Image source: Getty Images.
Any investment carries some degree of risk, but for FuelCell Energy (FCEL) -- an unprofitable company operating in an unprofitable market -- the degree of risk is considerably more substantial. With great risk can come great reward, though, so let's take a look at the three greatest risks facing this fuel cell specialist.
A lot of eggs in one basket
From the 10-K: "We are substantially dependent on a concentrated number of customers and the loss of any one of these customers could adversely affect our business, financial condition and results of operations."
How does management quantify "substantially dependent," you ask? It's 67% -- the portion of FuelCell's FY 2015 revenue contributed by POSCO Energy, a subsidiary of POSCO (PKX 0.76%), one of the world's largest steel manufacturers.
The POSCO Energy fuel cell facility in Pohang, South Korea. Image source: FuelCell Energy, Inc.
POSCO Energy's contribution to FuelCell's revenue is marginally better than the 69% it contributed in FY 2014, but looking a little further provides a different perspective: POSCO Energy (still the largest customer) accounted for 44% of FuelCell's revenue in 2011. Ideally, this number would be increasingly smaller as the company's customer base diversifies.
FuelCell's customer base woes transcend POSCO Energy. We can see another indication of how ineffectively the company has expanded its base by looking at its top three customers. Again, one would hope to find that the company's top three customers account for an increasingly smaller portion of its revenue. Over the past five years, however, FuelCell has failed to achieve this. In 2011, FuelCell's three largest customers accounted for 66% of its total revenue; in 2015, the three largest customers accounted for 86% of total revenue.
At a loss
Again from the 10-K: "We have incurred losses and anticipate continued losses and negative cash flow."
In seeking quality long-term investments, we don't pigeonhole ourselves by only beginning our search with profitable companies. Warren Buffett famously said, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." Implicit in Buffett's observation, I believe, is the idea that it's also far better to buy a wonderful company with poor profits than a poor company with wonderful profits.
FuelCell's continued losses could be tolerated if the business was picking up market share and growing its top line. Unfortunately, that's not the case. The $163 million in total revenue that the company reported for FY 2015 represents a 13.1% decline from the $188 million it reported in FY 2013.
Management says it expects to continue incurring losses until it can generate enough revenue to cover its expenses. But in the same time that revenue has dropped 13.1%, the company's operating expenses have increased 12.8%. Those are two trends that don't bode well for the company's future.
The best-laid plans
Once more from the 10-K: "Our plans are dependent on market acceptance of our products."
FuelCell Energy's vision of a profit-filled future will amount to nothing more than a pipe dream if it can't find customers to sign on the dotted line. And convincing customers to pick up their pens is no easy task -- in fact, it seems to be increasingly difficult, judging by the company's product sales over the past several years. There are two obvious green flags for the company: the first is increasing revenue from both product sales and service agreements, and the second is a growing backlog of product sales and service agreements. Between the two indicators, no green flags are flapping in the wind.
| Revenue Source | 2015 | 2014 | 2013 | 2012 | 2011 |
|---|---|---|---|---|---|
| Product sales | $128.6 | $136.8 | $145.1 | $95.0 | $103.0 |
| Service agreements | $21.0 | $26.0 | $28.1 | $18.2 | $12.1 |
Data source: FuelCell Energy 10-K. Dollar amounts in millions as of 10/31 for each year.
| Revenue Source in Backlog | 2015 | 2014 | 2013 | 2012 | 2011 |
|---|---|---|---|---|---|
| Product sales | $90.7 | $113.1 | $170.1 | $288.1 | $131.8 |
| Service agreements | $254.1 | $196.8 | $166.8 | $78.5 | $78.1 |
Data source: FuelCell Energy 10-K. Dollar amounts in millions as of 10/31 for each year.
We see inconsistent growth in every area except for service agreements in backlog. Although it appears to be at least one positive sign, remember what you learned about a bird in hand and what it's worth. Backlog means nothing if the company can't convert it to actual revenue. The growing service backlog would be reassuring if we also found actual growing revenue. Unfortunately, we don't.
The growth in service backlog does make sense, as the company often signs long-term service agreements once it sells the initial equipment. But here's the rub: It needs to actually sell the product so that it can then provide the service. The declining product sales backlog suggests that slowing growth in the service backlog is not far away. All in all, the future doesn't look very bright at this point.
The takeaway
There's risk in any investment, from the most speculative of nanocap stocks to the bluest of the blue chips. The question, therefore, is "How much risk can you tolerate?" For those considering powering their portfolios with FuelCell Energy, their risk tolerance better be pretty high. Is it possible for this stock to wind up being a lucrative investment? Sure, anything's possible. But there are significant hurdles that the company must overcome.
Diversifying its customer base and converting backlog to revenue would be good indications that the company was successfully surmounting those hurdles, but at this point, there's little to suggest that these two are anywhere in sight.
