Outlining the Fundamental Bull Thesis
Polar Power (NASDAQ:POLA) just closed what I think is one of the most overlooked IPOs in years. In fact, I think the company underpriced its IPO to institutional investors, only to see a lack of market visibility and a lack of understanding of its business model (by retail investors) even further discount IPO pricing; shares are flat to down from IPO pricing (as of last close - 2/10/2017). Again, I don't think buying reluctance post IPO has anything to do with Polar Power fundamentals - which, I'll illustrate, are fantastic - but more so to do with a lack of total market visibility as well as ancillary issues regarding customer concentration. Both issues, it should be noted, are being remedied in real time: the company has 1) hired IR and, more importantly, 2) deployed IPO proceeds to several strategies intended to diversify revenue streams. With Polar Power, I believe buying any dips will pay off longer term.
Polar Power designs and manufactures purpose-built DC generators. It provides modular "power boxes" that are purpose-built on a situational basis. These "power boxes" help provide power, manage power, and in some capacities, store and/or distribute power. The company's core technologies are: DC power generation, energy storage, digital control systems, system integration, and manufacturing. Polar Power can provide a turnkey solution to its customers (and to the space in general) in that it has optimized all facets of the DC power arena. It has been in business (and evolving) since 1979.
To summarize an introductory note, Polar Power has established the following competitive advantages over peers - the company is the only pure-play enterprise in the space - to which it has been able to leverage into contract wins with major telecom customers (namely Verizon (NYSE:VZ), AT&T (NYSE:T), and Telstra (OTCPK:TLSYY, OTCPK:TTRAF):
- Polar Power eliminated the starting battery;
- The company holds its products to the standard of "IP65" when it comes to sealed electronics;
- Its generators have no transfer switches;
- Polar Power has NEMA 4 Storm Resistant enclosures;
- Its generators are corrosion-resistant;
- Polar Power helps facilitate remote monitoring and control;
- The company's generators have near-zero maintenance and high reliability;
- Its generators have long life with no parts to wear;
- They are very compact;
- The generators deploy permanent magnets in design and execution to increase efficiency;
- The generators are lightweight.
As stated in the introductory note, and reiterating here, this list of competitive advantages is in no way comprehensive.
Also summarized, my primary bull thesis for Polar Power - which, it should be noted, is long-dated and should be thought of as secular - is in its internally funded growth (inclusive of recent IPO proceeds), its positioning within the fast-evolving Power Complex (including next-generation evolutions in RF, inductive, resonant, etc.), and in its ability to uniquely service a TAM large enough to continue to allow the enterprise to self-sustain (i.e. to operate into what should be growing infrastructural costs from a cash flow-only basis).
Definitively, I see Polar Power becoming a larger and larger presence in: 1) the general power-dependent physical infrastructure buildout of the US (See: telecoms like Verizon are using Polar Power's modularly deployed power boxes to expand their network capacity, using Polar Power to power tower expansion) and 2) the evolved power infrastructure buildout of the US (as Polar Power can be used on a modular and/or grid/micro-grid basis to provide primary and/or backup power to this infrastructure).
For me, on a modular, grid/microgrid basis, Polar Power provides one of the most reliable, cost-effective solutions for addressing current needs. This is based on my review of the Power Complex and my knowledge of new technology that is coming (or presumably coming via the next wave of startups) to the Power Complex. Maybe, over time, the company becomes less competitive or obsolete altogether (although, based on its history and based on what I know of management, I seriously doubt this ever happens); but right now, Polar Power is extremely competitive and far from obsolete. Asset managers looking for further information or context are encouraged to reach out to management, which has been incredibly accessible through my due diligence process.
Internally Funding Growth and Self-Sustaining the Model
While Polar Power's financial prowess starts and ends with the word "responsibility", as in responsibly growing over time and in responsibly allocating capital (the company has balance sheet retained earnings of $2.73 million as well as a history of positive stockholder equity), its steady sales growth is an excellent starting point for a financial breakout. Now, investors should keep in mind that being so responsible with growth has, in the past, led to Polar Power being growth-constrained at times (Read: Physical infrastructure constraints have limited sales growth historically, as management has been reluctant to deploy large amounts of CAPEX at infrastructure buildout); but still, the sequential nature of its growth is marvelous.
