The Long Case for Capstone Turbine

Capstone (CPST) develops and manufactures fuel agnostic (gas or liquid: Low Pressure Natural Gas, High Pressure Natural Gas, Compressed Natural Gas, Diesel, Gaseous Propane, Kerosene, "Sour" Gas, Landfill Gas, and Digester Gas.) microturbines for commercial and industrial use. Their turbines range from 30 kilowatts to 1 Megawatt. For reference, 1 MW will power approx 250 homes or a good sized office building.

Capstone was started in 1988 and originally planned to concentrate on smaller turbines, using their patented air bearing technology, to develop power for the hybrid transportation market. 

The company went public in 2000. The previous management team built an expensive, expansive, state of the art, US based, manufacturing facility with robotic welding equipment and sophisticated software systems, and consequently, the business is currently faced with high fixed costs that have kept the bottom line in the red despite significant top line improvement.

Under the new management team, the business focus has shifted to providing more powerful, energy efficient, emission reducing, cost controlling equipment to many different, larger, end markets. 

Those markets include:

1. The oil and gas industry:  Capstone sells their turbines for use on offshore oil & gas rigs. The turbines reduce costsas they require very little maintenance. Service is needed after 40,000 hours of operation whether it’s intermittent or continuous.  In addition, the flared gas that is usually wasted can be used to fuel the turbine, reducing power costs.
   
2. Large retailers, hospitals, schools, office buildings: Capstone's turbines can be used as either a backup or a primary power system. It can be used for combined heating and power or combined cooling heating and power (currently used in the downtown Manhattan Marriott and at least one midtown Manhattan office building as primary power).This offers a cost reducing, environmentally friendly, reliable, alternative or co-generation power solution.  As a backup power solution, Capstone's turbine replaces a bulky, diesel powered, environmentally unfriendly, backup system that needs to be carefully maintained because of all its moving parts and needed lubricants.  Capstone's turbine has one moving part, and because of its frictionless air bearing, does not require any petroleum based lubricants or any coolants. 
   
3. Digesters and landfills: Methane gas is normally wasted/flared off.  Installing a Capstone turbine that can run on the methane reduces costs and pollutants.

Bottom line is that Capstone is an under-followed small cap clean technology play with a new, highly qualified management team, proprietary technology, and an attractive fixed cost structure that will become highly profitable as it penetrates end markets that face rising energy costs, grid constraints, and environmental concerns.

Lastly note that Capstone most recently reported a cash balance of approximately $43 million, revenue up 60%, and a backlog that increased 458% yoy.

Disclosure: Author holds a long position in CPST

Comments

[R A F]

Excellent article. Capstone appears to be on the verge of benefitting from all the factors you have outlined and analyzed.

[weiwentg]

In FY 07, Capstone reported negative free cash flow of $22m, and negative operating cash flow of $21m. operating income was -$39m, and sales were $24.1m, for an operating margin of minus 162%. in other words, they were losing money on every sale. but hey, at least they're going to be making it up in volume!

[User 216914]

Capstone is a company which when first became public was way ahead of its time. They are supposed to break even by December. They've had orders come in left and right. Capstone controls approx. 80% of the Microturbine market and is always looking for new innovative ways to improvce their product. A few years from now Capstone may even be a household name.

[notsosmart]

i took it as a loss.at least it was a help that way.

[Zenfar]

Love Capstone, it is great to see a company dig in and come back. It really is in so many markets and is one of the hidden green gems.

[Stockguy456]

Capstone has a lot of potential!!!!!!!! Long CPST

[edhaq$]

Excellent article!This gives a lot of the info that I need.The important issues are 1.the high quality of the product. 2.timely applicability. 3.patented technology. 4.absence of competition from a comparative product I believe 5.the focus on high energy costs and the green movement among others.Its great to get in now because later this stock could get too expensive or gains will be substantially smaller when it becomes better known by traders and analysts.

[Marilyn T]

Remember when WMB was .50/share? People will be saying that about CPST next yr and the yrs to come.

