Be Very Careful With A123 Systems

Jun.22.12 | About: A123 Systems, (AONEQ)

Over the last month A123 Systems (AONE) has traded higher by over 60% following its announcement that it has developed an improved lithium ion cell that can cut costs of rechargeable and hybrid vehicles. The beaten stock has since traded with a sense of optimism as investors hope this is the answer that they have been desperately awaiting. However, with these new cells being produced next year, will it change the market for units that use the company's products or will we ever see these new cells?

The demand for the company's batteries has failed to meet high expectations due to limited demand for electric vehicles. The company now hopes this new battery can create new demand, along with increased demand for use in utility grids, telecommunication systems, and even power tools. And although I will not comment or speculate on the success of this new product, I still think it is obvious that this new cell has to become a success or the company will fail.

Over a period of one year AONE has lost 70% of its value, despite recent gains during the last month. The primary reason has been a lack of demand for its batteries and fundamentals that are dangerous at best. The company's revenue had risen each of the last four years, however, its loss has also become wider with each passing year. And in 2012, for the first time, the company's sales are diminishing, by nearly 40% during its last quarter.

As of now, AONE is a classic example of a bankruptcy waiting to happen. During its last quarter the company had only $10.89 million in revenue, but a net loss of $125 million! Quarters such as this cannot continue. The company simply does not have the leverage and financing available to handle such a financial storm.

If you look at the company's balance sheet you can find just as many problems as with the company's income statement. At first glance investors may find its balance sheet as a sense of optimism, with over $100 million in cash and a debt-to-assets ratio of 30%, which isn't considered bad for a company such as AONE. However, what are often hidden from the typical metrics on a balance sheet are the company's retained earnings or in this case it's accumulated deficit. AONE has an accumulated deficit of $774 million; in 2010 it was $391 million, therefore creating a wide deficit in a short period of time, which is a major red flag as a potential investment.

In reality the fundamentals of AONE are much worse than some investors realize and I am not sure that it can survive another year without testing these new products in the open market. The company's costs are most likely going to increase because of it now producing new cells throughout 2012, but we don't know if demand will increase. This will likely be the final run for AONE and if I were an investor I would almost expect a round of financing in the next couple months. In the past the company has been able to make its cash flow appear better than it is by positive earnings on other investing items, however this recently turned negative as well. Now that the company can't return $150 million per year through the issuance (retirement) of debt, I believe its $46 million loss from operating activities may be too much to handle, potentially not giving the company a chance with its new cells; it may give it one last chance to push the stock higher to possibly capitalize on another round of financing. My advice is simply to be careful and protect yourself with additional due diligence into the fundamentals of this company, because following my brief look, the fundamentals are not pretty.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.