The company grew full-year sales from 2014 to 2015 by 31.6% (via EDGAR filings), inclusive of infrastructural and sales talent constraints. It should also be noted, Polar Power achieved this level of year-over-year sales growth while operating at net income breakeven (or put another way, without operating into meaningful losses), while operating substantially at operational cash flow neutrality (using just $0.06 million and $1.03 million in cash at the operational level in FY2014 and FY2015) and without deploying meaningful CAPEX (deploying just $0.2 million and $0.8 million in FY2014 and FY2015, respectively). Underlying my point regarding responsible growth, Polar Power didn't "spend" its way to growth in either year of impressive financial performance:
When taking an intimate look at a more recent time sample - dating from January 2015 to September 2016 (the last period reported by Polar Power) - the sales at the company only get more impressive. Polar Power grew 9M/2016 sales by 255% (as reported via SEC filings for 9M/2016 - in comparison to 9M/2015). It has been able to scale monthly sales to a series of higher highs, often in sequential fashion. Again, this has largely been a function of a highly concentrated customer base - led by Verizon (which I reiterate is a leading risk of any investment into Polar Power) - increasing demand and increasing reliance. While the risk of the company's customer concentration, cannot be reiterated enough, so too made clear should be the positives of such a dynamic playing out.
Polar Power's major customers, to give one example, have effectively granted the company preferred vendor status. In turn, this has provided Polar Power with increased visibility into forward-looking time periods (it warehouses a $6.9 million backlog as of 9/30/2016) - which forced the company to be able to meet forward-looking growth expectations, to come to market with an IPO. This IPO, of course executed to manage cost of capital (as equity is, effectively, a zero-cost leverage vehicle when deployed into CAPEX - as is being done in the case of Polar Power), presumably will allow the company to reach scale which it has never before been able to reach before.
Summarizing, while customer concentration (which has driven revenues to this point) has been and will continue to be a risk in the mid-term, it is this same customer concentration which will have led to the funding event which presumably will help Polar Power diversify. In fact, I believe customer concentration risk is greatly overstated in the case of Polar Power, given: 1) its increased balance sheet size post IPO, 2) the credit quality of Verizon, AT&T, and Telstra (BBB+, BBB+, and A-rated by S&P), and 3) what I believe to be Polar Power's access to credit in a "worst case" realization of customer concentration risk. While Polar Power is not yet rated by S&P, Kamakura's KRIS risk management engine implies an S&P rating of "B"; as well as Polar Power lists $5.12 million in AR, $3.6 million in Inventories, and ~$0.75 million in PP&E on its balance sheet (as of 9/30/2016), which I believe it could collateralize into an expansion of its existing First Lien credit facility. The company currently retains a First Lien Credit Facility at $2.0 million in borrowing capacity, secured by a collateral package of $2.0 million. While I elaborate on Polar Power's activity ratios later in this note, since I did mention AR and Inventories as a derisking asset for potential creditors (in providing new or expanded credit to Polar Power), I will mention that the companuy last reported a 1.52 inventory turnover ratio as well as 85 days' average collection and 38 days' average payment.
Further offsetting customer concentration risk, it is my belief that Polar Power could sell unsecured junior debt dating out as far as 2025 for as little as 5-6% (based on my extensive participation and analysis of the high yield debt markets). I believe the overstated customer concentration risk, on strictly a fundamental basis, has provided an early opening to add Polar Power exposure at a discount.