[User 219379]

It would be of great importance to have capstone generators
installed at all fuel service stations that could use the fuel that
is sold . This will make everry service station in the many power outagges a reliable fuel fillup station.

[BUST1765]

CAPSTONE MICRO TURBINES ARE A CULTURE UNTO THEMSELVES AND A VERY SPECIFIC SEGMENT OF THE POWER INDUSTRY. REMEMBER "GUNS ARE FOR HOLDIN AND RIFLES ARE FOR SHOOTIN" TURBINES ARE NOT RECIPROCATING MACHINES. WHILE THE USERS OF TURBINES MIGHT BE THE SAME -THE TECHNOLOGY IS TOTALY DIFFERENT AND CALLS FOR IN DEPTH FAMILIARITY BY THOSE THAT DEAL WITH IT. STILL CAPSTONE JUST APPOINTED A DEALER WITH 60 YEARS OF RECIPROCATING EXPERIENCE AND LITTLE EXPERIENCE IN COMPARISON IN TURBINE TECHNOLOGY - THIS SHOULD BE INTERESTING IN THE LONG RUN. COULD BE LIKE TAKING A TRACTOR TO A GO CART EACE, I WONDER WHAT ELSE CAPATONE IS THINKING ABOUT.

[CPST1]

The article should mention that Capstone turbines are used in the transportation (mass transit) industry.

If you want to install a unit (new or used) globalmicroturbine.com is a good online source.

[mikejb]

saw article of big brush fire in chadsworth, ca where the company has its facility. do they have their own pure comfort system for heating cooling and electricity free of the grid to run their facility. just incase the fires burn down the electrical poles, and the same for earthquakes?

[me2]

Have we not said "WE" need to get away from our dependency of oil! Are not we and them looking for alternatives. So what happens to Capstone when we finally do start using other energy sources? Should I worry if I hold Capstone?
All it takes is one good breakthrough in an alternative energy and Capstone is down for the count!

[B+ve]

One technology can kill another one. The only way to keep ahead of the competition is INNOVATION. Capstone was incepted as an innovative technology of micro turbines and thrives on innovation. It seems they have improvised on their existing strengths and have an excellent nose for the customer tastes. The 1MW product will swipe the market and is an ideal generator for Oil and gas as also the 'Building' residential use. I see Capstone rising in its market in the years to come. The Question is - how well will they keep up with the growth rate. Good Luck to CPST.

[longtermstocks]

Great article, I am also long CPST.

[whoknows tma]

I would urge anyone seriously considering a purchase of cpst to read the financial statements. This company loses $2 for every $1 of revenue, it has lost $220,000,000 since 2004, lost $9M last quarter, and only has $50M in equity, half of which is machinery and equipment. It's current liabilities are $6M higher than last year, and its curret assets are down $21M. That is how the $40M in losses for 2007 were covered. It continues to sell stock and lose the stockholders money. It had 85M shares out in 2004- now 148M. Equity has dropped from $115M in 2004 to the current $50M -- I was put onto CPST by a friend, looked at the financials, and I am surprised that anyone would even consider buying this company. Personally, I would not buy it, and I urge anyone looking at a CPST investment to study the financials and ask yourself how this company is going to continue to lose money at this clip and stay alive -- you cannot lose $2 for every $1 of revenue and last long. Yes, the technology is attractive and probably a very good long term project, but if this company cannot keep finding stockholders to invest in supplemental public offerings so CPST has more cash to lose, it will cease to exist in the very near future.

[whoknows tma]

Correction -- on the above post, I said the company loses $2 for every $1 of revenue -- I should have said that the company spends $2 for every $1 of revenue -- it spends $60M to produce $30M in revenue. It is losing about $9M per quarter, or about $36M per year, and that is about equal to its annual revenue.

[Malanthus]

This company is low on cash and has stated in its conference call that it may have to turn to a bank loan, or a line of credit. If that fails, a secondary offering may be in the picture.

