Fuel Cells: The Latest Fad? What You Don't Know About Fuel Cell Stocks
Note: Thoughts of fuel cells becoming widespread in homes and autos helped push up fuel cell stocks recently, although the sector now appears to be in a sell wave (See David Poxon's recent special technical analysis report on fuel cell stocks). But could a fuel cell in every car and house be just around the corner? For his perspective on the practicalities of this happening, StockHouse asked its Canadian research advisor, Warren Shiau, who closely follows the auto industry and has worked as the chief financial officer of a construction materials company serving the housing industry.
Toronto, ONT, October 4 /SHfn/ -- Fuel cells are a technological marvel. But there are sizeable obstacles (noted below) to their widespread adoption in homes and cars for the next decade, and perhaps longer.
While stock prices for some major fuel cell companies such as Ballard Power Systems [BLDP] and Plug Power [PLUG] are well below their 52-week highs, their P/E multiples, and multiples for the sector in general, are still extremely high. They are so high that there is no fundamental justification for them. As in any sector where share prices have run-up on simple enthusiasm and momentum, there will at some point be a day of reckoning.
Driven by the belief that fuel cells will revolutionize the huge conventional heating and automobile engine markets, fuel cell stocks continue to trade at excessive valuations. Ballard's market capitalization to sales ratio is around 240; Plug Power's is around 114. If, instead of losing money, each company had a profit of US$0.01 per share, the price-earnings multiples would be easily in excess of 3,500. Other fuel cell stocks that are still near their highs are at even more excessive multiples.
But despite the lure of cheap hydrogen "burning" power with only water-vapor exhaust, the fuel cell revolution isn't about to happen anytime soon. When the market comes to this realization, fuel cell stocks will be in for a rough ride--just like broadband, Linux and wireless stocks ran-up and then fell down.
The short-term prospects for widespread fuel cell adoption--and hence sales and profits--are not particularly good, even if the long-term potential of fuel cell technology is great. "We are [not] all going to be humming around in hydrogen-powered vehicles anytime soon. Even the most enthusiastic fuel cell proponents estimate the transition will take from 20 to 40 years," says respected technology magazine Red Herring.
Less enthusiastic observers predict the time frame will be longer: "My guess is that hydrogen will not reach the same level of acceptance in the transportation industry as oil until 2050," says Karl Jessen of consulting firm Yankee Group. The chairman of the Fuel Cell 2000 conference, Peter Faguy, says: "The public [fuel cell] focus has been on cars, but the cost is a huge issue. We have to lower the cost of just about every component."
Even if component costs are brought down to acceptable levels, mass auto industry use over the short-term is unrealistic. There is currently no new mass production automobile platform under design or planned for that incorporates a fuel cell "engine." Given auto industry design-to-production timetables, this indicates all new mass production cars and trucks introduced over the next 10 years, at least, are going to be conventionally powered.
Auto manufacturers' research and development (R&D) spending also fails to indicate mass adoption of fuel cells any time soon. The oft-cited $1-billion-plus investment by Daimler-Chrysler [DCX] for long-term funding of Ballard's R&D pales in comparison to what Daimler-Chrysler, Ford [F], GM [GM] and other major auto companies are spending on developing conventional gas and diesel engine technology. In fact, R&D spending and forward product plans indicate there will be a significant shift not from gas to fuel cell auto power over the next 5 to 10 years, but from gas to diesel.
Should fuel cell cars make the leap to mass production, there is no guarantee they will sell. There are many extremely well-developed, stylish, sophisticated, high fuel economy, low/zero emissions, duel fuel, hybrid or electric vehicles on the market. They do not sell in volume. What sells is exactly the opposite: Ford Expeditions, long wheelbase minivans, Chevy Tahoes, 1/2-3/4 ton pickups.
As for mandates requiring certain percentages of cars sold within a state to be zero emissions, these have not proven to be etched in stone. Instead they have been pushed back when the automakers have been unable to reach the numbers. It does not particularly matter whether a state mandates that 10% of new cars sold within its borders be zero emissions if the mandate is simply pushed back when the automakers cannot reach the 10% target.
Fuel cells face a similarly difficult situation when it comes to achieving mass sales for home heating use. Widespread adoption of fuel cells for residential housing may happen over the long-term, but is highly unlikely over the next five to 10 years. Any expectation of rapid short-term fuel cell sector sales and profitability growth from housing is most likely unrealistic.
First, there is the question of obtaining product certifications for residential housing use. Evaluation bodies will not issue certifications for prototypes--the fuel cell companies will be required to provide final production units from their actual manufacturing plants, not from their R&D departments. After they are able to do this, the certification process itself will likely take from one to two years and will apply to products on an individual basis rather than to fuel cell heating units in general. Without certifications, volume housing market sales will be impossible.
Even with them, the volume sales may be a long time coming. When the fuel cell companies get their products through engineering approvals and certifications, they will still be faced with several difficult problems to overcome--problems that involve growing from R&D companies to companies with the infrastructure to manufacture and sell product.
It is likely the evaluation and certification bodies will impose a restriction that only certified, trained installers who are either direct employees of the fuel cell companies, or who have been trained by the fuel cell companies, install the heating units. So the fuel cell companies are going to have to know construction as much as they know fuel cells.
Then the issue of why contractors will want to install fuel cell heating units will have to be addressed. Residential developers will not pay contractors any more to install a fuel cell "furnace" than to install a regular furnace. If contractors can make just as much money installing a natural gas furnace, there is no incentive for them to install fuel cell units.
This is a real issue that has always held back progress in the residential construction industry. Concrete block construction is inefficient, expensive and of inferior quality to almost all alternatives. Yet it is still a very major type of construction method because contractors do not always make more money using the alternatives.
For similar reasons, it may be very hard convincing residential developers to use fuel cells. Residential housing development is a game of margins and developers do not specify products that cut into margin. It is hard to see fuel cell companies offering their "furnaces" at similar prices to conventional heating units without taking big losses because they do not have the business volume to have scale efficiency in production.
And if fuel cell "furnace" prices are above the cost for conventional heating units, they simply will not have a chance. This is because developers will in all likelihood decide that they will not be able to recoup the extra cost in their new home selling prices. The mass market of home buyers does not pay extra for energy saving or environmentally friendly features. If it did, triple-glazed windows, heat pumps and extra insulation above minimum building code requirements would sell. They do not sell and developers do not put them in their construction.
Instead, the mass market of home buyers pays for features that add to home resale value such as granite countertops, nice kitchen cabinets and whirlpool tubs. In fact, a very strong argument can be made that fuel cell heating will detract from resale value because buyers will not want the risk of having an unproven heating unit.
The long-term future of fuel cells is probably quite good, but the time horizon for widespread fuel cell acceptance is far enough away that investors should be wary of jumping aboard a sector that is trading on unrealistic momentum. Just like broadband stocks, Linux stocks or any other area that has had big momentum trading gains, there will be a point where the momentum falters and then disappears. For fuel cell stocks, this will happen when the stock market realizes the difficulty fuel cell companies will have in generating consistently strong sales growth and profitability until many years from now.
stockhouse.com
Jack |
