FuelCell Energy Continues Its March Toward Profitability

| About: FuelCell Energy, (FCEL)
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FuelCell Energy (NASDAQ:FCEL) reported fiscal Q3 results last Wednesday, September 4. At first I was blown away. FCEL reported record revenue of $54 million, record gross profit of $4.5 million, and record gross profit margins. The last 3 running quarters this year has seen the gross profit margin turn from negative, to 5.5% positive, to 8.4% positive. Gross profit in dollars had a $6.8 million positive swing during this period. SG&A expenses have stayed steady around the $9.0 million range, give or take a few hundred thousand. Net loss was still not a small number at $5.8 million, but it's been coming down significantly.

Let's put this another way. Over Q2, FCEL had a $2.21 million gross profit increase on $11.26 million in higher sales while keeping SG&A expenses flat. This comes to around a 20% incremental profit margin on sales increases. Based on 20% profit margins for further increases, the $5.8 million net loss would swing to break-even or profitable with a $29 million increase in sales.

There was a deal announced shortly before the earnings release with NRG Energy (NYSE:NRG) to provide financing for potential customers. This is great news for the long term, but I have to be honest: FCEL already has an enormous backlog ($380.8 million), so finding more customers is not exactly a worry for me at this time. Production and filling their backlog is my focus, though I wouldn't be surprised if NRG, being such a large and successful company, is able to help FCEL along in other ways as they stand to make some nice coin on the deal. From the PR:

"The co-marketing agreement announcement with NRG Energy, the largest independent power producer in North America, leverages our resources and is expected to lead to meaningful order flow," said Mr. Bottone. "The agreement includes a power purchase agreement model for customers that prefer a pay-as-you-go option whereby NRG Energy will own the power plant and sell the ultra-clean power and high quality heat to the customer."

Expect FCEL's already large backlog to get a lot bigger.

Now let's turn to the conference call for further clues. FCEL is currently operating at 70 megawatts. Around 1/4 in the call you'll find this:

We expect our margins to continue to expand at the 70-megawatt annual run rate due to continued manufacturing efficiencies and cost reduction and then expand even further with higher production volumes and a favorable sales mix. We are well positioned for continued global growth and to achieve profitability on an EBITDA basis, with annual production volumes of approximately 80 megawatts.

This means two important things. One, management expects continued profit margin expansion with the current run-rate they already have. Two, they are looking only a 14.3% increase in megawatt production to profitability (on an EBITDA basis). I estimate interest and depreciation at about $2 million in total from the 10Q so my estimated EBITDA for the quarter was around negative $3.8 million. This means gross profit needs to swing from $4.5 million to $3.8 million higher or $8.3 million on the 14.3% increase in sales. This would put gross profit margins at 13.4%. Though it wasn't repeated in this particular call, the 13.4% is in line with statements made in the previous call, specifically:

The business model has us in double-digit, low-teens margins as we get to that 80 to 90 megawatts of production volume

Although there's certainly risk and uncertainties with a not-yet-profitable company such as FuelCell Energy, management continues to meet its goals they have paved the path to profitability. Increased sales, increased margins, consistent overhead, high incremental margins, and improving margins for base sales are all necessary goals that are needed to be achieved for FCEL to reach profitability within the volumes stated. If any one of these components fails to materialize as planned, profitability will not be reached when expected, and the stock price may drop as a result. If these goals are met and profitability is achieved, I believe FCEL will hit the radar screens of alternative green energy fans everywhere, and the shareholders will be well rewarded. Good luck to all FCEL investors.

Disclosure: I am long FCEL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.