A123 Systems’s (AONE) deal with General Motors (GM) has been clarified. Good news for the company. But how much should you pay for the stock? If you own the stock, is it time to sell?
Many investors have no top end price in mind for a stock. For them, a high stock price is just evidence that the company is doing great. They remind me of the winners in Las Vegas, who have a lucky streak and inevitably keep increasing their bets until their money is all gone. If you are one of those people, you can stop reading now.
We believe you should have a top end selling price in mind for every stock you own. There is a price where any asset is overvalued. You may have a very different formula for calculating that price. But have a price in mind. In our case we estimate future earnings, and then discount those future earnings to reflect the riskiness of the estimate. A lot of judgment goes into such an estimate, but at least it provides a rough shot at calculating the fair value of a stock.
This week GM announced that its new mini car, the Spark, will be introduced in an all-electric version sometime in 2013, after being introduced next year in an internal combustion version. GM also announced that it would be sourcing the battery packs from A123. This is not really news, we discussed it in an earlier article, but it does provide some more details about the arrangement. Nevertheless, the stock price rose sharply on the anouncement.
Sales predictions by analysts this week range from 2,000 units to 20,000 Spark EV units sold in the first full year. The launch is expected in 2013, but the first year of significant production is not expected until 2014. To us 20,000 units sounds very optimistic, given recent sales of other electric cars, but we’ll accept that estimate for now, if only to provide a high water mark for the company.
Another SWAG prediction is the cost to GM for a battery pack. Based on dozens of discussions on Seeking Alpha pages we will assume $400 per kw-hr is the price GM will pay for battery packs, and that the Spark EV will need a 25 kw-hr battery pack.
We are ready to do back-of-the-envelope calculation for AONE’s revenue from GM: 20,000 units x $ 400 x 25 = $200 Million.
Let’s take a leap of faith that GM (or another company) buys 20,000 units from AONE in 2014, that AONE can use this jump in volume to get product costs and expenses in line to deliver 10% net profits, that AONE follows up the revenue spike in 2014 with long-term growth rates of 25% compounded annually.
Although the “leap of faith” assumptions seem possible to us, to have all the good news happen simultaneously seems to be the upper level of optimism. After all, GM will have several plug-in electric vehicle competitors in 2014, and several other lithium battery manufacturers will be competing with A123 driving down the market price. We can be sure that GM's buyers will not leave any money on the table in their price negotiations with A123.
Consumer acceptance of all-electric vehicles has been tepid so far. We can be fairly certain of continuing large losses by the company in the current year through 2013. In the June 2011 quarter A123 had an operating loss of $52.9 million on $36.3 million in revenue, so turning around operations to generate 10% profit is a big change for the company.
Demand for limited range all-electric cars is yet to be proven. GM's Volt sales have been poor, as have the Nissan Leaf's. The biggest concern with all electric cars is range anxiety. Tesla Motor's (TSLA) Model S is one of the only all-electrics that can go more than 100 miles on a single charge, compared with limits for the Spark likely to be in the 60 mile range. It is possible that consumers will be much more comfortable with a plug-in hybrid such as Toyota (TM) is planning for the Prius, or for extended range electrics such as the Volt.
By 2014-2015 there will be several more all-electrics, hybrids, clean diesels, efficient internal combusion cars, natural gas cars, and even fuel cell cars all competing for green car buyers dollars.
Nevertheless, even calculating a discounted earnings stream based on optimistic assumptions, our formula says that A123’s current stock price is slightly overvalued. But should we buy stocks based on multiple optimistic assumptions? In our earlier article, we said A123 is “priced to perfection.” At this point we’d say nothing has really changed.
With the support of GM and the US Department of Energy we expect that A123 Systems will have several years of success as a supplier. However lots of good news appears to be already baked into the stock at its current price. To us this is a sell signal. The downside price risk looks higher than the upside opportunity. We are still taking a pass.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.