MPHYF - Battered And Bruised McPhy Needs To Deliver On Order And Revenue Growth

2023-08-23 14:59:05 ET

Summary

• Weaker than expected revenue and order growth trends have driven shares of clean hydrogen technology plays lower since 2021, including sharp declines for McPhy, ITM, Nel, and Plug Power.
• McPhy's first half results were mixed, with improved revenue but higher losses, weaker orders, and not a lot of net progress over the last three years.
• McPhy faces challenges in the new technology adoption process and lacks manufacturing scale compared to rivals. The company needs to prove itself in the next 12 to 24 months.

Writing about McPhy ( OTCPK:MPHYF ) in the spring of 2021, I noted that this French manufacturer of electrolyzers for clean hydrogen production and distribution equipment for hydrogen filling stations was a speculative play in a promising field. While the opportunities in green hydrogen production remain attractive, there has been a surge of new entrants into the market, as well as capacity expansion announcements from existing players, and orders have been slower to materialize across the space.

With that, McPhy shares have declined almost 80% since my last article . For what little solace it brings, this isn’t a McPhy-exclusive issue, as ITM Power ( OTCPK:ITMPF ) and Plug Power ( PLUG ) are down similarly over that time, and Norway’s Nel ASA ( OTCPK:NLLSF ) has done only marginally better (down about 60%).

This process of winnowing out is not uncommon in new technology fields and it’s part of why I considered McPhy to be a speculative play back in 2021. Although I still believe that McPhy has credible technology, partners, and opportunities, they are lagging behind when it comes to capacity, orders, and revenue, and the company does not have an overabundance of cash at this point. While there are still paths forward from here that could lead to meaningful long-term revenue and returns for shareholders, that window of opportunity is narrowing and this remains a high-risk play on a promising opportunity.

Recent Results Show Some Progress, But Also Ongoing Challenges

First half results from McPhy were, in my opinion, mixed at best, with progress on some fronts, but not enough progress to really ease my ongoing concerns about how the business is positioned within the ongoing green hydrogen market scramble.

Revenue rose 35% on a reported basis but declined 5% on an adjusted basis (excluding an adjustment in the year-ago numbers for generation stations that were repurchased from customers). Electrolyzers made up about 60% of the EUR 7M reported revenue, down about 29%, while sales of hydrogen station-related equipment rose more than 81% to EUR 2.9M

Losses expanded modestly from the year-ago period, with EBITDA of negative EUR 21.6M versus EUR 17.1M in 2022 and an operating loss of EUR 24.8M (versus EUR 19.4M). The company consumed EUR 38M in cash during the first six months of 2023, leaving the company with EUR 97M.

Orders declined 32% from the year-ago period and although the book-to-bill was above 1.0, just under EUR 11M in orders isn’t exactly “thesis-changing” and nor is the 9% backlog growth (to EUR 33.4M). Likewise, considering that orders were EUR 7M in 1H’21 and higher than that in 1H’20, I can’t say there’s been sufficient progress here.

On the positive side, McPhy has seen projects with ArcelorMittal ( MT ) (two 1MW electrolyzers at a facility in Germany) and Plansee (one 4MW electrolyzer in Austria) move forward. On the negative, the company’s CEOG project, where it has partnered with Siemens Energy ( OTCPK:SMNEY ) to provide a 16MW electrolyzer for the production of hydrogen from a solar park, has been postponed and the company doesn’t seem to have a lot of visibility into when this project will resume.

“Hurry Up And Wait” Can Be Brutal For Smaller Companies

One of the challenges facing McPhy (as well as ITM Power and to some extent Plug and Nel as well) is the nature of new technology adoption. While the promise of using hydrogen generated on-site through clean means (solar or wind-powered electricity, for instance) is attractive in many sectors (including steelmaking, cement, and electricity generation/storage), companies aren’t going to go “from 0 to 60” immediately. Instead, they’re going to launch pilot projects (like ArcelorMittal’s project in Germany), run those for a while, and see how they go before deciding to commit to large-scale implementation.