That being said, it is the tier 1 player in this space. No one else can touch its technology. One of its biggest obstacles has been its high fixed costs as the author mentions. They are however ramping up production, they have recently added a partial second shift and have hinted at a further ramp up. Listening to the companies conference call last quarter will reveal that CPST has been in direct talks with its parts suppliers to ensure that they will be able to ramp up production in order to meet their increasing demands.

Capstone's key to profitability is to increase the volume of its sales. People who claim CPST loses $ for every turbine they sell and then go on to claim that if they sell more turbines they will lose more money are completely ignorant of how fixed costs work. Or are blowing smoke up your bum for their own agendas.

Look at it this way, CPST has in place a sales team, an R&D team, a shipping team, a management team, a manufacturing team, offices around the world, parts/supplies etc etc. These all account for costs that, regardless of whether CPST sells one turbine or 150, the company will have to pay for. If you increase production using the same listed resources above, you would only have to increase spending a small percentage to cover increased labor needs and increased parts/supplies. All other costs will remain the same. So lets say CPST had produced 150 turbines, they double their workforce and now are producing 300 turbines. They have doubled their revenue while the costs of the operation more or less remain the same, only increased by the labor and parts increase. So the outcome results in better margins per unit.

As this is pretty basic accounting, and everything that I mentioned is pretty much layed out in their latest CC. I would imagine that some posters are trying to shake some shares out of the retail investor community by using scare tactics. I have seen a large spike in the "bashing" chatter on several message boards, Yahoo's especially.
I am just saying do your own DD before listening to what someone on a message board tells you.

This is definately a speculative stock with risk, but its also a diamond in the rough with a foothold in a lot of market. If they can make it through this rough patch, it should really shine in the long run.

Best of luck to all.

[whoknows tma]

I have no agenda. I have no position in this stock, and have not had a position in CPST for many years. I looked at it as a long position, and I am simply cautioning anyone interested in this stock to look at its history and the financials. The number do not lie -- here they are from the etrade site:
Total Revenue
2004, 2005, 2006, 2007 2008
12,607 16,968 24,103 21,018 31,305
Total Operating Expense
61,446 58,088 73,323 60,034 69,633
Operating Income
(48,839) (41,120) (49,220) (39,016) (38,328)

Revenue almost tripled in 5 years, and they moved operating loss from $48 million to $38 million annually. This company currently has $50 million in total equity, (half of which is equipment and machinery so the real number is probably more like $25 million) so it is set to lose its entire net worth over the next 12 months. Order backlog is up, which indicates that its overhead structure is not as deep as the previous post implies (if it has a deep overhead structure capable of increasing revenue with minimal incremental overhead increases it should be able to keep up with orders, revenue should be up, and backlog down). Since it is increasing order backlog, it is clear that the argument that it has massive production capability without increasing incremental overhead is questionable. Look, if you want to buy the stock, buy it. It was $0.98 a share a year ago, it made it to $4.40 June of 08 and at $2.5 August 08 there is a chance that news of a large order, supplemental offering, borrowing relationship, etc., will send it up towards $5. But there is also a very realistic possibility that it will revist the sub-$1 price it was sporting in August of 2007, and it may go down from there. My point is that this is a very risky investment and anyone looking at a long position on this stock should seriously look at the numbers.

[whoknows tma]

As a follow-up to the incremental revenue argument, compare 2006, 2007, and 2008. Revenue dropped from 06 to 07 by $5M, and the operating loss decreased by $10M. But from 07 to 08, revenue increased by $10M and the loss stayed flat at $39M annually. The idea that this company has a track record that supports the claim that increased revenue will result in a corresponding decrease in operating losses is questionable, and since it has only $50M in equity left and is losing $9M per quarter, even if it is true does it have the legs to get there?

[whoknows tma]

September 26, 2008 - unfortunately for the longs, my prediction one month ago is coming true -- the stock just hit $1.17 and looks like there is more down. Be careful.