Also, notice that the company has been able to, in time, stair-step higher its margin profile (gross margins) - a result, no doubt, of higher utilization of infrastructure, a maturing sales team, higher efficacy of utilization of other fixed costs, etc. I note this in that I'd like to state definitively: Polar Power's growth (while already established as not purely a function of spending) is not a function of commoditization. The company has not driven growth at the expense (or at the catalyst) of margin. While I've attempted to illustrate this margin profile expansion via the data visuals below (primarily by way of color saturation differentials - darker equating to higher margin), I do find the margin expansion from Q1/2015 of 29% to Q3/2016 of 45% worth noting on a quarter-by-quarter basis in overt data callout:
- Quarter: 3/31/2015; Margin: 29%
- Quarter: 6/30/2015; Margin: 29%
- Quarter: 9/30/2015; Margin: 39%
- Quarter: 12/31/2015; Margin: 37%
- Quarter: 3/31/2016; Margin: 43%
- Quarter: 6/30/2016; Margin: 40%
- Quarter: 9/30/2016; Margin: 45%
Looking further down the income statement, on both a historical and an up-to-date basis, Polar Power's responsible growth and financial management is apparent as well. In taking a "three financial statement" review of the company, as all three financial statements are strategically and dynamically interdependent, Polar Power's CAPEX management program (and by way of that, it's GAAP-defined, on-balance sheet debt management) has run parallel to an OPEX management program that has been well executed. Healthy gross profit creation has been able to effectively drop down through OPEX into operating income (on healthy operating margins), as well as to net income. Investors should note that 9M/2016 operating income was 83.8% of total FY2014 revenues. It really is difficult to put into context the recent economies of scale that the company has captured, but that statistic is one I'd offer as context to prospective investors:
Even prior to reaching economies of scale - again I'd point investors to the quarterly revenue breakout data visual above - Polar Power has been able to run its enterprise at cash flow neutrality. This, in turn, has allowed it to conservatively manage its balance sheet - in not taking on substantially any debt - and to avoid punitive dilution (while operating as a private enterprise). Now, however, having achieved scale and having executed an IPO, the company should be substantially cash flow-positive at the operational level. This, of course, is all depending on how quickly management decides to deploy capital towards immediately cash flow-negative endpoints (but endpoints that, with maturation and full utilization, will presumably reach cash flow neutrality and/or cash flow positive). The general point being, Polar Power is in continuous capital productivity improvement mode and has proven it can execute through periods of low capital productivity time and time again. The company is constantly managing the next step forward (to sustain superb financial metrics and activity ratios - expressed in the data visual below).
I would also reiterate, Polar Power has retained earnings on its balance sheet. The company hasn't historically operated at a net loss, and it hasn't operated at cash flow negative on a historical basis (as evidenced by its nearly non-existent NET DEBT/EBITDA ratio of less than one half of one turn). Growth has historically been internally financed, even if on multi-year payback periods and/or on multi-year cycles of positive capital productivity.
Polar Power reported the following, as of 9M/2016 reporting (annual sales growth as well as income from operations results only reflect nine months of sales for 2016, which have been annualized compared to twelve months of sales during previous period 2015):
Given the company's financial metrics, its activity ratios, history of responsible growth, and its only just now achievement of anything of economies of scale (i.e. operating leverage at scale), I'm highly confident that Polar Power can internally fund growth (ex. IPO proceeds) for the next several years at least. Considering IPO proceeds, I see no reason for the company to turn to capital markets for either debt, credit, or equity in the mid-term. If successfully managed, I would suggest with a reasonable degree of certainty that Polar Power never need to come to the capital markets ever again. Of course, this assumption only models internally funded rates of growth - whatever those ultimately come to be; should Polar Power want to achieve rates of growth that required larger than internally generated investment - say, to further establish its defensible leadership position or at the request of a larger partner - there are scenarios in which either or all (debt, credit, and/or equity) could be turned to. Still, that the company should have access to all three avenues (for driving growth) is encouraging and substantially derisking. Again, I strongly believe Polar Power could issue mid-yielding junior debt with terms extending out as far as eight years.
Looking forward, the consensus analyst opinion is that we'll see more of the same from on the company; obviously, the case I've been making throughout this note: continued execution, continued responsible management, continued realization of operational leverage, and continued capture of economies of scale. Again, there are currently only two analysts publicly reporting on Polar Power.
