Plug Power: New Tax Credits Trump Abysmal Second Quarter Results (NASDAQ:PLUG)

Abstrakte nanomolekulare Struktur. H2 Wasserstoff

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Note: I have covered Plug Power previously, so investors should view this as an update to my earlier articles on the company.

Earlier this month, Plug Power Inc. (NASDAQ:PLUG) reported another set of abysmal quarterly numbers as the company’s core material handling business remains an unmitigated disaster:

Plug Power Gross Margins

Company SEC-Filings

The company missed consensus estimates on both the top- and bottom line again despite a whopping $46.8 million contribution from recently acquired companies Applied Cryo Technologies, Frames Group and Joule Processing.

Not for the first time, the investor letter contained a number of questionable or outright misleading statements.

For example, management was “pleased to report 36% service margin expansion sequentially in the second quarter of 2022, and up over 141% from the second quarter of 2021“. While technically correct, the improvement was solely the result of massive charges taken last year in anticipation of ongoing, elevated losses from long-term service contracts, primarily with key customer Amazon (AMZN).

In Q2, the company released a whopping $11.9 million from the so-called “loss accrual for services.” Adjusted for the release, service gross margins would have been negative 166.5%, essentially in line with last year and up just slightly from Q1.

The lack of tangible progress in service margins is also visible in the company’s leasing business which Plug Power labels “Power Purchase Agreements” or “PPAs”. As accounting rules do not permit upfront loss recognition on service contracts attached to leased equipment, the segment’s abysmal gross margin performance continues to reflect the true state of the company’s service business.

GenDrive units shipped during the quarter were down an eye-catching 65.7% year-over-year and roughly in line with the weak first quarter number. As a result, core fuel cell system sales were down approximately 40% year-over-year, very much in contrast to management’s claims of “robust demand” in the investor letter.

Adjusted for recent acquisitions, reported revenue was down by 16% year-over-year.

Plug Power Major Product and Service Lines

Company SEC-Filings

As usual, management was quick to dismiss the ugly performance by pointing to historical seasonality with approximately 70% of full-year revenues generated in the second half but at least in 2021, almost 40% of revenues were recorded in H1.

In fact, Q2/2021 represented almost 25% of full-year 2021 revenues, while Q2/2022 calculates to just 16.5% of the company’s projections for this year.

The disappointing sales performance of the core material handling business doesn’t exactly come as a surprise with key customer Amazon reportedly already having paused, delayed or canceled more than 40 sites this year after heavily expanding its distribution network during the pandemic.

Please note that Plug Power does not intend to continue sales of engineered oil and gas equipment (the former Frames Group business) beyond current commitments which will result in an annualized $100 million revenue headwind going forward.

Electrolyzer Backlog

Sales performance of the much-touted electrolyzer business remained immaterial for Q2 while the backlog of $77.6 million disclosed in the 10-Q appears to be in stark contrast to the 1.5 GW number celebrated by management in the investor letter which would translate to approximately $750 million in revenues when using Morgan Stanley’s (MS) most recent assumptions.

Please note that three large-scale projects represent the majority of the 1.5 GW electrolyzer backlog claimed by management:

Plug Power Electrolyzer Orders

Company Press Releases

While New Fortress Energy’s (NFE) final investment decision is expected in the very near-term, the time frame for the projects in Egypt and Denmark remains unclear at this point. As long as these investments have not been formally approved, Plug Power won’t be able to add them to the backlog number disclosed to the SEC.

In the question-and-answer session of the conference call, CEO Andrew Marsh guided to $140 million in electrolyzer sales for the second half of the year which would be almost double the backlog disclosed in the 10-Q.

As equipment orders are usually placed well in advance of the projected shipment date, it is difficult to envision 2022 electrolyzer sales coming in anywhere close to the number stated by management, very much like last year.

Hydrogen Production Capacity

In addition, the company will likely miss out on its stated 70 tons-per-day (“tpd”) year-end hydrogen production capacity target. At the date of the Q2 presentation only 12.5 tpd of gaseous hydrogen production capacity appeared to be online with 6.4 tpd of that capacity acquired more than two years ago.

With just four months left to bring online an additional 57.5 tpd, a major miss appears to be in the cards, particularly when looking at the most recent status update:

Plug Power Capacity Expansion Status

Investor Letter

As of August 9, construction/expansion work had not yet commenced in Louisiana and Tennessee while the company had not even selected a site in Texas.

Adding insult to injury, the much-touted $290 million New York plant has experienced delays and will now be built in multiple phases with a tiny 5 tpd gaseous hydrogen facility representing the first phase.

