NKLAW - Plug Power: Initial Thoughts On The Collaboration With Nikola

Summary

• The Plug Power and Nikola collaboration benefits Plug Power in the form of new hydrogen liquefaction and green hydrogen supply agreements.
• This collaboration highlights the strong competitive positioning of Plug Power due to its vertical integration strategy.
• In addition, it adds further credibility to the hydrogen liquefaction technology that Plug Power has.
• Plug Power is unlikely to rely solely on Nikola for its heavy-duty vehicle strategy.
• My 1-year target price for Plug Power is $30.02, implying 156% upside from current levels.

Investment thesis

While Plug Power ( PLUG ) has continued to struggle in this market environment given that it is still currently an unprofitable company, I think that the fundamentals continue to look good for Plug Power. I reiterate my investment case for Plug Power and continue to see Plug Power being a key beneficiary from the opportunities coming from the strong tailwinds of increasing adoption of and utilization levels of the hydrogen economy. Specifically for Plug Power, it has a strong revenue growth potential as it looks to meet its mid- and longer-term revenue targets. The company's vertical integration strategy is starting to bring additional advantages as customers see the strong value add that Plug Power can bring across the entire hydrogen ecosystem. This is further illustrated in the article below as the collaboration between Plug Power and Nikola continues to demonstrate Plug Power's strong competitive positioning.

I wrote an article about Plug Power's Plug Symposium after attending it, which can be found here , as well as other earlier articles, which can be found here .

More about the collaboration with Nikola

Recently on 15 December 2022, Plug Power announced that it was entering a collaboration with Nikola ( NKLA ) on green hydrogen, liquefaction and fuel cell electric vehicles ("FCEVs").

This announcement is significant, in my view, in part due to management having mentioned in the past that as part of its vertical integration strategy, class 8 trucks were one of the new key markets it was looking to accelerate growth in. At that point in time, there was no reference to which one of the class 8 truck companies that Plug Power might work with, but the management did mention that a partnership was more likely.

Fast forward 6 months, later, this collaboration with Nikola was announced and this was really in the making since then. What will the new collaboration with Nikola mean for Plug Power?

Firstly, Plug Power and Nikola announced that they have entered into a green hydrogen supply agreement where Plug Power will, from 1 January 2023, supply green hydrogen to Nikola. The volumes will ramp up to 125 tons per day ("TPD") as the company's production network for green hydrogen ramps up and more of it comes online. Under the agreement, there is an expectation that 125 TPD in volume will be contracted by December 2026 and 80% of that will be under a take-or-pay contract.

Secondly, Nikola awarded Plug Power the contract for one 30 TPD hydrogen liquefaction system. This will be for Nikola's Arizona hydrogen hub . Specifically, the hydrogen liquefaction system to be delivered to Nikola that will be designed, engineered and manufactured by Plug Power, will have the ability to scale up to 150 TPD and is expected to be for the first phase of Nikola's hydrogen hub. Nikola intends to access up to 300 TPD of hydrogen supply and up to 60 hydrogen dispensing stations by 2026. For Nikola, its Arizona hydrogen hub is now under the process of permitting and rezoning and the company is in the process of procuring long-lead equipment. According to Plug Power in the press release , its hydrogen liquefaction system is one of the most energy efficient as well as one of the most cost-effective designs currently available in the market, using hydrogen as the refrigerant in the main liquefaction cycle.

Last but not least, Plug Power will buy 75 Nikola Tre FCEVs in the next 3 years, with 2023 being the year in which the first trucks will be delivered. According to the company, this initiative will reduce Plug Power's current scope 1 emissions by up to 50% and will enable further decarbonizing of the hydrogen supply chain for its customers. Plug Power's own liquid hydrogen tankers will be paired with these purchased FCEVs from Nikola that will bring the best over the road payloads due to Plug Power's liquid hydrogen tankers being the largest and lightest currently in the market.

Some thoughts on the collaboration

The collaboration is certainly positive for the hydrogen ecosystem as it does help to accelerate the use of hydrogen as an alternative for applications like heavy duty vehicles. For Plug Power, it is able to provide partners like Nikola with support along different parts of the hydrogen value chain and ecosystem, while it is able to also show its own customers that it is using FCEVs itself.

One concern in particular for Plug Power's investors is the reliability of Nikola. While the collaboration does bring benefits, will these benefits materialize if Nikola is no longer a viable business in the future?

The key concern is having Nikola as a counterparty for the take-or-pay agreement adds another element of risk for Plug Power as Nikola has a weak balance sheet and continues to be burning significant cash.

That said, in my view, I think that Plug Power will not just rely on Nikola on its FCEVs for the company's heavy duty vehicle strategy. Over time, I think we will see Plug Power go into more agreements with other trucking companies that are able to provide a more balanced profile to its suppliers of FCEVs. Along the same lines, I think that these other trucking companies will be lured to partnering with Plug Power due to its strong value add from its vertical integration strategy that will enable its partners to obtain supply of hydrogen that is cost competitive.

Positive implications for Plug Power

This collaboration demonstrates to me the strong competitive positioning of Plug Power in the hydrogen ecosystem, and less so for Nikola. For me, the agreement shows that Plug Power has a strong competitive positioning in the hydrogen ecosystem as it is a key partner to downstream players like Nikola. Plug Power's vertical integration strategy is starting to pay off as it is increasingly demonstrating its ability to enable its hydrogen ecosystem partners in one or more ways.

