Plug Power (PLUG)

Rating: OUTPERFORM
Price (10 October 2022, US$): 19.90
Target Price: 28.00
52-Week Price Range: 12.70-46.50
Market Cap (US$M): 11.5B
Shares Outstanding: 579.28M

​10 October 2022
Americas/United States
Equity Research
Electrical Components and Equipment

Plug Power: Solid Q2 FY22 and Tremendous Catalysts Ahead

Figure 1 — Plug Power's Stock Performance Over the Past Year

•  Q2 Results: Plug Power reported solid Q2 results on Thursday, with revenue jumping to $151.3M from $124.6M in Q2 of FY21, representing 21.4% YoY growth. $56 million of this revenue jump is due to new product offerings. The net operating loss was $173.3M from $99.3M in Q2 of FY21, but this was largely due to both the impact of COVID-19 on international supply chains and inflation due to a worsening macroeconomic situation. Estimated earnings per share have historically been higher than actual earnings per share (-0.16 estimated vs. -0.27 actual in Q1 of FY22, -0.21 estimated vs -0.3 in Q2 of FY22).
• FY22 Guidance: Plug Power reaffirmed its FY22 guidance of $900-925M of revenue, with 80% growth YoY. Gross margin, up 11% YoY, still sits at -21%; however, a lot of the COGS in the recent quarter (roughly $300M) is due to recent purchases of electrolyzers, fuel cell applications, and stationary power. Additionally, the company believes it's positioned to reach $3B in revenue by 2025 and 30% margins by 2024. Though they have Common Equity/Total Assets at 71%.
• Catalysts: 1) Validation of 3MW stationary power demo unit with Microsoft represents a pivotal point in the company's story, opening the gateway to a potential $40B+ market opportunity. They are expecting delivery in 2022 of 20-25 MW, and an estimated 200-250 MW shipments in 2024. 2) Electrolyzer sales have already hit a backlog due to sharp demand, an order of 1GW by H2 order is the largest to date, and this could eventually contribute to $15 billion sales funnel. 3) The Inflation Reduction Act (IRA) bill is a major catalyst, specifically with the Clean Hydrogen Production Tax Credit, enhancing Plug's leadership in the green hydrogen industry given its first mover advantage. It will provide a tax credit of $3.00 per kilogram per green hydrogen and is available to any facility before 2033. This will help with capital formation, recycling of capital, and back leveraging. In previous experience, solar and wind became scalable capital assets. The IRA also extends 30% investment tax credit for fuel cell application until 2024 and tech-neutral credit beyond 2025. This will contribute to improved plant payback by 4 years and incremental cash flow of $500M per year at 500TPD (tons per day) by 2025, and 1000TPD by 2028.
• My target price sits at $28.00 is based on FY22 EV / EBITDA multiple of 16x and FY23 EV / EBITDA multiple of 14.7x. vs. median peer company multiples (i.e., Hubbell, Regal Rexnord Corporation, Generac Holdings, etc.), of 13.8x and 12.6x. Given Plug's revenue growth potential, currently negative but hopefully 30% margins by 2025, and subsequent EBITDA growth, I believe Plug is trending well but their high multiple must be justified through good subsequent earnings reports in the coming 5-7 years. This however, has become far more likely after the passage of the IRA, which will help with paying down PP&E. My DCF analysis with long-term FCF projections suggests that Plug will have negative levered cash flows for the foreseeable future. Discount rate is 7.0% due to high inflation, and the inverse relationship between interest rates and inflation rates.

Figure 2 – Plug Power Historical and Projected EBIT/Revenues Calculation

• My model illustrates that earnings before income tax turn positive by the year 2025, when Plug expects the brunt of its revenue stream. With the IRA and Clean Hydrogen Production Tax Credit, PP&E loans and short-term debt can be repaid much quicker due to the generous tax laws.
• Q2 Results: The company announced results just below the lines of market expectations. Notably, the surprise was just 40%, compared to a surprise of 120% YoY.
• Negative Margins: Plug suffers from negative margins that give it a negative EBITDA. Recent quarters hope to reverse that trend. The company is in a tight spot due to macroeconomics and recent capital expenditure jumps that invest in electrolyzers.
• Outlook: The Microsoft product approval combined with a jump in electrolyzer sales could push Plug ahead of consensus estimates; with a supply-constrained process, Plug is at a competitive advantage to expand into new market frontier. Furthermore, PTC and more market share through the TPD metric may secure its dominance in the electrical components and equipments industry.

