Capstone Turbine Needs a Montage

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If you love '80s movies, you know that one of the best parts of those films is the montage. It generally involves watching a down-on-his-luck character train really hard in eccentric ways until he's ready to win a big karate match or an arm-wrestling tournament. It's a great plot device, because it can help to condense what should be months of practice into what's basically a two- to three-minute music video.

Unfortunately, we don't get montages in real life. If we did, I'm sure that investors in Capstone Turbine  (NASDAQ: CPST  ) would want one, to watch the slow march toward potential profitability in short order.

Getting over the top
Investors who have followed this company know that it's been a slow and arduous process to try to get quarterly income into the black. At least the company is consistent: This past quarter, it posted yet again another loss, continuing its streak of losing money every year since its public offering in 2000. Many investors have hung on to the company through thick and thin, thinking that its superior co-generation technology would be enough to bring it to profitability. But it looks as though 2012 marked a time when investors finally started to lose patience, as shares of Capstone suffered an almost 30% haircut in the past year.

CPST Chart

CPST data by YCharts.

If there's one encouraging sign to come from this loss, it's that the company is still heading in the right direction. This quarter saw only a per-share loss of $0.01, another uptick from a $0.03 loss year over year. Capstone also posted its first double-digit gross margin ever this quarter. Thanks to these kind of trends, analysts estimate that Capstone can finally expect to reach profitability in 2015.

Sources: Capital IQ, authors calculations

If the company can continue down this path and reach management's stated goal of 35% gross margins, then profitability should follow.  

You're the best around
One of the reasons the company has had such a hard time reaching profitability is its industry. As a manufacturer of co-generation turbines, the company is in a space dominated by industrial giants General Electric (NYSE: GE  ) , United Technologies' (NYSE: UTX  ) Pratt & Whitney Division, and Caterpillar (NYSE: CAT  ) . The offerings for each company feature incredible efficiency ratings -- Caterpillar's co-generation engines rate the highest, with a 96% efficiency rating.

What makes Capstone unique, though, is that it's able to build a co-generation turbine at a small scale and run on multiple types of fuel, something that none of its competitors can claim. This makes Capstone a much more viable option for smaller-scale power needs, such as commercial and residential markets. What's keeping the company from breaking through in the market, though, is that most Capstone products sell at a 30% premium to the competition. The company has gone to great efforts with its distributors to emphasize that the lifecycle costs with its products outweigh the premium paid, but in some cases it just hasn't been enough to justify the sticker price.

Capstone has also gone to great lengths to foster better relationships with one of its best customers: remote oil and gas drilling operations. Since the company's turbines are able to consume several different types of fuel, they can be very handy for powering drilling operations that are off the grid. In the past two years, oil and gas exploration has gone from 25% of sales to more than 66% for the company.

Not only are these products selling in the U.S., but shale gas plays around the world are also taking notice of the benefits that these generators can provide. Today, Capstone sells its products in multiple countries in South America, Europe, and Asia. With oil and gas exploration still growing at a rapid pace in the U.S. and abroad, it's likely that Capstone could find a very strong demand for its products from this customer base.

Here I am, not rocked by the hurricane
Hurricane Sandy, which caused billions of dollars in damage in New York and New Jersey, was quite possibly the greatest unintentional advertising campaign Capstone could have ever asked for. All but one of its turbines remained fully operational throughout the storm. With more recent storms in the Northeast causing several hundred thousand power outages, it's likely that people will look to other forms of power generation for their electricity. And in the wake of Sandy, the New York State Energy Research and Development Authority just announced a multimillion-dollar initiative to encourage the use of co-generation systems. Several of Capstone's products fit the criteria for the initiative, so it's possible that Capstone could see a large boost in critical power systems sales thanks to this initiative.  

What a Fool believes
There are still a lot of ifs in the Capstone story before the company will see profitability: if Capstone can continue to court off-grid oil and gas operations, if it can keep up its cost reduction plans to increase margins, if it can build out a stronger distribution network and warranty service. A lot of pieces need to fall into place.

That's not to say it's impossible, though. The momentum, albeit slow, is on Capstone's side. It's probably going to take longer than a montage to get there, so investors who have hung on for the ride will need to hold tight for a bit longer before they see any profits from this company.

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Read/Post Comments (3) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 13, 2013, at 9:58 PM, ae37 wrote:

    Maybe in another article, could you look into

    Denver Colorado's order for 36 new electric buses

    that will have Capstone Microturbines?

    and if other cities across the nation or the world may also be interested

    thank you

  • Report this Comment On February 15, 2013, at 11:36 AM, JmvFwiw wrote:

    Hi Tyler,

    As an investor I have indeed been frustrated by what I feel is the biggest apparent failing of the company, and I have voiced this to them. It is their poor 'retail' marketing - i.e., presence in the 'retail' market. The marketing does not reflect the de-centralizing potential of the product - which represents a great engineering accomplishment, but the company sells the product like engineers - not marketers. They need to create interest and demand from the ground level. Sure, oil and gas 'plays' are accretive to revenue, but many small businesses, light mfg, etc. etc. do not even know about them. For instance where is their presence on YouTube? - where many companies build appeal - for free! They should consider using 'Madison Avenue' expedients to generate (npi) 'retail-level': interest, possibility thinking, and eventual demand of product on the part of what is now b/c internet - the AVERAGE person who is in business, and has friends and associates in business who could use this product - instead of the old-school 'power and oil/gas ind. "focussed" approach. Do you see what I am saying? Cause they don't seem to get this. It just seems obvious to me. thx for any comment.

  • Report this Comment On February 15, 2013, at 1:22 PM, stevariffic wrote:

    Hello Tyler,

    I agree with JmvFwiw that a restructuring of the way this technology is thought about has to happen in order for Capstone to be successful. I'm not sure that GE's partial unofficial stake in the business, isn't to keep this business under control since to me they could've had a 'blow out' product at this point.

    I believe a retail demand could be generated by bundling this product with HVAC installations on a per home basis, with a smart switch that would go to the cheapest source of electricity. This capability would put the local power companies in competition with the natural gas companies and healthy competition could form in this industry. I'm sure there are technical hurdles to overcome, but these are minimal. This isn't rocket science, so I'm very skeptical of Capstone at this point as having an executive team that knows how to exploit the potential of its technology.

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