Plug Power: Consider Selling The Rally

Summary:

• Plug Power Inc.’s shares have declined by 40% since the last article, but rallied on news of a $1.66 billion loan for hydrogen production plants.
• The company’s high cost of ownership and maintenance issues with its PEM technology hinder profitability.
• Plug Power’s aggressive expansion strategy and inability to turn a profit raise concerns about its long-term viability.

Investment Thesis

Since our last article on Plug Power Inc. (NASDAQ:PLUG), its shares have declined by 40%, until today’s rally on news of a $1.66 billion loan designated for six new hydrogen production plants. We view this as a prime exit opportunity for those who missed our previous warning.

The loan is designated for hydrogen production, mostly to supply PLUG’s GenDrive customers under long-term contracts. While building these plants gives PLUG more control over the hydrogen supply chain, maintenance issues persist. This vertical expansion is unlikely to boost profit margins enough to push PLUG’s gross margins into positive territory.

The Core Issue

The Proton Exchange Membrane “PEM” technology underlying PLUG’s product offering, from GenDrive, GenPro, and GenSure to electrolyzers, suffers from a fundamental flaw: High Cost Of Ownership.

GenDrive and GenPro are hydrogen fuel cells installed on vehicles to replace a battery power source. The GenPro is relatively new compared to the more established GenDrive product line. PLUG also sells stationary power generation fuel cells branded as GenSure.

For the past decade, PLUG has fueled its growth by subsidizing its customers through unprofitable long-term contracts that cover maintenance and hydrogen fuel (referred to as GenCare and GenFuel).

The key issue is heat, which causes erosion, wear, and tear, requiring periodic replacements of various parts of the fuel cells. Additionally, high production and maintenance costs and a lack of hydrogen infrastructure drive up the total cost of ownership, making PEM technology less economically viable. Management’s pitch for the past decade rested on the premise that as the Hydrogen economy scales, the infrastructure cost will decline. However, with rapid advancements in Solar, Wind, and Battery technologies, the productivity and cost gap has widened, with Hydrogen fuel cells lagging far behind.

To encourage sales growth and wide adoption, PLUG has historically sold its products and services at a loss to match the unit economics of Solar, Wind, and Battery alternatives.

Lately, PLUG attempted to renegotiate these unprofitable contracts, but these efforts haven’t been really successful, as mirrored in the company’s negative margins. Corporations like Amazon (AMZN) and Walmart (WMT), which PLUG touts as customers, base their purchasing decisions on broader sustainability goals, including carbon footprint reduction. There are many alternatives to achieve these goals, such as using electric vehicles (“EVs”) or sourcing electricity from utility companies using Solar and Wind power.

Contradicting Strategies Lead to Losses

PLUG continues to expand its manufacturing capabilities, with six new Hydrogen Production plants expected to be funded by the DOE loan. This is in addition to a plant in Louisiana currently under contraction and two recently completed plants in Georgia and Tennessee. Other capacity expansion projects include its Gigafactory in New York, which produces stacks for its Fuel Cells and electrolyzers. The company also acquired the manufacturing operations of Applied Cryo Technologies, a manufacturer of cryo containers for hydrogen storage and transport.

However, this excessive capacity expansion contradicts the current management’s stated focus on targeting selective, profitable clients, which are pretty rare. This misalignment is reflected in a 42% YoY revenue decline in Q1. Making things worse is that this revenue decline is coupled with a massive increase in fixed costs associated with the new capacity, further deepening PLUG’s negative gross margins. For example, the company lost $67 million on Fuel Cells and Electrolyzers sold in Q1 alone. The company’s pipeline of future fuel cells and electrolyzer systems deliveries for the next 12–24 months is valued at $359 million, most of which are contracts signed before management’s decision to focus on profitability, making it highly likely that it will incur significant gross losses on these systems.

The Hype of Hydrogen Production

PLUG entered the electrolyzer and hydrogen production market in 2020 with the acquisition of Giner ELX and United Hydrogen. Four years on, the company still struggles to turn a profit.

In Q1 24, the company lost $59 million, delivering $18 million worth of hydrogen to its customers. This eye-watering figure is actually an improvement from the same period of last year when PLUG incurred $54 million delivering $10 million of Hydrogen. Still, these figures show that, even with the $3/kg green hydrogen Inflation Reduction Act (“IRA”) subsidy, PLUG’s hydrogen production business remains deep in the red, challenged by technical issues that hinder its competitiveness compared to other energy sources.

Recent policy changes further complicated PLUG’s ability to capitalize on the Inflation Reduction Act subsidies. The new regulations stipulate that the electricity used for hydrogen production must come from sustainable sources to be eligible for the $3/kg benefit.

Power Purchasing Agreements

During Q1, PLUG generated $18 million in revenue from Power Purchase Agreements (“PPA”), where clients only pay for electricity generated from PLUG’s systems. Producing the contracted energy from its Fuel Cells cost the company $55 million, with a gross loss over double the revenue generated during the same period.

While this is an improvement from the previous quarter, where the gross loss was 4.5 times the revenue, it still highlights significant issues, notwithstanding that one quarter doesn’t make a trend. PLUG has been promising profitability for decades, which remains elusive to this day despite a meaningful increase in scale, supporting our hypothesis that PLUG is yet to resolve the core productivity problems with its products. To make its PPA profitable, the company needs to lower the costs of power production from its fuel cells. This could involve increasing uptime, boosting energy output, or reducing maintenance expenses.

PLUG must address these issues urgently. Over the next 5–10 years, it needs to finance $420 worth of PAAs. Based on current figures, this could result in over $840 million in gross losses if no improvements are made.

Balance Sheet

In its recent financial statements, PLUG added a “Going Concern” notice, indicating a risk that the company might go bust within the next 12 months. The company added that with plans to issue more shares, it might be able to remain liquid. With shares rallying 50% today on the news of the DOE subsidized capacity expansion loans, this could be a perfect time to exit.

The company ended the quarter with $172 million in cash, supported by the issuance of $305 million worth of new shares in Q1, weighed against $167 in operating cash outflows.

Given PLUG’s tight liquidity position, high operating cash outflows, and conditions tied to its $1.66 billion loan – (specifying its use for new capacity expansion), we believe that PLUG will aggressively capitalize on the recent rally to issue more shares.

Summary

Plug Power Inc.’s aggressive expansion strategy, persistent high costs, and inability to turn a profit raise serious concerns about its long-term viability. Despite the recent rally and margin improvements (possibly temporary) in Q1 ’24 financial statements, the company’s core issue remains unresolved, as manifested in its negative gross margins.

The recent $1.66 billion loan from the DOE is conditioned on increasing production capacity, which further contradicts management’s stated focus on targeting selective, profitable clients, a nearly impossible feat given the divergence of the unit economics of hydrogen fuel cells with other sources of energy. The impact of PLUG’s excessive expansion of slowing growth has led to a reversal in the gross margins of its Product sales in Q1.

With a tight liquidity position, PLUG will most likely aggressively issue more shares to remain solvent, making the recent rally a unique opportunity to exit.

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Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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