Fuel Cells - Investors Getting Carried Away
smartmoney.com
WHAT A YEAR for energy stocks. As utility bills soar, the share prices of traditional power providers such as Duke (DUK) and PPL (PPL), and power-plant builders like Calpine (CPN) and Dynegy (DYN), have been positively electric. The Morningstar Electric Utility index is up nearly 33.5% since the beginning of the year.
Of course, investors are never satisfied until they've scoured every square inch of a hot sector in search of sleepers. Now, they're exploring the outer fringes of the energy world: fuel-cell companies.
Fuel cells are devices that chemically convert fuel, such as natural gas or, better yet, water, into electricity. Investors are betting that people will start looking to fuel cells as a complement to the giant fossil-fuel-burning power plants that produce the vast majority of America's power.
The result: This tiny niche boasts some of the hottest stocks around. H Power (HPOW), the newest publicly traded fuel-cell builder, is up nearly 117% since its initial public offering in August. Rival Plug Power (PLUG) is up 66% year-to-date, and at one point was up 455%. Ballard Power Systems (BLDP), which makes fuel cells for cars and other applications, is up 234% on the year, while FuelCell Energy (FCEL), which concentrates on commercial and industrial markets, is up 721% this year after another big pop Tuesday. No, we didn't forget a decimal point.
It looks like investors might be getting carried away. Most fuel-cell companies, while offering great growth potential, still don't have marketable products. In fact, the earliest product to hit the residential market will likely be H Power's — and that won't happen for at least another year. And since most of these companies have no products — and hence no earnings, you can't look for price-to-earnings ratios as a valuation guide. And profitability likely won't visit this subsector until the middle of the decade.
Nonetheless, fuel cells are awfully promising. They provide a reliable, environment-friendly power source that can be as small as a minirefrigerator. The quick science: fuel cells extract hydrogen from an existing fuel source and chemically recombine it with oxygen to produce electricity, with heat and water as the sole byproducts. Auto makers have high, if distant, hopes for the technology as a nonpolluting replacement for the internal-combustion engine. But the current market fervor mostly surrounds companies that aim to develop fuel cells for stationary applications. Fuel cells seem particularly attractive for rural electricity customers far from main power lines, and companies, particularly tech-related firms, that plunge into chaos anytime there's a power failure.
Utilities are intrigued by fuel cells because they're small and cheap — unlike the huge power plants they've built to deal with power shortages, which can run at half capacity when power's plentiful. Fuel cells also kill the need for power lines and towers in rural areas with few customers — transmission grids that often cost utilities $50,000 per mile to construct.
H Power, which sold some fuel cells to the New Jersey Department of Transportation in 1998 to power highway signs, is now targeting rural homes — and investors are rewarding it handsomely for its efforts. Since going public Aug. 8 at $16 a share, H Power's stock has been lightning in a bottle, going as high as $34.69 before closing Tuesday at $30.56. Its current price-to-sales ratio: 459. Again, no forgotten decimal points.
Bullish investors say H Power should be judged on its future revenue prospects, not its current sales. The company has already signed a deal with Energy Co-Opportunity, an association of electric cooperatives that serve about 14 million customers, to market fuel-cell products on an exclusive basis. The deal could lead to sales of $81 million over 10 years, writes CIBC World Markets analyst Hugh Holman, who predicts the company will break even in 2003.
But H Power is still about a year away from entering the residential power market. When the product is ready, it'll cost about $8,000 per home to install for the first couple of years, says Bob Gibson, of Energy Co-Opportunity. Utility companies must then decide whether to ask customers to pay for fuel cells, or to eat the upfront expense themselves with an eye on long-term savings. Moreover, fuel-cell power, at least initially, will cost several cents more per kilowatt-hour to generate than power from a traditional plant, according to Energy Co-Opportunity, which predicts it'll likely take three to four years for prices to moderate. Memo to utility companies: Power customers probably won't pay $8,000 up front for the privilege of buying more expensive electricity.
Another company that's had a wild stock-market ride is Plug Power, H Power's main rival in the residential power market. Its shares soared from $27 in early January to $149.75 on March 10 before falling back to the $40s in August when Chief Executive Gary Mittelman left the company. (Plug is still searching for a CEO.) Plug faces the same market problems H Power does, and Lehman Brothers analyst Maureen Murphy predicts the company will burn through more than $100 million in cash a year until it reaches profitability in 2005. Needless to say, this is about as speculative a stock-market play as you could make.
At some point, of course, investors will start caring about earnings. Because of the ever-changing electricity industry, it's tough to determine which fuel-cell companies, if any, will be long-term winners. Like all electricity-related companies, the prospects for the fuel-cell market largely depend on how electricity deregulation pans out.
Moreover, the fuel-cell market faces stiff competition from a bunch of other power alternatives, including microturbines, which run off natural gas, and pack enough punch to power a neighborhood or big office complex. Young microturbine producer ActivePower (ACPW) has already teamed up with Caterpillar (CAT) to help market the technology.
Fuel-cell producers also face some competition from solar energy — yes, it's still around — and from traditional power producers, who could look a lot better to consumers when prices fall back to earth. And keep in mind that, as with all new technology, fuel cells could quickly be replaced by another as-yet-unforeseen technology.
The result of all this: CIBC's Holman, who's high on H Power, warns investors to expect the stocks of H Power, Plug Power, FuelCell Energy and Ballard Power Systems to fluctuate even more than the broader Nasdaq market for some time to come.
A less risky investment in the fuel-cell business could be United Technologies (UTX). The diversified company, which builds everything from elevators to air-conditioning units, made fuel cells for the Apollo space missions, and is now developing new cells for buses and even larger power customers such as hospitals, hotels and airport terminals. Last week, the company said it expects $1 billion in revenue from fuel cells by 2005 and $4 billion by 2010.
The fuel-cell market's prospects are bright in many ways. But investing in these stocks now is like putting a 75-watt bulb on a 30-watt fuse. It's intensely bright now, but don't be surprised if you suddenly find yourself sitting in the dark. |
