NLLSY - Nel ASA: Norwegian Hydrogen Underperformed Updating After Q1'23

2023-06-11 07:36:51 ET

Summary

• Nel ASA, a small Norwegian hydrogen company, has experienced a 20%+ decline since the author's initial recommendation to hold rather than buy.
• The hydrogen market is still under development and not yet mature, but the company presents potential at the right price.
• The author is revisiting their stance on Nel ASA to determine if now is the right time to invest.

Dear readers/followers,

It was some time ago that I wrote my first article on Nel ASA (NLLSF), a Norwegian company in hydrogen. This is a very small business in the greater context, but despite this, it comes with an impressive history. Also, if you're an investor in the renewable space, this small company might actually be right up your alley.

While Hydrogen is still mostly under development in the forms of applications that this company is targeting - or at least the market is in no way mature yet - the company does present an interesting potential at the right price. When i first wrote about the article, my stance was clear. Don't "BUY" this business - rather "HOLD" it and wait for things to calm down. Since that time the company has severely underperformed, by which i mean a 20%+ decline during a time when the S&P500 grew - in this case, double digits.

So, my stance at the time proved to be correct - and it's time to update it to see if now is the time to start investing in Nel ASA.

Nel ASA after 1Q23 - some updates to the stance

Nel isn't as bad or as unknown as you might think, despite its small size. With a century-long history, and the fact that Nel ASA is the world's largest manufacturer of commercial electrolyzers, there are a few things that make this company "interesting", so to speak. The company has delivered close to 4,000 units of its product to over 80 countries, and it's not unfair to say that the recent 10-20 year push into renewables has really ramped things up here.

Aside from electrolyzers, Nel ASA also constructs the fuelling stations for Hydrogen vehicles - and it's one of the largest manufacturers in the world here as well, with 120 stations in 14 countries including assets found in Denmark, Norway, and the USA.

On the fundamental side, it has no credit rating, but also has very low leverage. It has a debt-to-equity of 0.04x, and cash-to-debt of almost 20x, which makes it one of the best-rated industrials in terms of financial strength in the entire sector. However, financial strength of course isn't enough to make me interested.

Nel's primary challenge lies in its profitability - because it's not actually a profitable company at this time. Operating and net margins are deep in the negative, return on equity, assets, and invested capital is deeply in the negative, and the company's invested capital even taking into consideration a conservative weighted average cost of capital, or WACC is not good - nor is it positive mathematically.

This is what the company's revenue/net looks like, and how it currently works.

Or, perhaps better put, how it doesn't work. A company that doesn't make a profit is, after all, a problem - and Nel's problem is not just this year. Profit is currently difficult for this business. As you can see, the negative net income is actually larger than the entire 2022 revenue of the company. The best thing that can be said for Nel currently is that it has very low leverage. In the past 10 years, the company has been positive in terms of ROIC net of WACC only once.

This company has every sign in the book of being a company that's in a pre-profit state. Stockholder equity is extremely high relative to assets, shares outstanding are expanding, and it's very cash-heavy.

Nel takes the place right after electricity production, manufacturing not just fuelling but the equipment needed to produce Hydrogen on-site. This production can in turn be used not only in fuel cells for cars but across industries in the interest of decarbonization.

The company has incredible expertise in this field because this is what they've been doing for the past 80-90 years, though expertise might not necessarily help when you're not making money.

The company has a majority shareholder in the form of Clearstream SA, a banking institution owned in turn by Deutsche Börse AG.

1Q23 is the latest report, and it did little to provide investors with confidence for near-term profitability. 600 employees and 4.6B NOK in cash reserves make the company what it currently is. In 1Q23, the company managed 359M in revenues with an order intake of 580M NOK - up, which is positive. We're on our way to over 1B NOK in annual revenues, with a backlog approaching 3B NOK. However, the company was still EBITDA-negative during the quarter, and the new private placement raising 1.6B NOK of equity further diluted shareholders in this company.

The company plans to use the raised capital to expand its facilities, grow its organization with new trends, and scale up production and capacity. Notable orders include a 40 MW purchase order...

...as well as a contract with HH2E for 120 MW of alkaline equipment in Germany, including 2x60 MW plants. This is the first order and the largest electrolyzer project in Germany to date. The company also presents a lot of "soft" results. Politicians visiting, discussions with policymakers, generally catching up with favorable frameworks - both policy and industrial, and state aid regulation relaxation in the EU.

Nel ASA markets itself as the preferred high-capacity hydrogen fuelling partner and manufacturer. It has an impressive 15% global market share, and it would not be wrong to say that this business is at the forefront of development in ways that matter here. In electrolyzers, the company is even larger in terms of market share, coming in at 20-30% if we exclude China.