Figure 3 — Before tax, the return on invested capital is slated to reverse directions as early as 2023, in my model. 

• ​​ROIC is expected to reverse in 2023 due to increasing EBITDA/EBIT, as covered in Figure 2. 
  • Cost of Goods Sold: Because of the production tax credits from clean hydrogen found within Biden's new Inflation Reduction Act, many expenses can be trimmed or even brought to zero with this game-changer policy deal for Plug Power. The 6 months ending mid-FY22 showed $157M in investing activity from Purchases of Property, Plant & Equipment.
  • Volume of electrolyzers and stationary power demo units: With a backlog due to excessive demand for electrolyzers and the recent breakthrough with Microsoft, Plug can expect a tremendous increase in the amount of product purchased. Its first-mover advantage and market share dominance guarantees its win over the addressable market ($15B and $40B+, respectively). 
  • Increased tons per day (TPD) nationwide: Currently below 70 TPD, Plug envisions reaching 1000 by 2028. This remarkable potential growth makes Plug a solid LBO candidate by 2023-24, when its pre-tax ROIC turns positive, its cash flows are hitting higher numbers, its margin is positive, and its growth potential is still far from its peak — it will likely reach this point in the early to mid-2030s.

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Figure 4 — The bar graph below denotes the value promised by the tax credit across Plug Power's product lines.

• Q2 Outlook: This explains how in its entirety, Plug Power will obtain more value than lose value following the tax credit.
• International: 60% of Europe's purchasing power is located within 300 miles of Plug's green hydrogen facility in Antwerp, Belgium. This would
  
  • boost volume by guaranteeing more demand and therefore revenue for Plug Power
    
  • cut on PP&E expenses by building the facility in a central location, reducing COGS and contributing to higher EBITDA and lower multiples.

Figure 5 — This bar graph illustrates the revenue breakdown of Plug Power: the vast majority are fuel cell systems, followed by services performed on them, fuel delivery, and finally power purchase agreements.

Valuation

• My target price of $28.00 is based on a mixture:
  • Multiples: FY22E EV / EBITDA of 16x and FY23E EV / EBITDA of 14.7x, both just around comparable public companies (13.8x and 12.6x)
  • DCF Analysis: The base case, with a 7.0% discount rate (WACC/cost of capital), beta = 1.2, and a 2% terminal growth rate, left me at an approximate valuation of $28.00. A sensitivity analysis is provided in Figure 10.

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Figure 6 — The model illustrates a DCF waterfall model approach, claiming that $50.93 is a fair value metric. 

• Estimate Risk: This brings up the fact that my calculation of $28.00 falls below the boundary condition between undervalued and the 'about right' range. This estimate is conservative in nature, assuming 50% revenue CAGR YoY without any improvements between 2022-2028. 
• Current Share Price: With a current price of $19.90, there is nearly 50% upside when considering the long-term levered FCF and the present terminal value of the FCF.
• Methodologies Choice: The multiples method is out of favor here, with no other hydrogen fuel cell technology on the market; Plug Power is the first-mover and the monopoly, and so its value depends on its ability to capitalize on the addressable market. Hence, DCF and the waterfall method seems most logical.
• Leadership: Andrew Marsh — CEO of Plug Power — has previous experience as a CEO dating back to Valere Power between 2001-2007. He then took Plug Power from concept to commercialization and has helped drive revenue up 300%. 

Comparable Companies

Figure 7 — The charts below show Plug Power in the leftmost column, alongside comparable companies on the right-hand side.

Figure 8 — The graph below illustrates the sharp rise in owners' equity in the years 2020 and 2021. This was the the time of the "meme" stock bubble and growth stock rally, which ultimately culminated in a major crash in 2021 that has carried into 2022.

• The equity compared to the other companies varies heavily; there are nearly 600 million shares, compared to similarly valued companies reaching just 60 million shares.
• This rise in equity has enabled Plug Power to make various purchases of plant properties and more general capital expenditures throughout its business value chain. 
• Notably, long-term debt is consistently going up; this must be paid off effectively using the FCF and especially when the pre-tax ROIC flips positive in FY24.