That can be brutal for small companies like McPhy that lack manufacturing scale to produce limited volumes cost-effectively and have ongoing drains on their cash balances. What’s more, many of those early entrants willing to launch larger pilot projects want to tie up with suppliers that they can rely on for future commercial-scale supply, and a company’s production capacity can be a significant factor in winning business – putting these companies in the unenviable position of having to produce low volumes at a loss and simultaneously invest capital into capacity expansion projects to secure more pilot projects (and potential commercial orders in the future).

To that end, McPhy’s 300MW of annual capacity trails the 1GW or so capacity of rivals like Nel, ITM, and ThyssenKrupp , and while the company’s Belfort “gigafactory” should be ready for commercial production in 2024, rivals have also announced significant capacity expansion plans (including a multi-GW factory project in Berlin from Siemens Energy) and new entrants from China are further muddying the waters. Said differently, even if the Belfort facility opens on time, McPhy will still be trailing many rivals in terms of its capacity.

One of the key issues I have with McPhy at this point is that the orders just have not materialized as I had hoped to see. The extent to which that was a factor in the firing of the prior CEO (in the summer of 2021) is perhaps debatable, but the reality is that revenue of EUR 4.3M in 2019 has only climbed to EUR 7M in four years, and that’s just not enough for what needs to be a growth story – and that’s even allowing for the fact that inflation, supply chain issues, and regulatory uncertainties have led to some challenges in scaling up new pilot projects.

The Opportunity Is There … But It May Not Be McPhy’s

As I’ve said in this article, my prior article on McPhy, and in articles on other companies like Cummins ( CMI ), I’m a believer in the potential of green hydrogen generation. I believe clean hydrogen has credible use-cases in high-emissions industries like cement and steelmaking, as well as vehicle fueling and renewables-based energy (solar and wind can be used to generate hydrogen which can then be stored and used to power fuel cells to maintain consistent electrical generation output).

I believe annual hydrogen consumption could grow from around 70mt in 2019 to 200mt or more in 2040 and even further in the years beyond that. Much of that incremental demand will be for green hydrogen, translating into perhaps 100GW of annual electrolyzer capacity demand by 2040. That further translates into billions of dollars of potential revenue (even allowing for competition driving electrolyzer prices lower over time) for the industry.

How much of that can and will go to McPhy is of course very much up for debate. Although McPhy is getting significant subsidies from the French government for its Belfort facility, the reality is that the cash burn is still meaningful and the company looks like it will have to raise capital on unfavorable terms at some point within the next year or so. While the company does have some valuable partnerships (including ArcelorMittal as a pilot customer, Electricite de France ( OTCPK:ECIFY ) and Chart Industries (GTLS as strategic investors, and Larsen & Toubro as a licensed manufacturer in India) the clock is ticking.

In my prior article I said that if things went McPhy’s way, the company could generate over EUR 1B in revenue with double-digit free cash flow margins in the mid-2030’s. That’s still possible, but the window is starting to close. Government-funded green initiatives in both the U.S. and EU (the IRA and GDIP) should drive increased interest in green hydrogen projects and increased electrolyzer orders over the next couple of years, but McPhy has to show that it can win more of those than it has in recent years – Nel already generates about 10x as much revenue (comparing results for the first half of 2023) and 8x more orders (again, comparing 1H’23 results) and companies like Cummins, Siemens Energy, and ThyssenKrupp have considerably more financial resources to draw upon to support growth.

The Bottom Line

At this point I basically consider McPhy a binary stock call – it will either work and generate substantial returns from here or it will fail and there will be little more left than capital losses that investors can harvest for tax purposes. Unfortunately, I think the arrow is pointing more toward the latter outcome than in my prior article.

It's not uncommon to see high volatility and sharp declines in the early stages of commercializing new technologies, but not many contenders make it through this process. I’m not giving up on McPhy, nor on the wider hydrogen sector opportunity, but I do think McPhy has a lot to prove in a relatively short period of time (the next 12 to 24 months) to regain investor enthusiasm, access the capital it needs, and show itself to be a real contender for leadership in this emerging field.

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