VWAGY - Solid Power: Too Risky For Me

2023-12-11 15:00:00 ET

Summary

• Solid Power currently trades around ten times lower than its all-time highs, which might be the reason for risk-takers to opt in.
• However, my valuation analysis suggests the stock is massively overvalued even with optimistic underlying assumptions incorporated into the financial model.
• The company does not have any competitive strengths in the fiercely competitive industry, and the premium to the fair value does not look fair.

Investment Thesis

Solid Power ( SLDP ) was one of the hottest IPOs amid the pandemic-fueled stock market frenzy, but now the stock trades almost ten times cheaper than its late 2021 all-time high. Long-term investors seeking a potential moonshot might be tempted to opt in, but my valuation analysis suggests that there will likely be better buying opportunities as the stock is massively overvalued. The company operates in a promising solid-state power batteries field, but my analysis suggests that the industry is already crowded with the largest automotive OEMs. That said, SLDP's strategic partnership with BMW does not look like a competitive advantage. The balance sheet is solid, but given the cash burn pace, SLPD will likely run out of liquidity by 2026. All in all, I assign the stock a "Strong Sell" rating.

Company Information

Solid Power develops solid-state battery technologies to enable the next generation of rechargeable batteries for the fast-growing electric vehicles ((EV)) and other markets. According to the latest 10-K report , SLDP has a strategic partnership with the leading global OEMs like Ford ( F ) and BMW ( BMWYY ).

The company's fiscal year ends on December 31 with one operating segment.

Financials

The company is at a nascent stage of its development. SLPD went public in 2021 , so the earnings history is short. That said, there is not that much to discuss from the longer-term financial performance perspective: the company is deeply unprofitable because revenues are insignificant and substantial amounts are spent on R&D.

Solid Power raised around half a billion during its IPO, and the majority of IPO proceeds have been burned. The outstanding cash balance is slightly below $200 million, with almost no debt. As SLPD, on average, demonstrates around -$20 million of the levered free cash flow ((FCF)) per quarter, cash reserves are likely to be sufficient to operate for the next ten quarters. This means that the company will unlikely need to raise additional finance within the next 2.5 years.

However, since the company is deeply unprofitable and the scale is still small, consensus estimates forecast the adjusted EPS to turn positive only in FY2029. With that being said, SLPD will likely need to raise additional finance in FY 2026. Since it is unlikely that a young company like SLPD will be able to raise debt finance on favorable terms, it will need to issue more stocks and dilute current shareholders. While I do not consider additional share issuance a big problem for young, growing companies, potential investors should be aware of this fact.

The latest quarterly earnings were released on November 7, when the company topped consensus estimates by a wide margin. Revenue grew by 126% YoY, but the adjusted EPS did not improve. It might be ready to speak about the economies of scale effect, but as the quarterly revenue more than doubled, the operating margin demonstrated positive movement.

It is important to underline that the YoY quarterly revenue growth is not quite stable. For Q4, consensus estimates forecast revenue at $4.08, which is a slight pullback compared to the same quarter of 2022. The adjusted EPS is also very volatile and expected to drop YoY from zero to -$0.13. The earnings release for the upcoming quarter is scheduled for February 28, 2024.

The solid-state battery industry is in the early innings of its development, and this market is expected to compound at a staggering 42% by the year 2030. However, in our rapidly evolving world, especially in terms of energy technologies, the level of uncertainty regarding the industry's growth pace is substantial. There are several reasons solid-state batteries win against traditional lithium-ion ones, including smaller size, lighter weight, fewer explosions, and greater energy efficiency. But what is the most important for EV manufacturers is that this new technology can ensure greater range, which is one of the most important battlefields between legacy cars and EVs. And that is the reason why all the largest automakers are investing heavily in this new technology. For example, Mercedes-Benz ( MBGAF ) is partnering with the Taiwanese solid-state battery company named ProLogium . Another global automotive giant, Volkswagen ( VWAGY ), has invested in QuantumScape ( QS ). The world's largest automaker, Toyota Motor ( TM ), does not believe in partnership in this field and bets more than $13 billion on its in-house solid-state battery R&D and facilities buildout. That said, the vast potential of solid-state batteries is already recognized by all the major automotive players , and the technological race will be tough, softly speaking. The industry already looks crowded, where all the biggest players are already present.

Apart from being a crowded space, the industry faces substantial supply-chain headwinds. The sourcing of raw materials seems to become a big problem even for traditional lithium-ion batteries in the near future . Solid-state batteries require even more specific materials, such as solid electrolytes and electrode materials, which will also mean supply-chain challenges as the industry ramps up. During the latest earnings call , SLDP's management acknowledged that it faced significant supply chain and vendor quality issues on both the cell and powder production side to ship around 80 EV cells to BMW. That said, industry players will need to solve substantial supply-chain problems to be able to ramp up production.

To conclude, from the strengths side, Solid Power has exposure to the industry, which is expected to grow multiple-fold over the next decade. However, there are apparent industry-specific headwinds with the supply chain, which it faces even at the early stage of development. This brings a great extent of uncertainty regarding the economic feasibility of the business over the long term. Moreover, the space is already crowded with all the strongest global legacy automotive players' capabilities, and the EV leader Tesla ( TSLA ) has its own energy business, which is focused on battery enhancement. That said, it does not look like Solid Power has any competitive advantages that will help it stand out from the competition.

Valuation

SLDP tanked by 40% year-to-date, significantly underperforming the broader U.S. stock market. The stock looks well overvalued from the perspective of valuation ratios, especially from the price-to-sales ratio, which is close to 15, way over the sector median.

The discounted cash flow ((DCF)) simulation looks like the best option to value a young growth company like SLPD. Consensus revenue estimates project the top line to compound at a staggering 67% over the next decade, which I consider unfairly high since the overall industry growth is projected at 42%, and I do not see any strong competitive advantages for SLDP to enable it to significantly outpace the overall industry growth. Therefore, I incorporate a 42% revenue CAGR for my DCF simulation over the next decade. As we have seen in the above analysis, consensus estimates forecast the adjusted EPS to break even in 2029. Therefore, I also project the FCF margin to turn positive in 2029 and expand by two percentage points yearly. Due to the massive level of uncertainty regarding the ability of solid-state batteries to be commercialized, I use a high 20% WACC for discounting. I ignore the current solid net cash position for my fair value calculation because it will be burned within the next couple of years.

According to my DCF simulation, the business's fair value is around $186 million. This is around 33% higher than the current market cap, meaning the stock is overvalued. That said, my fair stock price estimation is closer to $1.

Risks For My Bearish Thesis

Betting against young companies in industries that are projected to compound at 42% per annum is risky. Companies like Solid Power are not expected to start generating profits in the foreseeable future; breaking headlines is the biggest factor affecting stock price fluctuations.

Potential positive developments regarding substantial supply-chain improvements might be a significant catalyst for the stock price because easier raw material sourcing will mean fewer costs and will likely shorten the company's path to achieving profitability. Or the company might expand its strategic partnership with BMW or other companies, which will not bring conflict of interest to its existing contracts. This will also likely be positively absorbed by the market and might lead to a spike in the stock price.

Bottom Line

To conclude, Solid Power is a "Strong Sell." The company's stock is substantially overvalued, and my analysis suggests that SLDP has nothing to offer to potential investors that will differentiate it from fierce competition. The company is exposed to a promising industry, but there are massive risks related to the already intense competition and supply chain issues which companies already face when production output volumes are low.

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