ITM Power - ITM (Buy)
Thank you @don_quixote for the interesting suggestion!
ITM is a British manufacturer that provides hydrogen energy solutions. They are AIM-listed, which does limit the access to financials and analyst coverage, but they have been listed since 2004 giving us some history to judge. Looking at the fundamentals and what is happening in the industry, I’ll try and work out if this is a good long term investment or not.
What Does ITM Do?
Hydrogen energy solutions is a broad statement which doesn’t tell us too much about the business. What we can do is look through their financial reports to see how they divide up their own business as well as the products they have on offer.
Their solutions include grid balancing, energy storage, production of green hydrogen for transport, and renewable heat and chemicals. However, this isn’t what you will see on their balance sheet, there are two ways to breakdown their revenue, the type of operation and by sub-industry.
Source: ITM Interim 2019 Report
Construction contracts make up the lion share of the revenue for ITM. A large part of their business is installing large bases for refuelling, energy containment, or even processing plants. For example, having a fleet of hydrogen busses means you need a specialist refuelling station. You could either lease one or pay ITM to construct one complete with their hydrogen converting machines.
Source: ITM AGM 2019 Presentation
Consulting also makes up a large part of their revenue. Being experts in their field ITM also offers to consult for both their installations as well as others. Not only is this any additional revenue line, but it also means existing installations are kept at maximum capacity and clients are happy.
Maintenance is split out from consulting and very strict about the reoccurring revenue of their machines and sites. This is also an interesting measure of existing finished sites where they are making ongoing revenue versus lots of new projects. Seeing this number increase means we have more finished projects bringing in a stable base of revenue, for what we hope is dramatically less cost.
Fuel sales are direct sales where they own the site and equipment and clients are charged to purchase hydrogen for their machines. This also includes selling fuel in bulk.
Finally, we have the always present “other” category, for any minor revenues which don’t live anywhere else. This line is different from other operating income or one-off gains like selling parts of the business or a previously owned site.
Source: ITM Interim 2019 Report
Alternatively, we can break down the business lines by what industry they relate to. This does mean some projects will be split across different segments, the totals always add up the same but it gives us some insight into why clients are coming to ITM.
Power-to-gas also is known as P2G is converting electrical energy into a gas, in this case, hydrogen. Two reasons for wanting to do this, firstly this is the end product (for ITM the next business line is where you see this as the end product), and secondly to store power. Electricity is a pain to store and can be expensive to keep as raw electricity. By converting this into a gas, it’s easier to store and then use the gas as the power source. It’s a great way to transport power without all the expensive infrastructure.
Refuelling is where ITM is powering machinery and vehicles. The main business for ITM is building refuelling depots. Buying a contract from ITM to build you a hydrogen refuel station for your new busses would show up as a construction contract and be created as part refuelling in this view.
The chemical industry is the leftover parts of the process which can still be sold and converted. It also includes taking P2G and performing more work to convert it into LPG. This means you can still produce liquid petroleum gas from ITM’s equipment. Most of their customers won’t want to be left with P2G and will want the extra steps to end up with LPG.
ITM also has another source of income not listed here.
Grants from different governments and bodies to further the research and development of clean energy. In 2019 ITM took £6.8m in grants, in the same period they made £4.6m in revenue. This is powering a significant about of R&D for the business, given we are in a situation where global governments have more pressing needs for their money, this is at risk of slipping.
What Do The Fundamentals Tell Us?
I mentioned an AIM listing makes this a bit harder. From a regulatory standpoint, they don’t have to release as much information about their company as someone on the main exchange. AIM stocks are as a blanket rule, much higher risk because of this.
Source: Genuine Impact
This kind of heavily skewed relative rank is expected. It’s a small company which a lot of volatility. As always I want more context and will dive a bit deeper to understand what this means.
When looking at what ITM does I showed some financial statements and also highlight they historically have brought in more grants than revenue, which isn’t a long term sustainable approach.
The revenue for the trailing twelve months was £5m, and they ended up with a -25.49% gross margin. Even before we look at the rest of the financials we can tell the cost of making revenue is painfully high and bleeding cash. If we take into account the rest of the costs with running the business we end up with a shocking -£9.45M loss. A profit margin of -205.88% is rare to see. The bulk of this heavy loss is down to two items, cost of revenue (as we know) followed by prototyping, which is considered separate to R&D.
Being so cash-intensive there are no dividends and as a shareholder, you can expect a negative EPS, currently sat at -2.90x.