At least in my opinion, the company’s year-end hydrogen production capacity is unlikely to be materially higher than today’s 12.5 tpd.

Cash Usage and Liquidity

Even with rather limited capital expenditures, Plug Power used $634.8 million in cash in H1, a new all-time high for the company.

But at the end of Q2, the company still had approximately $3.1 billion in unrestricted cash and cash equivalents, available-for-sale securities and mutual funds so liquidity won’t be an issue for at least the next couple of quarters.

That said, capex is likely to pick up very substantially soon as the company’s ambitious hydrogen production capacity expansion plans kick into high gear.

Assuming the company uses another $600 million for the remainder of the year and another $1.5 billion next year, unrestricted cash and cash equivalents would be down to $1.0 billion by the end of 2023.

Prime Beneficiary of the Inflation Reduction Act

While the company’s ongoing operational shortcomings remain a cause for concern, poor financial results will likely continue to take the backseat for the time being as the subsidies established by the Inflation Reduction Act (“IRA”) should provide a massive boost to the company’s green hydrogen and electrolyzer business:

The IRA bill is a tremendous catalyst for all forms of clean energy development, and we believe it is a game changer for Plug and green hydrogen. The IRA would enact a Clean Hydrogen Production Tax Credit (“PTC”) to incentivize the production of clean hydrogen. The PTC provides a tax credit of up to $3.00 per kilogram for green hydrogen and is available for a 10-year period for any hydrogen generation facility that begins construction prior to 2033, including the ability to receive direct pay for the first five years.

Particularly the availability of direct cash subsidies for the first five years should provide a big benefit to Plug Power.

Even when assuming some further construction delays and leaving out the plants using feed-gas from Olin (OLN), green hydrogen production capacity at the end of 2025 should be at least 400 tpd which depending on utilization could translate into annual cash subsidies of well above $400 million.

New Fortress Energy Green Hydrogen Plant

Given this major positive development, I was somewhat perplexed by the company’s recent agreement with New Fortress Energy for a 120 MW industrial-scale green hydrogen plant in Texas.

Expected to be one of the largest of its kind in North America, the facility will leverage Plug’s industry-leading proton exchange membrane (PEM) electrolysis technology and enable the production of more than 50 tons per day (TPD) of green hydrogen. With the development of additional supporting infrastructure, the facility will be scalable to nearly 500 megawatts. The facility is the first investment in green hydrogen for NFE, a global infrastructure company committed to accelerating the world’s transition to clean energy.

“Plug’s decarbonization goals and NFE’s energy transition goals are strongly aligned, and our partnership has strengthened at a pivotal time for the green hydrogen industry,” Andy Marsh, CEO of Plug, said. “We are thrilled to support NFE’s first investment in green hydrogen. This facility is a model that we intend to replicate in other locations across the country.

At first look, the press release seemed to indicate some sort of joint ownership of the facility but New Fortress Energy’s Q2 conference call made clear that Plug Power will simply provide the electrolyzer technology for the new plant while New Fortress Energy will be the sole beneficiary of the resulting production tax credits:

On the projects themselves, as you heard, we’ve announced a partnership with Plug Power this morning. We’re quite proud of that. They are a leader in what’s called PEM Electrolyzer Technology. And so they’ll be supplying actually a series of 12, what are called, arrays to support our 120-megawatt facility.

(…)

The last real piece that’s a material one now is this production credit that actually then moves the economics from a modestly profitable transaction to one that we now think is actually one, which is compelling and can be the template for a number of these.

Amazon Green Hydrogen Supply Agreement

Lastly, let’s take a closer look at last week’s hydrogen supply agreement with Amazon:

(…)

The green hydrogen supply deal is a continuation of joint efforts between Amazon and Plug to expand the applications of green hydrogen beyond material handling. Since 2016, Plug has helped Amazon to deploy more than 15,000 fuel cells to replace batteries in forklifts across 70 distribution centers.

Specifically, Amazon and Plug have signed a deal for Plug to supply 10,950 tons per year of liquid green hydrogen to fuel Amazon operations. Using Plug’s electrolyzers, liquefaction capabilities and cryogenic tankers, Plug will deliver hydrogen to Amazon beginning Jan. 1, 2025.

(…)

Amazon’s press release added more some more color:

Amazon today announced that the company has signed an agreement with Plug Power to supply 10,950 tons per year of green hydrogen for its transportation and building operations starting in 2025. The company will start to use green hydrogen to replace grey hydrogen, diesel, and other fossil fuels as it works to decarbonize its operations, and this green hydrogen supply contract will provide enough annual power for 30,000 forklifts or 800 heavy-duty trucks used in long-haul transportation.