In the USA, the company is moving forward with its plans for a "Gigafactory", with the aim of a 4GW production capacity, with a phased building schedule to match supply with demand. No final investment decision has been made, but it's moving forward.

The positives for 1Q23 include increased revenue and backlog activity. Investors seem willing, even in this environment, to invest in Nel with another successful placement in new equity. However, whenever a company only points to revenue growth, I know that the issue is how that revenue is translated to actual earnings - and we get this confirmed when we look at top-to-bottom line results and growth - or lack of it.

Analysts also continue to be surprisingly positive on this company, giving it high targets that on an analyst basis make this company a "BUY" - if you believe their price targets at least - more on that in a while.

The best that can, additionally, be said for Nel is an improvement in actual profitability. But when I talk about improvements, I usually want to see that toward positive GAAP. We're nowhere near this at this time. At an EBITDA margin of negative 12% for the quarter, while substantially better than YoY, it's nowhere close to GAAP profit.

Drivers of the company's improvements are higher-margin contracts. It's a bit worrying to me that even under newer, better-margin contracts the company cannot reach even close to GAAP profit. However, I know well that this is also mostly due to constraints and inefficiency in production - and if Nel were to scale up its production, we'd see very different numbers. Having improved its margins to customers, the company now needs to improve its production.

Once we get clearer indicators - or any indicators - of what this could do to margins beyond pure guesswork, I'd be willing to be more positive about the company and really start to formulate a concrete plan for investing here.

Further improvements are on the way, but I'd want to see either EBITDA profitability or close to it before I take another look at this.

Further improvements, I think, we will see when the legacy projects, so to speak, signed in '20 and '21 are delivered out of our books and we can get more of the large-scale contracts into our P&L. That will bring further improvement.

(Source: Nel ASA Earnings Call)

Let's look at valuation.

Nel ASA valuation - still high for a company that doesn't make a profit

So, good news first. We do have analysts that, based on their knowledge about the business and what they think will happen, are willing to put their names on paper and give a forecast about GAAP profitability/net income profitability for Nel ASA.

Currently, they expect Nel to go positive in 2026E, with a net profit of around 330M NOK.

However, what i want you to focus on at this time is the sheer amount of revenue difference between even 2025 and the latest actual, filed results we have. They're more than 3 times the top-line results a single year, or more than the company's current entire backlog in a single year.

So, as you can understand, there are a lot of assumptions built in here about growth which may, or may not happen given the state of current macro. I would personally be very careful forecasting any expansion like this for a technology that is, at this time, still somewhat "niche".

While this is a potential development, what is also entirely possible is that the company sticks to far smaller growth rates even in revenue going forward - and that various complications make it difficult to ramp up capacity in the timeframe the company previously believed itself able to be able to.

Compared to my previous article, the analysts also now see the company going profitable a full fiscal before the previous thesis - which is again, a bit positive for my liking. I don't believe that will necessarily happen. I said in my previous article that the bullish thesis is based on debt expansion to the tune of 4-7x EBITDA, as well as a resulting gross margin reversal to 40-50% - but it leaves me wanting in how SG&A is being calculated in those bullish assumptions, or if the combination of new manufacturing coupled with higher-margin contracts will really wind down COGS relative to revenues as much as they think. When I apply conservative estimates, I get entirely difficult results - even at a positive assumption, only bare-bone profitability in terms of net profit, and a far steeper slope to climb for the company.

Here was the basis for my previous thesis in my last article, and as of 1Q23, improvements notwithstanding, this has not changed.

Until I see a turnaround or a plan for profitability - and the company doesn't disclose forward gross margin numbers because it wants to keep these a secret - I don't see a good thesis for investors to be made here. The company's answer that we'll have to wait for the revenues and P&Ls from those is not good enough for me, because it calls for the faith I do not have even in a Norwegian company like this.

(Source: Nel Article, Seeking Alpha )

If you're curious about more basic information about Nel, I refer you to that initial article, as it covers these more. For now, my investment thesis for Nel ASA is as follows, and unchanged.

Thesis

• Nel is an interesting project - but unfortunately not yet a profitable business. As I currently judge my investments, I am unwilling at this time to put my money to work in this sort of investment.
• I'll wait for the company to become interesting, meaning when it's able to show me at least an indication of turning around and getting better margins. At this time, there's too much opaqueness from the company and from the market for this.
• I don't see Nel being worth 14 or even 10 NOK - without profit, I'm unwilling to give it a PT, and I maintain my "HOLD" as of June of 2023.

Remember, I'm all about:

1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.

2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.

3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.

4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them ( italicized ).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside based on earnings growth or multiple expansion/reversion.

The company fulfills none of my criteria and is therefore not to be considered a business to invest in here. I'm at a "HOLD", but I will watch Nel for changes going forward.

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