STEM - Stem's Pivotal Turn: Unpacking The Unexpected Growth Rate (Rating Downgrade)

2023-11-13 13:13:10 ET

Summary

• Initially, Stem, Inc. enjoyed a soaring stock fueled by investor confidence in management's narrative.
• Despite notable successes like a record bookings quarter and strategic expansions, concerns surfaced about financial performance.
• Stem's once-robust triple-digit revenue growth rates decelerated, leading to doubts about stability into 2024.

Investment Thesis

Stem, Inc. (STEM) uses advanced technology to make renewable energy systems work better. They provide businesses and energy companies with tools like storage systems and smart software to improve the efficiency of clean energy and cut costs.

This was a company whose stock was flying high as investors were keen to back management's narrative. But the problem here is that management started making adjustments to its revenue growth rates.

And what previously was the most alluring facet of this story has suddenly become dimmer. Consequently, I'm forced to go to the sidelines with my recommendation.

Quick Recap,

In my previous analysis , I said:

The problem for Stem is that, aside from the fact that the need for energy security has faded away from the market's narrative , to complicate matters further for Stem, it's burning through significant cash flows while its balance sheet surfaces more questions rather than providing investors with a sense of ease.

This is a mixed-bag investment. Yet, I remain bullish for now, as I believe that most, if not all, of these negative considerations are already in the share price. In fact, certainly, investors' expectations can't be that high, after all the stock is already down nearly 70% over the past 12 months and its multiple has compressed from 6x forward sales down to just 1x forward sales.

While I was aware that this investment was a mixed bag, I counted on management's ability to accurately guide Stem's prospects. Indeed, the core of my thesis was contingent on management's guidance. But since management has now abruptly revised its outlook, I'm also forced to change my mind.

Stem's Near-Term Prospects

I'll first describe the bull case and provide context, before discussing the bearish aspects that keep on the sidelines.

Stem as positioned has had some notable success. For instance, its recent record bookings quarter and strong momentum across diversified markets.

Moreover, Stem's strategic expansion into the municipal and cooperative sectors, particularly in the Northeast, has yielded a 15% market share, with expectations for additional growth. The introduction of PowerBidder Pro in September received positive responses, signaling the potential for software and recurring revenue growth.

Also, Stem's collaboration with SP Power, a major developer with a 10-gigawatt pipeline, adds further optimism, despite the acknowledgment of longer project timelines.

Stem also describes its intention of achieving positive EBITDA in fiscal 2024 and maintaining a solid cash position.

Given this background, let's now delve into its financials.

Revenue Growth Rates Slow Down, But What of 2024?

In my previous analysis, I said,

Stem's revenue growth rates this time last year could be counted on for triple-digit growth rates. Today's growth rates are on a path to approximately half this growth rate.

Naturally, investors are concerned that Stem's growth rates could continue to slow down into 2024.

Case in point, back in August, Stem gave investors the impression that although it had to compare against a period in the prior year where Stem saw very strong growth rates, it could stabilize its growth rates going forward.

What investors didn't expect to see was a reduction in its revenue growth rates, so 2023 is now expected to grow by around 60% compared with the close to 80% CAGR investors were previously guided towards.

In practice, this alludes to two considerations. Firstly, if management can't guide from August into the year-end, this implies that there's a large likelihood that not only management won't be successful in guiding for 2024.

Secondly, this implies that the business is more susceptible to the market's whims, in terms of customer demand, and that Stem is less in control of its future prospects than we were previously led to believe.

Cash Burn in Focus

Anyone who follows Stem knows that this business is unprofitable. But that wasn't a key consideration when its growth story was getting stronger and stronger.

But now that its growth rates are rapidly decelerating, investors are more cautious.

In fact, one aspect that I find that investors are particularly harsh in punishing a stock is when a company makes adjustments to its revenues. Management used the earnings call to explain that going forward the company doesn't expect any further material reduction in revenues, if any at all. But once a company is in the penalty box, it's difficult to regain investors' trust.

Another element that weighs on this stock is that it is burning significant cash flows. Even if Stem reaffirms that in 2024 it will be EBITDA profitable, investors are so skeptical of this company's ability to accurately guide that even if the stock continues to get a lot cheaper, that consideration alone is unlikely to put a floor on this stock in the near term.

In my experience, I find that cheap stocks can get a lot cheaper. Dramatically cheaper than I could have previously deemed possible. What investors want here is confidence that management can truly deliver them a profitable enterprise.

The Bottom Line

As I dive into the dynamics of Stem, it's evident that a narrative shift has taken place, altering the outlook for this renewable energy technology company.

Stem, recognized for its innovative approach to enhancing renewable energy systems, faced a turning point as management opted to tweak its revenue growth rates.

While Stem, Inc. boasted achievements like a record bookings quarter and strategic expansions, concerns have started to emerge regarding its financial performance.

The unexpected reduction in growth rates raised questions about Stem's control over its future prospects, impacting investor confidence.

Moreover, the spotlight shifted to Stem's unprofitability, a factor previously overlooked in the face of robust growth. Now, with heightened scrutiny on cash burn and revenue adjustments, I'm pushed to the sidelines on this stock.

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