Be Very Careful When it Comes to FuelCell Energy

The clean energy revolution has arrived, and investors are gobbling up clean energy stocks left and right, often times without regard for valuation. This emerging dynamic has left many obscure, clean energy stocks – who have gotten caught up in the hype – trading in severely overvalued territory. One such overvalued, over-hyped clean energy stock is FuelCell (NASDAQ:FCEL) stock.

Over the past year, FCEL stock has risen 10-fold, from a 30-cent price tag in summer 2019, to a $3 price tag recently.

Why?

Because investors are growing increasingly optimistic that, amid a broader push toward clean energy generation, FuelCell’s hydrogen fuel cell (HFC) power plants will see significantly greater adoption across the U.S. and globally over the next decade.

This optimism is not misplaced. FuelCell will grow by leaps and bounds over the next several years.

But this optimism is priced wrong.

FuelCell is not worth $600 million today, and FCEL stock does not deserve to trade at $3. Instead, my numbers suggest the stock is worth little more than a buck.

Here’s why.

FuelCell Is Bound for Big Growth

The FuelCell growth narrative is simple and straightforward enough.

The shift away from dirty, polluting legacy energy generation – such as coal and natural gas – and toward zero-emission, clean energy generation – such as wind, hydrogen and solar – is underway.

Domestically, legacy coal and natural gas energy generation peaked in 2007 at roughly 2.9 trillion kilowatt hours. Since then, it’s decreased by 13% to 2.5 trillion kilowatt hours. At the same time, renewable energy generation has increased by more than 100% over that stretch, from 353 kilowatt hours in 2007, to 720 kilowatt hours in 2019.

Still, at 720 kilowatt hours, renewable energy generation in the U.S. represents just 17% of total energy generation. That share is bound to expand to 20%, 30%, 40% and higher over the next 10-plus years as both the public and private sectors attempt to reduce their carbon footprints. That implies huge growth potential for the clean energy generation space.

FuelCell finds itself smack dab in the middle of that space, with over 59 clean-energy HFC power plants across three continents. This includes a 6.5 megawatt plant at Pfizer‘s (NYSE:PFE) R&D facility in Groton, Connecticut.

The simple idea is that as the clean energy revolution accelerates throughout the 2020s, FuelCell will win a lot more power generation contracts and become a sizable player in the market.

Supporting this bull thesis is the rationale that FuelCell is a leader in HFC power generation. This is a unique vertical that is highly flexible and reliable (unlike solar or wind, it does not depend on external factors in order to produce energy, and therefore, storage is not a problem).

All in all, it is quite likely that FuelCell is on the cusp of huge growth over the next decade.

Small Market and Margins Dim FCEL Stock

The problem is that FuelCell’s growth prospects are overstated in the current FCEL stock price.

This big problem really breaks down into three smaller problems.

First, HFC power generation is and will remain niche. Fuel cells accounted for just 810,000 megawatt hours of energy generation in 2016. That represents 0.02% of the total energy generation market in the U.S.

Part of the reason for this niche adoption is that HFC power plants aren’t truly zero-emission. They still produce a lot of carbon dioxide. A new technology called carbon capture could help this problem. But for FuelCell, this technology remains in the concept and testing phase.

The other reason is that cleaner energy generation sources – like solar and wind – are starting to develop their own storage techniques, thereby eroding the reliability advantage of HFC power.

Thus, for the foreseeable future, FuelCell projects to remain relatively niche, even in a world where clean energy generation is everywhere.

Second, FuelCell’s profit margins are scant. Gross margins have hovered between negative territory and 7% over the past few years. Management has hinted at the fact that 15% to 20% is the highest gross margins could ever get at scale.

Scant gross margins on niche market growth prospects imply limited profit production potential in the long run.

Not Enough Growth to Warrant the Price Tag

And that brings us to the third problem. The profit growth prospects here are limited.

Even if FuelCell grows revenues by nearly 10-fold to $500 million by 2030, a 20% gross margin on that plus a $50 million opex base gets you to just $50 million in operating profits.

Take out $10 million in financing costs. Take out 20% for taxes. You’re left with just $32 million in net profits.

Throw a utility sector-average 18-times forward multiple on that. You’re talking about a potential 2029 valuation for FuelCell of less than $600 million.

In other words, the fundamentals say that FuelCell could be worth $600 million in a decade –not $600 million today.

Indeed, if you discount that back by 10% per year, you’re looking at a 2020 valuation of about $250 million.

Based on the current fully diluted share count, that translates into a FCEL stock price just over a buck.

Bottom Line on FCEL Stock

The mainstream emergence of the clean energy revolution has sent all clean energy stocks to the moon.

Some of these stocks will sustain their current strength. Think Tesla (NASDAQ:TSLA). Or Plug Power (NASDAQ:PLUG).

Others won’t.

FuelCell is one of those that won’t, because of limited market potential, scant profit margins and an already extended valuation.

To that end, I say fade the rally in FCEL stock. Sure, the stock can and may go higher so long as clean energy hype persists. But hype – regardless of form – never lasts forever.

Once this hype does fade, FCEL stock will come crashing down. Prices closer to a buck aren’t unlikely.