions and various third-party studies. This, as you can imagine, adds further uncertainty as to the accuracy of the study. The following quote from Section 2.1 of the report sums it up nicely:

"The economic costs of forklift usage can be difficult to determine because of the lack of public information regarding forklift usage, how facilities value space and time required for materials handling, and accurate price points for the powerplants and support equipment. This report synthesizes published information based on previous studies of forklifts, informal surveys of industrial forklift users, interviews with experts in forklift powerplant technology, and cost data from forklift manufacturers."

The second study on fuel cell forklifts was a research report published by the Department of Energy in April 2013. The findings of this study painted a much more favorable picture of the viability of fuel cell forklifts:

"…for fairly intensive warehouse and distribution applications-in the case studied, a deployment of about 60 fuel cell lifts for 2-3 shifts per day, 6-7 days per week-fuel cell-powered MHE can have a lower total cost of ownership than comparable battery lifts. Fuel cells are predicted to have a lower cost of ownership compared to traditional battery lifts in both Class I/II and Class III material handling equipment."

I believe the findings of the DOE report are more legitimate than the Colorado State University report for a couple reasons. First, unlike the Colorado report, the DOE's study is based on real-world deployment of fuel cell forklifts in multiple material handling facilities. Secondly, the DOE's report is more recent, and thus, the data is likely to be more accurate.

Fuel Cells Versus Traditional Battery Power

Now that I have established my belief that the DOE report is more relevant, I would like to dig a bit deeper into the results of the study. The DOE report provides the following chart, which compares the annualized cost of battery vs fuel cell systems for Class 1 and 2 forklifts:

As stated above, the DOE study is based on a deployment of 60 forklifts running 2-3 shifts per day, 6-7 days per week. As expected, the largest cost savings that fuel cell systems provide compared to batteries is in the labor cost spent on refueling (~1 minute of labor) vs. battery changing (~9 minutes of labor). In this scenario, the annualized cost of the battery lift was $19,700 vs. $17,800 for the fuel cell lift. Thus, the market for fuel cell forklifts does not appear to be limited to just outlier facilities (as stated in the Colorado report), such as large, 24-hour distribution centers. Instead, fuel cell forklifts appear to be the more cost-effective solution in facilities running 2-3 shifts per day for a medium to large-sized fleet (>60 forklifts).

By contrast, in facilities running just 1 shift per day, battery forklifts appear to be more cost-effective than fuel cell forklifts in most scenarios. This was expected due to the sharp reduction in battery changing costs. The DOE report estimates that in a 1-shift scenario, the annualized cost of the battery forklift decreases to approximately $16,000, which is cheaper than the fuel cell forklift in the same scenario. The report does not provide an estimation of the annualized cost of the fuel cell forklift in a 1-shift scenario. However, in this scenario, it is unlikely that the annualized cost savings of a battery forklift versus a fuel cell forklift exceeds ~$1,000. This is due to lower battery changing costs being partially offset by a reduction in the consumption of higher-cost hydrogen vs. electricity.

Although battery forklifts are currently cheaper than fuel cell forklifts for 1-shift facilities, I believe that this could change sometime in the near future. The costs provided in the DOE study are largely based on 2011 data, so it likely does not take into account relative cost improvements in fuel cells vs. lead acid batteries since then. Also, this study assumes a cost of $8/Kg for hydrogen, which is fairly expensive. The cost of producing hydrogen is likely to improve significantly over time. Further, this scenario assumes a medium-sized fleet of 60 forklifts. Due to the scalability of the fuel cell infrastructure, the annualized infrastructure costs for fuel cells declines relative to battery power for larger fleet sizes. Finally, as PLUG ramps up its infrastructure installation and hydrogen fueling services, the Company will gain purchasing power, which will most likely further reduce infrastructure and hydrogen fuel costs. In total, these potential cost improvements could allow PLUG to reduce annualized costs by >$1,000 and eventually become cost-competitive in larger 1-shift facilities.