Revenue and Growth:
Regarding revenue, consensus opinion is that Polar Power will grow by 82% into EFY2017 (from an EFY2016 figure of $22.95 million - which in itself is a ~235% Y/Y increase from FY2015). Further interesting, but obviously of lowest visibility and reliability, is the analyst community's willingness to model in EFY2018 revenue (which is estimated to be at $98 million). In the microcap space, $100 million in revenue is a significant investment thesis milestone - often looked to as a derisking point by asset managers, small family offices, hedge funds, etc. Often, this correlates with significant improvements in liquidity and a significantly expanded shareholder base (by count). That the company could be just seven calendar quarters away from this mark provides a sense of urgency. At the very least, this provides a reason to follow the name.
It's interesting to note that Polar Power is expected to take a step back from its breakneck pace of growth (expected to be reported for FY2016), only to return to 100%+growth rates during EFY2018. No doubt, this is the result of what are expected to be smart IPO proceed deployments by management; speaking to the initially low capital productivity expectation I outlined earlier in this note. Just to reiterate, even if management deploys IPO proceeds to immediately low capital productivity endpoints (or negative productivity endpoints) - such as sales headcount, etc. - these endpoints are ultimately expected to be capital productivity positive in time (with maturation). The analyst community, expressed via modeled growth rates, believes this low/negative capital productivity period will be just four quarters (or substantially 2017). I would agree. Still, revenue growth is expected at 82% Y/Y from EFY2016 (for EFY2017). Put simply, even in Polar Power's "step back" year (in deploying IPO proceeds) - growth rates are not unacceptable, even if sub-optimal on a three-year basis.
EBITDA Creation and Income Statement OPEX Management:
Regarding EBITDA creation, while not willing to model out EFY2018 EBITDA just yet (which I think is the conservative thing to do), analysts are expecting a doubling of EBITDA from EFY2016 to EFY2017. On an adjusted EBIT basis, analysts are expecting a doubling from EFY2017 to EFY2018 (after doubling from EFY2016 to EFY2017). Clearly, this is a function of the company's clean operational structure (i.e., top line revenues being able to drop down effectively through OPEX); which, again, is a strategically dependent function of superb balance sheet management. I reiterate, Polar Power ownership (specifically CEO Arthur Sams, who owns pro forma 59.4% of outstanding common) being willing to give up equity ownership via an IPO - in my opinion, strictly as a cost of capital optimization mechanism - is huge into being able to scale to many multiples higher without overleveraging the balance sheet and/or enterprise. I can't stress how perfectly timed this IPO was/is and how helpful the IPO proceeds should be in capturing economies of scale. Analysts are expressing this via adjusted EBITDA and adjusted EBIT breakouts.
Profitability and Shareholder Value:
Regarding profitability and shareholder value, as one might expect given what we've just broken out - both are expected to do well into EFY2018. Assuming just modeled execution - again not a stretch, given management's history of execution as well as the new tools the enterprise will be provide via the IPO proceeds - Polar Power is expected to be throwing off $1.27 in EPS on ~$12.7 million in net income by EFY2018. Obviously, investors should be able to map projection-tracking incrementally as each quarter is reported. While some could argue these projections are aspirational, I don't think given the historical financials outlined, the trend creation of the historical financials, the IPO proceeds, and the company's activity ratios that these projections are fantastical by any means. The fact is, Polar Power is the rare newly-public enterprise that came public strictly as a function of financing "productive CAPEX" (an industry term which references CAPEX already tethered to positive capital productivity). That Polar Power "financed" this productive CAPEX via zero cost of capital equity fits perfectly into the "projection narrative" being outlined by analysts covering the name. Again, I can't stress enough the strategic interdependence of all three financial statements.
Framing the Opportunity
While Polar Power is alone in being a pure player in its particular niche, there are other semi-comparable players in the ecosystem in which it operates; and while I always caution against using comparable company analysis as a standalone valuation method when perfect comparables cannot be found, I do find the above comparable set to be reliable. When using comparable company analysis to "frame the opportunity", clearly Polar Power stands out as a deeply discounted peer group opportunity. This holds true regardless of which valuation metric one chooses to scrutinize.
