Hydrogenics Train About To Leave The Station

Jul.24.14 | About: Hydrogenics Corporation (HYGS)

Summary

Hydrogenics has come a long way and unlike the other fuel cell companies has a small market cap with a small float and shares outstanding.

Will be first profitable fuel cell company in q3 or q4.

Will be the only major player in energy storage which is a $20+ billion market.

Hydrogenics and it's energy storage solution is the missing link to hockey stick renewable adoption.

There have been several articles written about Hydrogenics (NASDAQ:HYGS) and the massive discount to the other fuel cell players. Despite this, the stock has remained depressed and unloved by investors (not analysts who have been touting the stock to no avail). This article will point out how and why Hydrogenics will reach $100 in one year.

Hydrogenics came public in 2000 and was victimized by the bursting of the tech bubble. The much hyped fuel cell industry saw companies rise to massive levels (Ballard BLDP and Plug Power PLUG) both over $100 per share prior to dilutions only to fall and come within a whisker of their financial lives. In many cases bankruptcies were the only option as fuel cell excitement didn't match the reality of the cost backdrop and likely revenue traction.

Much like many new industries and technologies the hype phase of these nascent businesses outstrips the capacity to deliver on the conceptual promise of what they may some day achieve. However, much like the internet, solar, and many other disruptive technologies, the strongest companies consolidate and survive only to re-emerge as leaner, stronger, and better companies. Such is the case with Hydrogenics which has consolidated its operations and cut costs. They have picked up strategic partners and positioned themselves as leaders in each area.

In it's current structure Hydrogenics has four lines of business. 1) Propulsion 2) Power Generation 3)Energy Storage 4) Hydrogen Fueling Stations. Each one of these markets is large and they are a leader in each of these segments but it is the energy storage market that I would like to discuss here.

Depending on which analyst you read, the energy storage opportunity is between 15 -40 billion dollars currently. I think that is an extremely conservative way to view it since it's growing rapidly as renewables reduce costs and accelerate adoption. Energy storage is the missing link for the renewables problem of intermittency and the fact that the sun doesn't shine at night. It's one thing to generate electricity via wind or solar and it is another to store it so that the excess can be used during night time or non windy days. This is where Hydrogenics comes in. Their clean solution industrial pem technology, which has already been on display with E.ON (one of the largest German utilities), and has already been reordered, converts energy generated by wind and solar into hydrogen. That hydrogen can be injected into the already existing natural gas pipelines (between 15-25% safely) and sent to utilities to produce energy and allow for consumption of previously stranded electricity generation. As the cost for solar and wind have come down adoption has risen. Solar and wind have pierced grid parity in many topographies on a non-subsidized basis but the ability to store the excess power generated has been an inefficient process. Expensive, heavy, and inefficient battery systems have done their best to fill the gap. That is about to change in a massive way thanks to Hydrogenics.

In a recent presentation Hydrogenics discussed how it could double output of a $200 million dollar wind or solar farm with an incremental investment of less than 25% of the initial purchase price.

In its most recent earnings call management discussed their $50 million dollar plus backlog and their intent to deliver on 30% annual revenue growth which will take them to profitability by the end of this year. However, what has not gained much attention was the discussion of the bids which are currently out, in various stages, for energy storage of roughly $70 million. Yes that's right $70 million on top of the already existing $58 million, most of which has happened over this past year. Andy Marsh, CEO of Plug Power talked of his exploding backlog for about 8 months before the mother of all rips in his stock occurred. I think the same is about to happen with Hydrogenics and energy storage.

Hydrogenics has the only megawatt scalable solution for hydrogen generation. The next nearest competitor is 100kw or 1/10th the size. As the second E.ON energy storage system gets into the marketplace, and other utilities can kick the tires, I expect orders to hockey stick. $70 million will be a drop in the bucket as customers become comfortable in this.

