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Invest today in the fuel cells of tomorrow
Though profits are years away, a small subset of companies in the sector is sparking interest among investors. Here's what you need to know as the industry gets moving.
By Michael Brush
Like Al Gore, President George Bush cant lay claim to inventing the Internet. But with one small statement in his State of the Union address, Bush single-handedly seemed to create an entire technology revolution -- complete with a mini stock bubble.
As soon as Wall Street learned the president would be promoting and funding the development of hydrogen fuel-cell powered cars, a whole sector of previously ignored companies saw their shares blow through the roof. Plucky little Plug Power (PLUG, news, msgs), for instance, jumped a decidedly dot-com-like 47% in two days.
But as soon as they hit the stratosphere, they dropped right back down to earth. And thats where they remain, an already-discarded group that lost its luster virtually overnight. The problem, of course: These companies require government subsidies to support what little sales they have; most arent even close to profitable; and theres not yet much market for their services.
The funny thing is, though, there are some intriguing stock plays left to make. Even aside from the feel-good story that they really could supply a cheap, ubiquitous source of energy that leaves the environment clean and reduces our dependence on foreign oil, theres a small subset of companies in the sector that shows some promise over the next two years -- if not as big players in a soon-to-be-viable market, at least as small suppliers or takeover bait for the big fish in the energy and transportation industries.
Eight years away
Fuel cells work by producing reactions between oxygen and hydrogen to throw off electricity, heat and water. Theyre already used in space vehicles and certain military operations, plus the occasional office building where government subsidies shrink the exorbitant cost.
Its important to know that despite the Bush-generated fanfare, fuel-cell-powered vehicles wont be commercially available for at least eight years or so. The key issues: high costs, onboard storage of fuel tanks and the lack of a fuel-supply network alongside roadways.
Then theres the cost factor. For example, Ballard Power Systems (BLDP, news, msgs) supplies the fuel cell used in a new Coleman Powermate AirGen backup power system. That seems like a breakthrough until you look at the price tag. It costs around $6,000, whereas Coleman's closest gasoline-powered equivalent goes for around $200.
So why was Bush so fired up about this technology?
No disruptive technology starts out with lower costs, says Art Mannion of Sure Power, which sells power systems for buildings -- including some run by fuel cells made by United Technologies (UTX, news, msgs). Diesel and gasoline engines have been perfected and the costs have been taken out of them for a hundred years.
That reasoning helps explain why fuel cell industry insiders remain bullish even though profits are years away. I dont think it is a matter of if on fuel cells, says Dennis Campbell, the president and operations chief at Ballard. It is a matter of when it is going to happen. The news we got in the presidents speech is a huge puff of wind in our sails.
Spotlight adds momentum
But did the Bush speech really matter so much to this fledgling industry?
In a word, yes. Its not about the money -- $1.2 billion over five years for research. Instead, the presidents enthusiasm is important for a couple of other reasons.
First, he singled out hydrogen as the main energy source for fuel cells used in transportation. That may help draw the big oil companies to help build up a national network of filling stations -- exactly whats needed to get fuel-cell cars on the road. Help from the big oil companies is crucial, because theyre the ones with the money and energy market know-how to get the job done, says James Lucier, an analyst who follows fuel-cell policy in Washington, D.C. for Prudential Securities.
Second, Bushs national focus on fuel cells will help make states develop uniform standards for the sector, says Peter Hoffmann, editor of the Hydrogen & Fuel Cell Letter.
3 ways to play the fuel cell sector
With this background in mind, here are the three key ways to play this unusual stock sector:
Steer clear of pure transportation plays. Look for sales of stationary power supplies to pick up first in areas where customers are the most desperate. That might be parts of the world where electricity users arent hooked up to the main power grid. Or areas where electricity from the power companies is expensive, like Japan, California or the Northeast, says Gary Brandt, the chief executive of Hydrogenics (HYGS, news, msgs), which makes fuel-cell test equipment.
The military also is expected to serve as an important market. I think we are getting to point where costs are suitable for premium power applications like military uses where they will pay for a silent, reliable source of power, says Brandt.
After fuel cell companies have legged into these markets, fuel cell proponents say, theyll sell more and bring costs down so they can broaden out their business.
One stock to consider here: FuelCell Energy (FCEL, news, msgs), which makes large, stationary fuel cell-based power supplies used at buildings like hotels and factories. The company does a fairly brisk business selling power units to a Sheraton Hotel in New Jersey, a Mercedes-Benz factory in Alabama, as well as office buildings and data centers in the United States and abroad. To be sure, all of these sales occurred with the help of some kind of tax or state environmental subsidy.
This is the year that we are going to be moving the product from our back yard to customer sites, says Steve Eschbach, who handles investor relations for FuelCell Energy. This could be the start of where the technology takes off.
Focus on equipment providers. The equipment makers may be the first to make money off the fuel cell market. We do see a very attractive industry evolving around the supply of components and equipment, the hydrogen supply chain, says Jerry Weiland, the director of market development for fuel cells at General Motors (GM, news, msgs).
Jack Robinson, president of Winslow Management, thinks Quantum Fuel Systems Technologies (QTWW, news, msgs) will be the first fuel cell-related company to turn a profit, perhaps in two years. The company supplies energy storage tanks and fuel systems to the big automakers developing fuel cell vehicles -- including General Motors. Two other equipment suppliers are Hydrogenics and UQM Technologies (UQM, news, msgs), which sells wheel chair motors and also is developing air compressors that might be used in fuel cells.
Find opportunities in strong partnerships. Worries that the shares of cutting-edge fuel-cell companies such as Ballard, FuelCell and Plug may go to zero seem overblown -- if only because they have so many partners with deep pockets.
Ballard, for example, is teamed up with Ford (F, news, msgs) and DaimlerChrysler (DCX, news, msgs), which own 42% of the company. FuelCell Energy has allies in ChevronTexaco (CVX, news, msgs), the electric utility company PPL Corp. (PPL, news, msgs), Caterpillar (CAT, news, msgs) and a division of DaimlerChrysler. Quantum has an alliance with General Motors, which holds about 20% of the company. General Electric (GE, news, msgs) owns about an 11% stake in Plug Power.
Meanwhile, other giants have large divisions working on fuel cells -- including United Technologies, DuPont (DD, news, msgs), 3M (MMM, news, msgs), BASF (BF, news, msgs) and Siemens (SI, news, msgs). Companies such as these may be eyeing the small, pure-play fuel cell companies as a way to expand their research efforts.
The smaller companies that are more successful are more likely to be acquired by larger companies as a way of outsourcing their research and development, says Prudentials Lucier.
Follow the money
As you sift through the fuel-cell stocks, make sure to follow the money -- something some of these companies have too little of.
A company like Plug Power, for example, looks like it might have to return to the capital markets for more funding if it cant cut costs enough. The company should have about $85 million in cash after a recent acquisition goes through. It spends about $40 million a year and doesnt think it can break even until some time between 2005 and 2007.
Others may be on a little firmer ground. Ballard has $375 million in cash -- enough to last to 2007, when it thinks it can break even. FuelCell Energy has over $220 million in cash, and it burns about $50 million per year, which might give the company enough time to turn profitable without returning to the capital markets.
Hydrogenics went through $15 million in cash in the past two years, but, at the end of 2002, it had $61 million. And it expects to break even on operating cash flow by the end of this year. UQM Technologies has only $2 million in the bank. But it doesnt burn much cash because its fuel cell-related research is funded by customers.
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