Like solar and wind power, many alternative energy advocates have touted the potential of hydrogen power for years. Investors in fuel cell companies like Plug Power (NASDAQ: PLUG) are still waiting, however, for the inflection point that marks the company's transition to sustained profitability. Perhaps in 2017, though, that time has come.
Rising 128% in 2017 as of this writing, Plug Power has delighted the market -- unlike in 2016 -- with several announcements, suggesting that the tide has turned. Thanks in part to a deal with Amazon.com (NASDAQ: AMZN), fuel cell fever is working its way through Wall Street. Indicating a bullish outlook on the stock, analysts at FBR Capital and Cowen have each identified a $3 price target on the stock. Moreover, an analyst at the investment bank Rodman and Renshaw issued a $4 price target. But Wall Street's enthusiasm doesn't necessarily mean investors should start powering their portfolios with this fuel cell industry leader.
Fuel for the bulls
To say that news of the company's deal with Amazon was well received would be a gross understatement. Shares soared more than 60% in April -- the month in which the announcement was made -- and the stock hasn't looked back, continuing to climb ever since. What fed the fervor? For one, Plug Power's management expects the deal to add $70 million to the company's top line in 2017. This is no small sum considering the company reported $86 million in revenue in the prior year.
Besides the deal with Amazon, Plug Power pleased investors with its second-quarter earnings report. Management announced a new agreement with long-term partner Wal-Mart (NYSE: WMT), with an estimated the contract value to be $70 million. And speaking to its fiscal 2017 finances, it was quite optimistic, estimating negative free cash flow of $25 million to $35 million. Additionally, the company expects further progress in its pursuit of profitability, and is forecasting an expansion in its fiscal 2017 gross margin (excluding the impact of warrants issued to Amazon and Wal-Mart) to 8% to 12%; the fiscal 2016 gross margin was only 4.6%.
In terms of the stock, because it's unprofitable, we can't use the traditional price-to-earnings metric to value shares, so let's consider the price-to-sales ratio. Shares are trading around 5.4 times sales, slightly higher than the stock's 5.2 average, but those who are optimistic about the company's future could certainly shrug off this seemingly high price tag.
Time to pump the brakes
Despite the deal with Amazon and an improvement in some areas of its financials, the bear argument for Plug Power remains strong.
For one, management's forecast for its fiscal 2017 performance must be taken with a healthy dose of skepticism since it doesn't have a great track record of meeting its guidance. In 2013, it estimated Plug Power would break even on an EBITDA basis by the second or third quarter of 2014. Slightly off, the company reported an EBITDA loss of $84 million in 2014 according to Morningstar. Last year, during its Q1 2016 presentation, it announced a gross margin goal exceeding 12% for fiscal 2016. The company instead reported a gross margin of 4.6%, thereby coming up quite short. Management, furthermore, set an operating cash flow target of negative $20 million. Again missing the target, it reported negative $30 million in operating cash flow in fiscal 2016.
Besides missing guidance, Plug Power's inability to achieve profitability looms as a major factor. Companies whose bottom lines are colored red by no means should be disqualified as unworthy investments. As long as the growth catalysts that will translate to profits are clear, investing in unprofitable companies has the potential to yield a healthy return on investment. For Plug Power, however, this remains unclear. Further complicating things is how critical it is for the company to reduce the cost of its fuel cell solutions, making them more attractive to customers in light of the expired investment tax credit. To do this, it must continuously commit revenue to research and development -- a serious impediment to reporting operating income. In fact, the company has averaged a 58.7% operating margin over the past three years.
Accounting for 28% of revenue in the trailing 12 months, revenue earmarked for R&D will likely remain a large obstacle on the road to profitability as the company pursues development of its ProGen prototypes for both the domestic and Chinese markets.
What to watch for from Plug Power
Predicated on a future where hydrogen has supplanted traditional fuels, picking up shares of Plug Power at this point remains too risky. As one who's been enthusiastic about alternative power for years, I'd be more than happy to add Plug Power to my portfolio. Unfortunately, trust issues regarding its management team still persist, and the failure to translate top-line growth to the bottom line remains a concern. Unless the stock nosedives and reaches rock-bottom prices or the company remedies its issues, I'll be rooting for Plug Power from the sidelines.
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