The timing of this technology couldn't be better for Europe and Germany in particular. Given Europe's dependence on natural gas from Russia, particularly in the winter, the ability to convert excess renewable generation into hydrogen could lessen the dependence on Russia for its gas. Germany has gotten to the point where solar can generate half of the needed electricity via renewables. If they could solve their problem of intermittency and storage with hydrogen we could see fireworks. It was no coincidence that they gave $6.6 million dollars to fund fuel cell development within a couple of days of the downing of a Malaysian flight presumed to be fired upon by Russian separatists. Germany recognizes the value of fuel cells and much like they led the way with adoption of solar they are likely to do so with fuel cells.

Energy storage is only one of four business lines for Hydrogenics and the others are exciting as well (evidenced most pointedly by the recent order of a new customer for $3 million dollars for power generation in S. Korea). Plug Power (NASDAQ:PLUG) has routinely traded with a market cap of late near or over 1 billion dollars. Fuel Cell (NASDAQ:FCEL) and Ballard (NASDAQ:BLDP) the same. However, HYGS has not come close despite reaching $35 a share earlier in the year (would have put the company around $350 million market cap). The same $1 billion dollar valuation for HYGS would give them a $100 stock price. The energy storage market alone is larger than any of the other opportunities PLUG has.

Let's take a look at how the market is valuing the other pure plays BLDP, FCEL, and PLUG. Ballard , whose main markets are motive and backup power, has a 560 million dollar market cap. Since no fuel cell company is currently profitable and since most have no debt (FCEL the one exception with about 70 million but as much in cash to cancel out) figuring out valuation based on revenues, future profitability, growth, and size of markets selling into are the best ways. Ballard has fluctuated in revenues from 119 million in 2003 dropping to as low as 46 million in 2009. Since 2009 it has unevenly grown its revenues to 61 million in 2013 with a projected 79 million for 2014. Importantly Ballard is set to turn profitable in mid 2015 (expected to lose a penny for the year) and make 2 cents for 2016 on revenues of 103 and 122 respectively for those two years. Thus Ballard is trading at 5.4x next year's revenue and 4.59x 2016. Since the street thinks they will lose money next year and make 2 cents in 2016 we can say it's trading at 250x 2016. Growth in revenues is hard to say as it is returning to levels it had already done years ago. Supplying Plug with their stacks is a commoditized business that Plug has already begun to diversify away from with their recent acquisition. The market opportunity is large in backup power but is only one arm of the same business Hydrogenics is in with their distribution partner Commscope. Therefore I would argue that whatever valuation is ascribed to Ballard, Hydrogenics should be greater.

Next is FuelCell Energy(FCEL). FuelCell also still doesn't make money but is expected to do so in 2016 when they analyst community guesses they will achieve their 80 megawatt run rate and make 4 cents. FuelCell has shown fairly steady, with a couple notable exceptions, growth in revenue starting in 2003 at 33 million to its current 194 million 2014 expectation. 2015 is expected to grow to 242 million and 2016 344 million. This implies 25% growth for 2015 then an acceleration to 42% for 2016. FuelCell trades at 2.69x 2015 and 1.9x 2016 revenues. Also, it trades at 66x consensus EPS estimates for 2016 with none available for 2015 since no profit is expected. FuelCell is a unique player in the fuel cell space in that they are targeting larger power generation projects. As such, their business model requires much larger revenues and business to reach profitability. Hydrogenics is also in the power generation business. Unlike FCEL Hydrogenics carries 25-30% gross margins on their business lines and their power generation business whereas FCEL has only recently crossed into the black on their gross margins. Hydrogenics just recently gained further traction in their power generation business with their South Korean tie-up and roughly three million dollar initial order. FCEL sold their Asian rights to Posco and so their ability to benefit as much as an unencumbered Hydrogenics, which has a better margin product, in this large and early adopting region is not as good. FCEL has made steady progress but will need somewhere around 300 million dollars in revenues to break even which won't likely come for another year. The same 300 million dollars in revenues for Hydrogenics would equate to nearly $4 in EPS. I would argue that Hydrogenics deserves to trade at a premium to FCEL given its better margins, larger markets and lines of business, greater profitability, and lower revenues necessary to achieve profitability.

