Could Plug Power Be Massively Undervalued?

Plug Power (NASDAQ: PLUG  ) investors have had a very good year:

PLUG Chart

PLUG data by YCharts

Shares are up over 13-fold on the news of major new orders from Wal-Mart for 1,700 fork lift fuel cells and six-year service contracts. This helped to raise Plug Power's backlog from 1,400 units to 3,700 units. Recently FBR analyst Aditya Satchare issued an $8 price target, based on projected 10% fork-lift market share and $200 million in annual revenues by 2017. 

Those sales projections represent a 700% sales increase in just four years and have some analysts predicting Plug Power can achieve profitability in 2015.

Mrs. Satchare's price target reveals her view that Plug Power is 41.5% undervalued -- at least based on these growth expectations. 

However, the key to such an analysis is whether those growth expectations are reasonable. As I'm about to explain there are very good reasons to believe not.

The problem with Plug Power

PLUG Chart
PLUG data by YCharts

Fellow Fool contributor Lennox Yieke recently wrote an eloquent bull case for Plug Power. His argument was that Plug Power is doubling its sales force in an effort to strongly grow sales and that its recent acquisition of ReliOn would make it independent of competitor Ballard Power Systems (NASDAQ: BLDP  ) from whom it sourced its fuel cells, resulting in long-term cost savings. 

However, there are three reasons I must respectfully disagree with these arguments and recommend against investing in shares of Plug Power: accelerating dilution, accelerating costs, and a small potential market.

First, though its order count is growing, Plug Power has a worsening history of diluting shareholders faster when sales are growing. For example from 2009 through 2011 Plug Power increased sales 133% from $12 million to $28 million. The share count rose by 46% over this time. 

Since 2011, the share count has increased 1,050% while sales for this year are projected to increase 164% since that time.

Plug Power's fundamental problem is that to achieve its immense growth potential it will need cash, a lot of it. The ReliOn acquisition may prove to have long-term cost savings, however Plug Power purchased it for just $4 million. This indicates that ReliOn was a small time producer of fuel cells and if Plug hopes to source its fuel cells away from Ballard Power Systems, it will need to invest large amounts of capital into ReliOn. Thus, at least in the next few years, Plug Power's margins are likely to drop, not improve, as it massively grows its business.

This could result in Plug being an excellent growth story, but a terrible long-term investment. Consider that since 2010 Plug Power's market cap has increased 750%, yet its share price is down 37.5%. That's a result of dilution, and Plug Power's track record is to print massive amounts of shares to raise capital, often at 50+% discounts to market value.

Another problem with the long-term bullish argument for Plug Power is the size of its potential market. The recent analyst upgrade estimated the forklift market at $2 billion/year but I've seen estimates of the equipment handling market as high as $4 billion.

In order to justify the kind of long-term growth estimates I quoted above, investors in Plug Power have to assume three things:

  • Plug Power's potential market will grow substantially.
  • It will grow its market share.
  • It will stop raising capital by selling shares.

It is a chicken and egg problem. Plug Power can't stop diluting shareholders until it can become profitable but it can't become profitable without raising more money, all at the expense of existing shareholders.

Foolish bottom line 
Plug Power's track record thus far seems to be that the faster it grows the faster it issues shares. This will make long-term earnings growth high enough to justify the existing share price difficult if not impossible. Therefore I recommend against investing in Plug Power, at least until the valuation comes down and the company can prove its ability to grow without obscene amounts of shareholder dilution. 

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Read/Post Comments (4) | Recommend This Article (11)

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 July 21, 2014, at 8:36 AM, ICanFool wrote:

    ReliOn is a money pit. Plug Power bought a dead company. ReliOn is Noway a company like Ballard. Cutting off Ballard is suicidal for PLOG Power. Only ignorant Fools will believe that PLUG can live without Ballard IP portfolio. Smart Money bets on Ballard. Plug Model is good, but if ballard chooses to get into ForkLift Truck business, pay attention. Ballard's focus to make the fuelcell stacks cheap and the Best makes PLUG proponents little arrogant and that is not good.

  • Report this Comment On July 21, 2014, at 10:34 AM, StillBill65 wrote:

    PLUG. I own it. It replaces batteries. Half the cost of the forklift unit is scrap metal for weight. What excites me is the potential uses of the technology. OTR refer units for trucking, rail, and shipping containers, get my drift. Yes, I understand all the stuff PLUG has to overcome to be profitable (sarcasm) . What if fuel cells are made with copper or aluminum instead of silver. What if the 2008 PRIUS My wife drives and loves didn't have all that battery to drag around, What result will that have on the cost of fuel and mileage. And for you Greenies what's it do to the carbon footprint of the afore mentioned PRIUS without the batteries or pump gas. Plug is a long shot, what isn't. Bill

  • Report this Comment On July 21, 2014, at 1:13 PM, kingofromania wrote:

    An investment rule that has served me well. Never buy stories, always buy earnings. PLUG might be the next GMCR, but not yet. If you want to buy a story stock, buy one that has positive earnings growth.

    $5 stocks are $5 for a reason. Only 6% of PLUG is owned by institutional investors. At $5/share many funds won't even look at a stock.

    If you subscribe to the greater fool theory, money might be made on a trade, but why risk your capital on this when there are better alternatives?

  • Report this Comment On July 21, 2014, at 2:39 PM, AdamGalas wrote:

    Another way to apply long-term valuations to speculative growth stories is to look at the potential market.

    For example, PLUG's market is $4 billion right now. Assuming they can eventually achieve 25% market share that's $1 billion in annual sales, say 10 years from now. Applying a generous p/s of 2, that gives a market cap of $2 billion.

    That is a 150% profit over a decade or 9.6%/year.

    The capital asset pricing model is a useful way of valuing risky stocks like PLUG.

    required return= risk free return+beta(market return-risk free return)

    This formula gives you a minimum required return that compensates investors for the risks of inherently risky companies such as PLUG.

    Risk free return=10 year tresuries=2.55%

    market return= 1983-2013 compound annual growth rate total return =9.2%

    beta for PLUG is 1.09.

    According to this formula PLUG needs to deliver at least 9.8% long term returns to compensate for its higher risk.

    It seems at first that it might meet the hurdle, since I calculated a 9.6% 10 year return above.

    However, when one considers the track record of PLUG then the math comes out against the company.

    For example, the above calculation assumes no dilution over the next 10 years.

    In reality, for PLUG to be able to scale up ReliOn enought to achieve even a fraction of the growth I'm projecting, it would need to massively raise capital, meaning huge dilution.

    Based on the most recent 2 years, with its 11.5x dilution, reasonable dilution estimates could range anywhere from 5 fold to 20-30 fold.

    Even assuming a low ball 400% dilution over the next decade, that would mean a share price 50% LOWER than today's.

    Thus it seems PLUG's long-term potential simply can't justify an investment anywhere near its current valuation.

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