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Summary

  • Extreme sell-off of nearly 40% in 10 trading days creates a tremendous entry opportunity.
  • Over-reactive sell-off was partly based on reliance upon misinformation.
  • Reasonably expected near-term operational performance and developments warrant a much higher stock price.

Since my recent article on May 6, "Capstone (NASDAQ:CPST) Part 3: Still Triple Value Bound," a tremendous sell-off has occurred, creating an even better buying opportunity. In response to my article, readers posed questions and made requests for clarification. In this article, I will address some of those concerns directly and provide further commentary on CPST's recent developments. Specifically, this article will discuss the current financials, recent developments and the regulatory environment; all key factors in making this stock grossly underpriced.

Regulatory Environment

Pending Bill HR 4428

On April 11, 2014, CPST announced that Congresswoman Linda Sanchez introduced a bill, HR 4428 - The American Microturbine Manufacturing and Clean Energy Deployment Act.

The Act would "…provide a 30% investment tax credit for microturbines, providing parity with tax incentives offered to fuel cells and renewable technologies. Capstone recently received a certificate from the US Environmental Protection Agency Combined Heat and Power Partnership recognizing the role Capstone's microturbine technology has had in removing more than 3 million metric tons of carbon dioxide with cogeneration projects alone. This award further highlights and quantifies the clean and green impact of Capstone microturbines.…By advancing smart tax policy and regulations to help businesses expand and grow, H.R. 4428 would enable American microturbine producers to triple their domestic manufacturing. The bill will also eliminate the project size restriction placed on microturbines in the current tax code, opening the door to larger deployment opportunities."

The bill is currently with the House Ways and Means Committee, of which Congresswoman Sanchez is a ranking member - thus increasing the likelihood of the bill moving to the floor of the House for a vote.

The Obama Factor

The Obama administration is continuously focused on climate change and has several other key environmental decisions to make in the coming months, including the fate of the Keystone XL pipeline and how to address methane emissions from oil and gas drilling; a problem which CPST solves.

Russian Sanctions Do Not Deter

Mr. Gefvert published an article on May 6, 2014, expressing concern that "Russian sanctions targeting the energy sector will affect its [CPST's] Russian distributor which represents over 10% of sales." Message board chatter following this article indicates that many investors sold the stock based on this misinformation.

In fact, Capstone subsequently addressed this concern on May 8th , stating, "…the sanctions have had no impact on Capstone's Russian distributor or the company. The current EU and US sanctions are directed at particular Russian citizens. Additional sanctions are directed at dual use items and have not directly affected Capstone, as microturbines are not dual use items (meaning an item that could also be used for defense purposes)." (Emphasis added)

Commentary on Financials and Related Concerns

Investors reacted to slightly lower than expected revenues along with the need for a capital raise. Although revenues missed the mark slightly, the net income growth compared to the same quarter last year has exceeded that of the S&P 500 and greatly outperformed the Electrical Equipment industry average.

The net income increased by 51.1% when compared to the same quarter one year prior and rose from -$4.48 million to -$2.19 million. Per the company's press release on May 7, Darren Jamison, Capstone President and Chief Executive Officer stated, "Management currently expects backlog to increase by approximately $22.7 million, or 15%, to a record $171.6 million as of March 31, 2014, compared to $148.9 million as of March 31, 2013....Our expected annual revenue growth of 4% in fiscal 2014 was slower than in recent years but still reflects an impressive compounded annual growth rate of 30% since fiscal 2007...Fourth quarter 2014 revenue was the second highest in company history...Healthy new order flow pushed our backlog to an expected record of $171.6 million as of March 31, 2014...Ending backlog is a leading indicator of future revenue growth, and coupled with expanding markets and market opportunities, exciting developments in our product suite, and advancements in our aftermarket services business, these trends bode well for our revenue and margin expansion opportunity in fiscal 2015 and beyond. Likewise, as customers continue to migrate toward larger units and larger projects, Capstone's crossover to positive EBITDA and cash flow is forthcoming."

CPST clearly has a strong balance sheet both in absolute and relative terms. With its cash balance of $31.57 million, yahoo finance reports a current ratio (also known as a working capital ratio) of 1.57 which implies current liabilities of $20.1 million ($31.57/1.57). Using the cash balance of $57.7 million after the equity raise reported in the SEC filing, the current ratio is now 2.86 (57.7/20.1 million), which is strong by any standards. In fact, the S&P 500 average working capital ratio for 1Q2014 was 1.17. So even before the capital raise, CPST had a working capital ratio higher than the S&P average. It is now nearly 2.5 times as strong as that average.