Then there is Plug Power . Since 2003 Plug has been losing money and continues to do so. Their revenues in 2003 were 12.5 million dollars and have unevenly grown to 26.6 in 2013. However Plug has promised that their business is inflecting and in the words of Andy Marsh "exploding." Their revenues for 2014 are expected to explode to 74 million and for 2015 and 2016 analysts expect plug revenues to jump to 124 and 214 million respectively. Despite this explosion in revenues, in 2014 Plug is expected to first break even in q4 of this year and not turn a profit until q4 of 2015. They are expected to make 12 cents in 2016 which means it trades at 331x 2015 and 47x 2016. The reason for this is that Plug has had negative gross margins and needed a good amount of revenues to turn its margins into the black. The large dilutions with several capital raises has left Plug with 167 million shares out and because of this will make it hard to meaningfully swing the needle for growing earnings. Plug currently carries a market cap of 941 million and has been as high as 2 billion in recent months. Based on the street projections above, Plug is trading at 7.59x next years revenue and 4.4x 2016. Plug has a niche market in material handling and also needs a good slug of revenue to generate a profit. Refrigeration and range extenders offer promise of new applications but are yet unproven markets. I believe that currently Hydrogenics has better and more profitable markets than plug. Materials handling and refrigeration combined are not as large as the energy storage market for Hydrogenics. Range extenders could be a large market but I'm not sure we are at the stage of discounting that yet. As such I believe Hydrogenics should trade at a premium valuation to Plug.

Hydrogenics on the other hand is trading with a 177 million market cap (no debt and over 20 million in cash). They are growing revenues at 30% with quarterly margins of 25-30% and are expected to turn profitable in q3 or q4 of this year. The street believes revenues will go from 51 million this year to 72 million next year and 94 million in 2016. EPS is expected to go from losing $.61 this yr to making $.14 in 2015 and $1.1 in 2016. That means Hydrogenics is trading at 2.4x 2015 and 1.9x 2016 revenue estimates. However, Hydrogenics is trading at only 16x 2016 EPS! Despite the fact that Hydrogenics has better margins, better profitability, superior earnings leveraged growth, larger addressable markets (particularly with energy storage) and a small 11 million shares outstanding (much of which is held in strategic hands leaving a very small float) it trades at a massive discount to the other fuel cell companies. Further, the 58 million dollar backlog is coupled with quotes out for nearly 70 million in energy storage alone. Hydrogenics backlog, revenues, and profitability (not just their revenues) are set to explode. In order to get to a premium valuation to the others one could easily see that Hyrogenics would need to have a billion dollar plus market cap. This would equate to $100 per share of HYGS.

For the past year Hydrogenics has discussed its prospects with the investment community only to see its message ignored as it was thought to be a second half 2014/ early 2015 story. After an admittedly lumpy quarter and a sloppy capital raise, the moving forward picture could not look better. We are finally in the window for energy storage to ramp and the Hydrogenics story to inflect.

Japan and China are rolling out aggressive automotive goals for fuel cell adoption which will require hydrogen fueling stations and infrastructure. Toyota and Honda are set to start selling fcv in march of 2015. Europe has increased adoption of fc busses and continues to build out infrastructure. South Korea has gotten aggressive on the power generation front. Europe and Canada are dipping their toes on the energy storage front. The time for commercial fuel cells has arrived in various settings/applications.

To the extent Hydrogenics executes and solves the renewable storage problem by converting excess power to easily consumable hydrogen in already existing/built out natural gas pipeline networks we will see something truly special. They have no apples to apples competitors and a ton of IP that creates a significant barrier to entry/moats.

Risks to my thesis of course include slower adoption, higher costs, and poor execution by management.

The company is set to report on the 30th. While I don't expect fireworks from this quarter, I will be closely looking at the energy storage commentary as this could really ignite this stock in the quarters to come. The market looks forward and will see that energy storage and power generation are set to inflect simultaneously over the next several years within a powerful secular backdrop of fuel cell adoption globally.

Disclosure: The author is long HYGS. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Plans to trade it actively as price dictates