Do You Think That the Run on FuelCell Energy's Shares is Over? This May Make You Think Again

Fuel cell stocks have pretty much have received one label since the major surge started by Plug Power (PLUG -3.16%) a few months ago: Overvalued. When stocks go up as high as Plug's and others' did is such a short amount of time, it's really easy to say that. There may be one exception to that notion, though, and that's FuelCell Energy (FCEL). Despite the company's shares being up over 180%, the premiums to pay for shares in this company aren't as great as you might think.  Let's put some numbers on paper to see what a long-term investor could actually expect from this fuel cell manufacturer.

FuelCell Eenrgy's 300kW fuel cell power generator (Photo source: FuelCell Energy)

What are we talking about?
Since fuel cell companies are quite diverse in what they do and what market they try to capture, it is important to know what FuelCell is after specifically. Unlike Plug Power, FuelCell isn't looking to build hydrogen fuel cells for small scale power uses that can replace batteries. A more accurate way to think of FuelCell is as a power generation equipment manufacturer. The smallest fuel cell the company produces is large enough to provide power to 150 homes. It also generates revenue through service contracts on its products, which today represent a little more than 10% of total revenue. 

These fuel cell generators are generally used as combined heat and power systems, which allows them to attain efficiency levels of greater than 85% while producing much less CO2 emissions than traditional combustion-style systems. The challenge for FuelCell Energy, though, is the higher upfront costs associated with the installation of these systems. FuelCell's most direct competitor, Capstone Turbine's (CPST) natural gas fired turbines, cost about 20% less than a comparable FuelCell system on a per kilowatt basis. However, the cost per Kw is coming down pretty quickly for FuelCell, and a 30% tax credit from the federal government helps as well. 

What do you get from a share of FuelCell?
For years FuelCell has lost money, which is understandable considering the company has been developing a pretty advanced form of energy generation. Since the company's creation it has accumulated a deficit of $781 million, most of which it has covered with paid in capital and equity issuance. In fact, it wan't until 2012 that the cost of sales was less than its revenue. Since the book value of the company is so small -- about $27 million, with a market cap of greater than $600 million -- and the company doesn't generate any EBITDA, the only real way that we can evaluate the company is through sales growth and its price to sales ratio.

This is quite possibly one of the most surprising parts of FuelCell. Despite shares being up over 180% over the past year, shares are still rather modestly priced at a price to sales ratio of 3.23. Not only is this well below the price to sales metric for most of its peers in the developing energy technology space, but it's not that far off of the aggregate price to sales ratio of the S&P 500, which stands today at 1.7.

Source: S&P Capital IQ

Based on these figures, it might signal that investors are concerned that FuelCell will struggle to grow its sales over the next few years. According to S&P Capital IQ, though, the company is expected to more than double its sales between now and 2016.

Source: S&P Capital IQ, author's calculations

Granted, to grow sales at a compounded annual rate of 33% over the next few years, a lot of things need to go right. One encouraging sign that sales are headed in that direction is that sales between 2010 and 2013 have grown at an annual rate of 39%. So it's not too much of a stretch to think that this kind of sales growth is possible. 

Looking into the tea leaves
There are two ways you can invest in a company like FuelCell: Try to play the short term surges in share price and hope that you get in and out at the right time, or buy and hold for years as the company grows. Both have certain risks involved, but when buying and holding over the long term we can more safely assume that share price will grow in conjunction with the business. 

So let's break down what that would look like over the long term. The following presentation is a forecast of sales that the company would need to achieve over designated time periods to make returns of 12%, 15%, 20%, and 25% based on its current price to sales ratio, if price to sales were to expand to its peers excluding Plug Power (5.64), and if price to sales were to compress to the level of the S&P 500.

Fcel valuation from Tyler Crowe

These numbers are not necessarily harbingers of what will happen, but they lay out what kind of sales numbers investors should expect over the long term. It's a rather crude method of forecasting, but without earnings or even EBITDA to speak of, there aren't many other methods. Based on these figures, even if the price to sales ratio were to compress on the way to the S&P average, it would take a compounded annual sales growth of 28% for shareholders to achieve a return of 20% annually. Even more surprising, though, if price to sales margins were to expand to the levels enjoyed by its peers, then it would only take 18% annual sales growth for a 25% return. That is even less than the expected industry growth over that period. 

What a Fool Believes
Remember, though, these are only crude projections, and lots of things would need to go right for FuelCell to see share price returns as great as these. Not only would the company need to significantly grow its manufacturing capacity -- the company will actually need to start making money at some point. Then again, the same can be said for just about every fuel cell manufacturer out there. While it is rather difficult to put a price on the shares of a company like FuelCell today, it is actually still rather modestly priced in comparison to its peers. If the company can execute on hitting sales targets and start to generate a profit by 2016 as analysts anticipate, then FuelCell Energy's shares may have some pretty substantial upside potential.