Source: Wallmine
What is interesting is the massive recent cash injection of £58.8m. This was completed as fundraise, meaning the company only has £18.11m in debt. Due to the way the reporting works all of this debt is listed as due within the year. If we face this off against current assets we see a very impressive £83.64m if we stretch ourselves and include long term assets we end up with a respectable £92.99m in assets.
While the company is bleeding cash, the assets are increasing. There is heavy investment in prototyping and developing new machinery to increase their reoccurring revenue beyond the first core sale. A riskier strategy but not an uncommon one for smaller companies. ITM can cover their liabilities and obligations in the short term, which does put them ahead of their similarly structured peers.
On the surface, the financials appear weaker than they are but based on the earnings we can expect this to be an overpriced stock.
Source: Yahoo Finance
We are trading at all-time highs, and the momentum behind the price movement is very strong. Which is going to drastically harm the value assessment.
A price to sales of 177.69x and price to book of 53.96x are both abysmal figures. The recent fundraising has helped push the cash to shares to 0.02x, still very weak compared to what we would expect but a move in the right direction.
This is not a value purchase in any sense. You are paying an extreme premium based on old figures for a company which doesn’t have the same level of reporting requirements you would expect from a main market listed company.
At this point, I would expect you to be very put off. The sell-side analysts with their future growth predictions for ITM are pegged to be extremely high and aggressive.
Source: Genuine Impact
We know that ITM has missed every single one of its revenue and EPS targets set by Wall St, and judging by the even split of analyst ratings I would say they are mostly out of date. This is a small AIM stock, it’s not going to have a strong following or large amounts of analysis available.
What stood out to me was the biggest driver behind why the future is looking so promising, and this helps us to understand the aggressive price growth as well.
Source: Genuine Impact
The smaller size of ITM means that in relative terms it is much easier to produce multiples in terms of future returns. Microsoft making an extra ten million a year won’t have a big impact, you’d expect it. For ITM it’s life-changing.
What Has Happened Since The Last Report?
With a lack of analysts, less frequent reporting, and lower coverage in general. It can be harder to understand. This is where I’m going to be a bit more predictive and look into the recent announcements since their last report.
ITM has won two new projects, new grant secured, and one other project is advanced to the next stage. This is huge news.
The last report mentioned £42.4m was currently in their backlog pipeline, with another £248m under negotiation. They have delivered on previous contracts and now executing on new deals.
Source: ITM Interim H1 2020 Results
We have a new JV kicking off, and these new deals entering testing to see if wider adoption is on the cards, there is a lot to be excited about.
Deploying Hydrogen Fuel Cell BusFleets for Public Transport across Australia
Funding Award to Supply an 8MW Electrolyser (£10m across 2021/2)
Green Hydrogen for Humberside Project DeploymentStudy
Industrial-scale renewable hydrogen project advances to the next phase
Right now ITM is losing out whenever it brings in revenue due to the higher costs, that is also why they are investing so heavily into prototypes and getting grants. To radically reduce the cost both to produce and buy.
Source: ITM Interim H1 2020 Results
Why Do I Like This Risky Buy?
Let me be clear, AIM stocks are sensitive and unpredictable beasts. It is a much riskier investment and can be way more volatile. As a smaller chunk of my portfolio, I am willing to take on some risk.
There is a lot for me to like here. They have a great pipeline of work and new contracts, which are spread across Europe, with some in Asia, but the biggest focus is here in the UK. ITM has 37 contracts they are trying to close currently. The cost of goods is decreasing and the prototype funding is not coming from their pocket or shareholders, it’s coming in the form of grants.
The latest fundraising has been done to address the working capital and to keep the books in balance while they keep delivering projects. Projects which once delivered still yield a return in the long run.
A company like this I would typically call an acquisition target and paint that as the exit. Here I feel there is more to give. Expanding with more JVs like the Linde deal, deepening their partnerships with Shell and Toyota, and pushing forward the deal to supply the infrastructure for keeping Australia’s hydrogen busses going are all huge prospects.
The renewable space is huge, and ITM is pushing the core technologies and requirements forward. For me, they are making the right noises and show a lot of promise. There is a big risk in terms of cash flow and deals falling out the pipeline, but I have a bullish outlook for longer-term infrastructure work, and COVID-19 has only pushed forward the demand for cleaner energy and living.
Let me know what you think of my assessment, is this a stock you have looked into yourself? One to watch or are you avoiding it?
I had a great time writing this and I hope you found it insightful, let me know if there is anything you feel is missing or I should add.
Thanks for reading and stay safe.