For example, the collaboration with Nikola spans both green hydrogen supply agreements as well as for Plug Power's hydrogen liquefaction system. For a downstream player like Nikola, its value add is in being able to provide class 8 FCEVs to Plug Power, although I would argue that there are other players that are able to play that role as well. However, not many other companies are able to supply green hydrogen as well as design, engineer and manufacture a hydrogen liquefaction system for its partners.

The other aspect of the collaboration also highlights to me that industry players value the liquefaction technology that Plug Power is able to deliver.

While Plug Power is able to state that its hydrogen liquefaction systems are the most energy efficient as well as one of the most cost-effective designs in the market, I think that the fact that Nikola contracted Plug Power for the hydrogen liquefaction system for its own hydrogen hub does tell me that Plug Power's liquefaction technology is competitive in the market.

Lastly, the collaboration also proves that Plug Power is not just interested to build its own green hydrogen network but is also willing to support and enable other hydrogen players in the hydrogen ecosystem to build their own network. This will bring additional external revenues, in my view, as other hydrogen partners in the ecosystem see Plug Power as a worthy and strong hydrogen ecosystem partner.

To quantify the impact of the green hydrogen supply agreement, assuming a $6/kg price point and 125 TPD of green hydrogen supply, I think that this could bring approximately $270 million annually for Plug Power for the supply of green hydrogen.

For the hydrogen liquefaction system, I think that some of the revenues will show up in the 4Q22 quarter while more of it will show up in the 2023 fiscal year. For Plug Power's purchase of Nikola's FCEVs, I think that Plug Power would not rely solely on Nikola for its heavy-duty vehicle strategy. While not currently disclosed, I think that Plug Power is likely paying somewhat similar levels to the price of current diesel trucks as there is a strong subsidy environment for commercial FCEVs due to the Inflation Reduction Act, state subsidy programs like California's HVIP , as well as other available grants.

In terms of revenue contribution, this deal could bring approximately $1 billion in revenues in total until 2027 and enable Plug Power to further improve its competitiveness among other established industrial gas and energy players, especially for hydrogen production.

Value add that is much needed for Nikola

While the direct benefits to Nikola are clear, I think that this collaboration with Nikola is what Nikola needs to supplement and boost its cash flows. Given that Nikola is still at a low volume production stage, the cash inflow that would come from the sale of 75 FCEVs to Plug Power will bring added cash flows that are material for a company looking to ramp up. This will also add Plug Power to Nikola's portfolio of significant customers

Apart from that, Nikola will also have greater security and certainty around hydrogen supply given that this was what the company has been focusing on recently. With this new agreement with Plug Power, this will enable Nikola to reach its plans to aggregate 300 TPD of hydrogen supply and 60 dispensing stations by 2026 to meet its own customer refueling demands. Lastly, the company also will have access to Plug Power's hydrogen liquefaction technology that will enable Nikola to be able to dispense hydrogen to customers.

Valuation

With regard to my 1-year price target, I use both the DCF method and EV/EBITDA method. When doing the DCF, my main assumptions are the discount rate of 17% that I applied and the 20x terminal multiple. I applied a 30x EV/EBITDA to my 2025 EBITDA estimates and apply a discount rate of 17%. The higher discount rate was a result of factoring in the higher rates environment. I reiterate my view that Plug Power should be trading at a higher valuation multiple given its clear strategy, strong competitive positioning and long runway for future growth.

With that, my 1-year target price for Plug Power is $30.02, implying 156% upside from current levels. To incorporate relative valuation, the company is currenting trading at 3.5x EV/Sales based on its 2023 estimates while it is growing at 50% CAGR over the next 3 years, according to my forecasts.

Risks

Difficult risk-off market sentiment

Risk-off sentiment drives multiple re-rating

As Plug Power is still unprofitable, it has been impacted more significantly by the recent sell off in global stocks as rates continue to rise and a risk of recession looms. The risk-off sentiment has affected Plug Power more adversely due to a more severe multiple re-rating that causes valuation for the company to drop as investors have a lower risk appetite in the current environment.

Execution risk

While Plug Power has been executing well according to its plans, there are risks that either Plug Power or Nikola is unable to execute well according to the agreement, that may have implications for the collaboration between the two companies. As such, the two companies need to continue to execute well for the collaboration to bear fruits.

Conclusion

With the collaboration between Plug Power and Nikola, I think that my conviction for Plug Power's vertical integration strategy has improved. The company is becoming a key beneficiary of the increasing adoption of hydrogen technologies given its extensive reach across the entire hydrogen ecosystem. This is bringing additional business opportunities to Plug Power at a time when more of its customers are looking to new applications for hydrogen. In addition, Nikola choosing Plug Power's hydrogen liquefaction system is an endorsement for its hydrogen liquefaction technology and bodes well for future business opportunities in this space. I expect that Plug Power will bring in more agreements with other heavy-duty vehicle players and it is unlikely to rely just on Nikola for its heavy-duty vehicle strategy. My 1-year target price for Plug Power is $30.02, implying 156% upside from current levels.

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