From an EV/EBITDA standpoint (which uses EFY2017 EBITDA as the denominator), Polar Power comes in at ~25% discounted to low-end valuation multiples (to peers). On the high end, the company could argue it deserves at least a 12X multiple given its forward-looking prospects, its recent influx of capital (i.e., its recent derisking, coupled with an influx of growth capital), the credit quality of its customers, its customers' established desire to expand business engagements (See: backlog), its ready access to capital, etc. A 12X multiple would imply a ~50% share price increase. For the record, while not taking an identical route to calling out a 50% uptick to pricing (to reset valuation multiples), Roth Capital has a current report out on Polar Power that calls for the same. Again, Roth Capital's analyst took a separate route in stating the discount.
From an EV/SALES standpoint, Polar Power appears to be relatively fairly valued to peers; however, when looking to 2018 valuation multiples, the company establishes a deep discount to this metric. It's not uncommon for infrastructure tech names to price at 12 months advanced sales (from a valuation standpoint). The company's EV/SALES EFY2018 discount is apparent, albeit requiring an investor to price at a forward-looking expectation. Still, I thought this worth pointing out. Should Polar Power price into the low to mid 2X range for EV/SALES on a EFY2018 basis - this would call for a greater-than-100% increase to share pricing. Obviously, I'm not calling for that - but I do think it is worth pointing out that if only given half credit for EFY2018 sales expectation, Polar Power would once again be coming in at a ~50% discount to peers (by this valuation multiple standard).
The entire table, in my opinion, is worth a deep analysis. Polar Power looks fantastic when analyzed next to this peer group - again, based on forward-looking expectations. For me, margin and EBITDA margin are worth some time, as these line items speak to differentiation, pricing power, ability to operate credit OPEX management programs, etc. Clearly, the company is a standout among peers in these categories. Again, I'll leave final valuation analysis to those reading this note - but I personally believe Polar Power should be pricing closer to $12.00 per share than the $8.00 per share at which it currently trades. Reiterating, while taking a separate pathway, this too is the opinion of the Roth Capital analysts currently covering Polar Power.
Polar Power is NOT without risk. For starters, it did just raise capital - capital which is setting forward-looking expectations to some degree. Should management mismanage the deployment of these proceeds, that would NOT do well for an investment in the stock.
Polar Power is, effectively, a controlled company. CEO Arthur Sams owns a substantial voting power via his ownership of shares. He alone can swing shareholder votes, and that should be taken into account from a governance risk standpoint.
This is also a technology company (at least that is how I consider it). Its technology could become obsolete, as mentioned in the introduction, or it could become commoditized. While this hasn't happened in the over 20 years Polar Power has been in operation, to simply reason by analogy (i.e., "it hasn't happened, so it never will") is to be on a fool's errand. It can happen. I don't think it will, but it can.
Finally, Polar Power does have a concentrated customer book. While "failure" is out of the question, at least in my opinion, its customers could decide to go another direction. Obviously, if they had a better alternative, my assumption is they would have already gone a different direction - but I don't know that for a fact. Polar Power, until diversified, is certainly tethered to the capital deployment decisions of Verizon, AT&T, Telstra, etc. Given how necessary the company's technology is to the expansion of each telecom partners infrastructure, I don't see customer concentration as a major risk - but it is, in fact, a risk.
Where's the trade?
I believe Polar Power to be ~50% undervalued, and I believe shares to be worth $12. Now, how quickly the company closes that valuation gap is anybody's guess, but I do believe a valuation gap to exist. The other thing I believe is that Polar Power will not be coming to the capital markets for equity anytime soon. I would welcome management to come to the credit/debt markets, as I believe the company is currently underleveraged, and that any additional leverage to reach for growth would be applauded by the public equity markets. Regardless of any speculation, though, the fact is that Polar Power can self-fund growth (especially inclusive of IPO proceeds) and has a long, long history of doing so.
I believe the company's capital productivity will remain high, despite taking a step back in FY2017, and will hit all-time highs into FY2018. This, of course, should do well for equity holders on a mid-term basis. It is my opinion that Polar Power is entering a secular bull - led by an evolution in both Power and Telecom. It can play a rare role, from an infrastructure standpoint, in both complexes. I believe Polar Power to be well positioned to continue to be a defensible leader in its niche, and I believe its niche will continue to experience sizeable growth rates into the next decade or so.
Good luck, everybody.
Disclosure: I am/we are long POLA.
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.