Analysts Concur

This year two analysts have substantially raised price targets, citing the high near-term probability of becoming cash flow positive.

On February 19, 2014, Capstone traded at $1.69 when FBR Capital increased its price target to $2.50 from $2 and upgraded Capstone from "Perform" to "Outperform" Analyst Aditya Satghare commented, "Based on our proprietary work on the horsepower opportunity in key end markets such as oil and gas, we believe that natural gas as a fuel is at an inflection point and that Capstone, with its reliable and versatile microturbine product, is well positioned in this market. We also see multiple other end markets where the higher-uptime, lower-emission profile of microturbines and CHP capability should result in meaningful market penetration. While the timing of new orders is difficult to predict, we see the potential for a sizable increase in order sizes, from both new and repeat customers, over the next 12-24 month. As a result, Capstone should transition into a profitable and cash flow-positive business model over the next 12-24 months. We rate the stock Outperform and recommend purchase, although we would not rule out near-term stock volatility around upcoming earnings, given the meaningful stock run-up, and would use any pullback as a further buying opportunity."

Additionally, as mentioned in my prior article, Cowen and Company raised its price target from $1.90 to $2.70 on March 11, 2014.

Developments

PACCAR/Peterbilt Partnership

Capstone recently partnered with PACCAR's subsidiary, Peterbilt, to develop economically viable natural-gas engines. On April 27, 2014, Tyler Crowe commented on a natural gas powered Wal-Mart truck, "This is what Wal-Mart envisions as the future of trucking in America, and natural gas engine manufacturers like Westport Innovations (NASDAQ:WPRT) might want to take note, because this Capstone Turbine powered truck could be one of its biggest threats in the long haul trucking market. Not only does this truck take advantage of cheap natural gas, but its fuel efficiency could potentially blow any previous truck out of the water."

Wrightspeed, FedEx and More

On May 6th, Wrightspeed, which uses Capstone Microturbines for its powertrains, announced delivery of its first "Cleaner than EV" truck to FedEx and on May 10th, Wrightspeed announced a partnership in Northern California to covert diesel garbage trucks to electric drive. Wrightspeed is catering to "anyone and everyone operating commercial fleets 'including companies like Cintas (NASDAQ:CTAS), UPS (NYSE:UPS), Waste Management (NYSE:WM), Brinks (NYSE:BCO), Frito Lay (NYSE:PEP), etc.'" Given Wrightspeed's growing market acceptance, it is reasonable to believe that Capstone's revenue will be positively affected.

Flare Reduction Project

On May 5th Capstone announced that it received multiple orders from its new distributor, Electro Mecanique Industries (EMI), for two flare-reduction projects. Capstone microturbines will burn the associated gas that is currently being flared, thus capturing otherwise harmful emissions and converting them to useful, onsite energy. According to the GGFR (Global Gas Flaring Reduction) Partnership, an estimated 150 billion cubic meters (or 5.3 trillion cubic feet) of natural gas are being flared annually. In other words, 25% of the gas consumption in the U.S. is being emitted into the atmosphere is essentially just harmful waste. "Capstone is committed to its role in environmental stewardship as a clean and green company and will continue to work with companies across the world to reduce the practice of gas flaring in an effort to be more ecofriendly and responsible. The best solution to the flare gas problem is to capture this gas from the wells and use it in the production process," added Jamison.

Conclusion

In the past 10 trading days, in response to lower-than-expected revenues, a capital raise and unfounded fears of impact from Russian Sanctions, CPST's stock price has dropped nearly 40% - falling from $2.20 on April 25th to a close of $1.33 on May 9th. In reality, the capital raise should serve to increase near-term revenue growth and the Russian Sanctions are irrelevant to Capstone.

As of April 15, 2014, a tremendous 15.4% of the float was short and that figure is likely much higher today. A major short-squeeze could be triggered by news of further positive developments such as additional orders for CPST's products and advances on the regulatory front. Such likely events could cause a dramatic surge in CPST's stock price.

Disclosure: I am long CPST. 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.

Additional disclosure: This is not an offer to buy or sell securities. Consult with a qualified investment professional before investing. There is no guarantee of any results.

Source: Capstone: Extreme Sell-Off And Reliance Upon Misinformation Creates Tremendous Entry Point