Figure 9 — The Income Statement below illustrates my financial model; EBITDA turns positive in 2024 and EBIT turns positive in 2025.

• Some of the assumptions in the financial model used above and the Excel spreadsheet are shown below:
  • The sales or revenue growth rate is constant at 50%
  • The COGS/Revenue reduces from 130% in FY22 down to 100% in FY23 and eventually 75% in FY28.
  • Depreciation is lowered throughout the projection to reflect the IRA's tax credit. This should pay off significant portions of the outstanding debt.

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Figure 10 — This is a Plug Power DCF Sensitivity Analysis. It compares Terminal FCF Growth Rate to the Discount Rate, or cost of capital (WACC). 

Investment Thesis and Risks

My analysis indicates that Plug Power remains undervalued and that a reversal in the pricing trend could occur in the next year due to the following reasons:

• Supply-Constrained: With booming demand in the new electrolyzer business and the recent approval of their joint product with Microsoft, Plug Power remains a leader and first-mover in the hydrogen fuel cell business. They are receiving orders from company clients, and are backlogged by purchases from competitors (including H2 energy for 1.5GW). 
• Increased Tons Per Day Nationwide and in Europe: Plug Power processes roughly 50 TPD (tons per day); by the end of FY22, they expect to be at 70 TPD and end of FY25 they project 500 TPD, and end of FY28 they hope to reach 1000 TPD. This will increase free cash flows by 2200% over the next six years. This increases terminal value, enterprise value, equity value, and therefore the implied share price. 
• Cutting Costs: With the passage of Biden's IRA, the clean hydrogen production tax credits will save on PP&E costs (which numbered $158M in the first 6 months of FY22). As denoted in Figure 4, the benefits will give Plug Power a competitive advantage over other energy companies in the long-run, similar to how wind and solar became widespread to compete against oil and gas.
• OPEC's Price-making Strategy: 90% of oil is held by nations in OPEC. The United States is not part of it, but regardless, by hiking up oil and gas prices by cutting supply (i.e., reducing supply b 2 million barrels a day), other clean energy options will be favored. This presents Plug Power as a legitimate option.
  

My targeted share prices are as follows:

• Bull Case: $32.00, based on sharper increases in TPD (90 TPD by FY22), many new international contracts to build plants by FY22, and more than expected >1 GW company orders
• Base Case: $28.00, based on expected increases in TPD (70 TPD by FY22), more international contracts to build plants by FY22, and same rate of >1GW company orders
• Bear Case: $24.00, based on lower than expected increases in TPD (55 TPD by FY22), no new international contracts to build plants by FY22, and reduced demand for electrolyzers and Microsoft prototype

Investment Risks

The following presents the greatest threats to my investment thesis:

• Reduced Demand from Company Clients: With Plug Power currently being backlogged with many existing orders, it's possible that clients might opt for different companies and/or build their own hydrogen solutions. Given the IRA, they have far more incentives to figure out how to produce hydrogen themselves. This would not allow revenue to reach to consensus estimate of $950 million by the end of FY22.
• Regulations from EU/Less International Contracts: If the EU decides to enforce harsh rules against American company manufacturing, this would significantly reduce company margins — preventing Plug from achieving their goal of 30% operating margin by 2024. However, this seems unlikely, but is something to be wary about. Something also concerning is not gaining any new international contracts; this would negatively affect volume and economies of scale, but Biden's IRA would not apply here and so this is one benefit.
• Macroeconomic Woes: If inflation does not subside, the cost of goods sold could remain high below ever reducing. With Biden's IRA, it's beneficial for Plug to purchase more plants to fit the criteria for the $3.00 per kilogram of green hydrogen. However, the cash flows from investing capital would be disproportionately high relative to pre-2021 inflation rates. This high COGS paired with any of the above scenarios would make it a challenge to see Plug Power make a consistent annual profit, let alone hit a margin of 30%.

Generally, some other investment risks include but aren't limited to (1) new entrants into the hydrogen fuel cell space (2) Biden's IRA also stimulating other forms of clean energy into the market (3) ability to flip a profit and keep costs down as they are in their expanding stage (4) regulation delays in the EU, malfunctions in prototypes with test cases not accounted for (5) loose handling over Plug's intellectual property if executives or engineers leave (6) suppliers cutting ties with Plug or hiking up their prices, leading to higher COGS.