(…)

We already have more than 70 fulfillment centers outfitted with hydrogen storage and dispensing systems, which will allow us to start using green hydrogen to replace fossil fuels. Today, we use that system to power over 15,000 fuel-cell propelled forklifts, with plans to grow that number to 20,000 across 100 fulfillment centers by 2025. That’s just the start,” said Dean Fullerton, vice president of Global Engineering and Security Services at Amazon. “Across Amazon’s operations, we’re exploring and testing the use of other hydrogen applications, such as fuel-cell electric trucks and fuel-cell power generation stations providing electricity to Amazon buildings.”

Based on numbers provided by the company on last year’s symposium, Barron’s arrived at a targeted sales price of $5 to $6 per kilogram hydrogen but with up to $3 in subsidies now available to the company, the sales price might end up being considerably lower.

Generously assuming a $6 sales price per kilogram hydrogen, the agreement would represent annual revenues of $65.7 million for Plug Power, just a little over 2% of management’s projected 2025 revenue of $3 billion.

Even worse, the incremental revenue benefit would only be in the range of $30-$35 million annually as Amazon already represents Plug Power’s largest hydrogen customer today.

Moreover, judging by the wording of the agreement, Amazon won’t take delivery of green hydrogen before 2025 which would result in the ongoing requirement for Plug Power to provide third-party hydrogen at outsized losses for another 2+ years.

In its current form, the agreement appears more or less immaterial to management’s stated 2025 revenue targets while potentially leaving the company with large losses from required third-party hydrogen supply for another 10 quarters.

Given this issue, I was surprised to see Amazon extracting warrants to purchase another 16 million shares of the company’s common stock:

Plug has granted Amazon a warrant to acquire up to 16,000,000 shares of Plug ‘s common stock (Warrant Shares), of which the exercise price for the first 9,000,000 Warrant Shares is $22.9841 per share, which is based on the volume weighted average closing price of Plug common stock for the thirty trading days ending August 23, 2022, and the exercise price for the remaining 7,000,000 Warrant Shares will be an amount per share equal to ninety percent (90%) of the 30-day volume weighted average share price of Plug common stock as of the final vesting event that results in full vesting of the first 9,000,000 Amazon Warrant Shares

Amazon would vest the warrant in full if it spends $2.1 billion over the seven-year term of the warrant across Plug products, including, but not limited to, electrolyzers, fuel cell solutions, and green hydrogen.

At prevailing share prices, Amazon’s current gain on the first warrant tranche already calculates to more than $60 million or approximately one year of free liquid green hydrogen supply.

Also keep in mind that in late 2020, Amazon forced the company to waive all remaining vesting conditions on a large number of warrants originally issued in 2017, a surprise move that resulted in a $400 million reduction to reported revenues for FY2020.

The $399.7 million reduction to revenue was recognized during the year ended December 31, 2020 because the Company concluded such amount was not recoverable from the margins expected under probable future revenues attributable to Amazon, and no exclusivity or other rights were conferred to the Company in connection with the December 31, 2020 waiver.

In addition, the unexpected waiver and related impact on the company’s financial results confused market participants and was one of the root causes behind the required restatement of several years of financial results last year. Plug Power is still dealing with a plethora of class action lawsuits related to the restatement.

Effectively, the 2017 warrant issuance resulted in Plug Power paying Amazon for using its GenKey solutions.

Given the company’s still meaningful dependence on its largest customer, there’s apparently nothing that would stop Amazon from requesting another waiver for the new warrants to vest ahead of time.

Moreover, the new warrants will once again result in potentially meaningful reductions to reported revenue going forward thus further complicating the company’s already complex and intransparent financial reporting.

Bottom Line

More of the same at Plug Power with management touting the company’s future prospects while the core material handling business remains a mess.

In addition, at least in my opinion, the company is likely to miss its year-end hydrogen production capacity target by a wide margin.

Management making some questionable statements with regards to material handling solutions demand, service margin improvements and electrolyzer backlog in the investor letter certainly doesn’t help things either, particularly given the company’s long history of misleading investors in its financial statements.

That said, the company’s ongoing execution issues will likely take the back seat for the time being as market participants focus on the company’s status as an expected prime beneficiary of the recent Inflation Reduction Act.

While Plug Power remains a story stock, the recent passing of the IRA has sweetened the company’s story and financial prospects substantially.

Given renewed momentum and absent any major sell-off in the broader market, I wouldn’t be surprised to see the shares eclipsing $35 or perhaps even $40 going into 2023.

Nevertheless, management will have to deliver upon its stated plans to generate cash in the not-too-distant future as otherwise, liquidity might run low again in 2024.

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