Overall, I believe the DOE study provides strong evidence of the ability of PLUG's fuel cell system to effectively compete against traditional battery power in a fairly wide variety of workload and fleet-size scenarios. The Company has also received positive feedback from nearly all of its customers. In fact, Lowe's recently announced that it began using 157 PLUG lift trucks at its GA distribution facility and expected a payback period of 2.5 years. This provides further confirmation of the value of PLUG's fuel cell products and services.

Large Addressable Market Justifies Current Valuation

Another puzzling aspect of some of the short seller reports was their attempts to value PLUG using valuation methodologies like comparable analysis and sum of the parts. PLUG is still in the early stages of the commercialization of its products. Thus, how much and how fast PLUG grows in the near term is anyone's guess. Applying a revenue multiple to PLUG's FY 2013 revenue of $26.6 million, as some short sellers have done, does not make sense, because that number does not reflect any of the recent momentum in the business. At the same time, applying a revenue multiple to projected 2014 revenue of $70 million also has its problems. If PLUG was to win another large contract that is similar in size to Wal-Mart, then the $70 million would most likely be revised upward by a significant amount.

In my opinion, rather than use traditional valuation methods, it is more appropriate to evaluate whether PLUG's total addressable market opportunity is large enough to support its current share price and future price appreciation. According to the Industrial Truck Association, in the US, 2013 factory shipments of Class 1, 2 and 3 electric forklifts was over 105,000. Assuming all-in revenue per unit of $23,333 (based on 2014 management guidance of $70mm revenue and 3,000 units shipped), this represents a total annual revenue opportunity of almost $2.5Bn for just the US alone. The Company is also focused on expanding into new geographic markets in Europe and other parts of the world. Based on 2011 data, the total addressable forklift market for Europe and the ROW is estimated to be over 2X as large as the US. Clearly, based on these numbers, the total potential addressable market for PLUG's products is very large over the long term.

PLUG's near-term growth prospects are also promising. For example, PLUG's recent contract with Wal-Mart appears to be just the tip of the iceberg. Wal-Mart has ~20,000 forklifts in 150+ distribution centers in the US. This equates to an average fleet size of over 100 forklifts per facility. Furthermore, most of Wal-Mart's distribution centers run at least two shifts per day, and some of them even operate on a 24-hour basis. Based on this information, it appears the profile of Wal-Mart's average facility in terms of workload and fleet size are an ideal fit for PLUG's fuel cell products. Today, including the recent order of 1,738 units, PLUG has only penetrated 8 of Wal-Mart's distribution facilities. If PLUG were to supply all 20,000 forklifts for Wal-Mart, this would represent a total revenue opportunity of almost $500 million. Thus, given the promising nature and substantial size of PLUG's near-term and long-term growth prospects, I believe further appreciation of PLUG's stock beyond the current share price will be justified if the Company continues its positive momentum.

Conclusion

As I discussed in detail, PLUG's historical performance holds little relevance to its future business prospects. As a disruptive growth company, PLUG should be evaluated based on the merits of its products and services, as well as the size of its addressable market opportunity. Investors in PLUG must make a calculated leap of faith that recent momentum in PLUG's business is sustainable. In my opinion, an investment in PLUG is a leap of faith worth making. Based on the analysis I have provided in this article, the Company appears to be at the beginning stages of a rapid period of growth. Its fuel cell products currently represent an attractive value proposition relative to traditional battery-powered forklift systems. Going forward, the attractiveness of PLUG's products should continue to increase as fuel cell technology improves and hydrogen and infrastructure costs decline. In addition to this, PLUG's recent landmark Wal-Mart contract and soon-to-be-announced auto deal are a strong indication that the adoption of PLUG's fuel cell products is accelerating. Finally, additional growth opportunities that the Company is exploring in areas like refrigeration unit trucks and airport fleets provide further upside potential. As a result, I believe PLUG shares are an attractive Buy at current price levels.

Disclosure: I am long PLUG. 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.