Are Capstone's microturbines losing steam? Source: Capstone Turbine
Capstone Turbine (CPST) has probably gathered more skeptics this year than it ever had. The stock has plunged 53%, as of this writing, over just the past six months, leaving investors wondering whether the company's future has any promise left. With the microturbine maker showing no signs of profitability yet, and management misjudging at nearly every step, is it game over for Capstone Turbine?
What triggered the slide in the stock price
Capstone started 2014 with a bang, flooding the market with announcements of several new orders that it received from markets across the globe through the first quarter. Investors were quick to join the euphoria -- Capstone stock nearly doubled by mid-March, even hitting its five-year high.
And then the tides turned.
A scathing article at Seeking Alpha valued Capstone Turbine stock at a quarter of its then share price, sending investors scurrying for cover. While the author's argument made little sense, it was enough to trigger panic and send the volatile stock tumbling double-digits in just the last week of March. Before investors could recover from the blow, Capstone Turbine dropped two bombs at one go: a dilutive stock offering with a dismal set of preliminary numbers for the financial year that ended March, 2014.
The mess keeps getting messier
Capstone's annual earnings report raised several questions about the way the company is being managed. To begin with, Capstone's revenue grew only 4% in financial year 2014, making it the slowest such growth in seven years, as shown in the graph below.
Annual Revenue Growth. Source: Capstone Turbine Management Presentation, August 2014
It came as a surprise, given Capstone's swelling order book and backlog value. As if that wasn't bad enough, Capstone reported a 4% decline in revenue for the quarter through June, blaming it on "delayed shipment requests" from customers. Since a growing top line is essential for a company that's yet to turn a profit, Capstone's decelerating pace of sales growth is nothing but ominous.
Ironically, management continues to hope that investors will overlook Capstone's slowing revenue growth and instead pay attention to its growing backlog as it hopes to "make up the first quarter shortfall in revenue" over the remaining quarters this financial year. The question is: How can investors believe this given management's recent short-sightedness? Not only did Capstone fail to break even on its earnings before interest, taxes, depreciation, and amortization, or EBITDA in Q4 as projected, it also fell short of its gross margin projections. The company ended Q4 with 17% gross margin when management was projecting 21% margin until the third quarter.
Capstone's shareholder-unfriendly practices
Investors' woes don't end there. Capstone managed to shrink its net losses by 28% to $16.3 million last financial year, but it also burned cash at an alarming rate, ending the year with only $27.9 million in cash versus management's projections of a $33 million-$36 million cash balance.
And here's the scariest part: Capstone appears to be running short of capital to even run its day-to-day operations – It sold shares worth a net of $30.2 million this past May to raise proceeds for "general working capital requirements." That's a double whammy for existing shareholders, because every sale of shares by the company also dilutes their wealth. Sadly, secondary equity offering has become the new-normal for Capstone.
CPST Average Diluted Shares Outstanding (Annual) data by YCharts
While you can see how substantially Capstone's outstanding share count has increased over the past few years, the above graph also shows how the company has been able to offset consistent negative free cash flow by financing its business with regular share offerings.
The big danger you might be unaware of
Aside from cash issues, few seem to have noticed that on several occasions Capstone has failed to comply with covenants attached to its revolving credit with Wells Fargo. For instance, the company failed to meet the annual net income covenant as of March 31, 2014. While Capstone managed to get a waiver from Wells Fargo as well as obtain additional credit of $5 million (taking its total credit to $20 million), investors should know that Capstone has pledged most of its asset base, including equipment, inventories, accounts receivable, and patents, as collateral with Wells Fargo.
That's perhaps the biggest red flag for any investor, since any default on Capstone's part will give the lender a right to seize all those assets. Meanwhile, the covenants substantially restrict Capstone's growth options.
It's a gamble
Capstone's multi-fuel microturbines have great potential, especially as economies across the world shift focus to energy saving and emission reduction. Unfortunately, that promising future has been overshadowed by management's sloppy estimates, weakening top line growth, unhealthy balance sheet, and equity dilution.
If anything at all, Capstone stock's recent plunge has made one thing clear: Investors are losing faith, and convincing them will become more difficult until the company turns a profit.
