2023-12-29 07:23:43 ET
Summary
- Green hydrogen stocks, including McPhy Energy, have faced significant pressure on their share prices due to challenges including higher interest rates, capex cost inflation, and subsidy delays and opacity.
- McPhy needs more orders to support the story, but higher rates, higher costs, and issues with incentive programs are leading many adopters to delay, suspend, or cancel green hydrogen projects.
- McPhy hasn't reported any large cancellations and has in fact announced a meaningful new order, as well as the lifting of the suspension on its CEOG project with Siemens Energy.
- Liquidity is a real risk; the company has arranged for an equity financing line and is pursuing the sale of its hydrogen refueling station business, but it will take substantial funding to reach positive FCF.
- Lower rates in 2024 could spur renewed interest in the green hydrogen sector and expectations have come down significantly, but this is a very speculative story now.
Little has gone in favor of green hydrogen in 2023, nor for small companies like McPhy Energy ( MPHYF ) (MCPHY.PA) that are seeking to establish leadership in the field of developing and manufacturing essential equipment like electrolyzers. Between higher interest rates, capex cost inflation, challenging subsidy rules, and more caution from would-be users, McPhy and other emerging hydrogen stocks like ITM Power (ITMPF), Nel ASA (NLLSF), and Plug Power ( PLUG ) have seen serious ongoing pressure on their share prices, with McPhy down 49% since my last update versus the 32% to 45% declines of the other names.
At this point it is difficult to recommend McPhy even as a speculative play on a market I expect to see significant growth over the next 20 years. Simply put, McPhy just isn’t generating the revenue (let alone cash flow and profits) it needs to, cash is flowing out, and raising capital on decent (let alone attractive) terms is increasingly difficult. While I am still a believer in hydrogen, it’s far from unthinkable that many of these early players will fail only to see other, larger and more liquid companies, pick through the debris, secure the technology and capacity these early players established, and then see success in the market in 2030-2040.
A Year Of Troubles For Green Hydrogen
This has been a challenging year for green hydrogen on many fronts, with several factors combining to drive up the cost of hydrogen generation and likewise the levelized cost of green hydrogen. At the same time, government policies and subsidies meant to incentivize adoption and investment have been slow to materialize, and often with laborious, opaque processes for would-be generators.
Higher interest rates are a pretty straightforward contributor to the pressure on hydrogen projects. Simply put, higher rates drive higher discount rates and lower expected returns from hydrogen projects that in many cases will need a long time to mature and generate meaningful positive cashflows (typically post-2030). Rates have started to ease, and 2024 could well see the Fed transition to rate cuts, that could set up stocks like McPhy as strong plays on lower rates, but it will take time for potential customers to revisit projects that have been deferred or canceled in 2023 due to unacceptably low expected returns in the face of higher rates.
Inflation has also had a significant impact on hydrogen projects and demand for McPhy’s electrolyzers. Estimated capex costs for green hydrogen projects have risen more than 70% (from around $1,750/kw, on average, to around $3,000/kw), further pressuring the expected returns from hydrogen projects. Likewise, inflation has hit green energy sources, with wind and solar electricity prices up more than 40%, driving the cost of hydrogen production up over EUR 1/kg (relative to a levelized cost of around EUR 6-7/kg).
While numerous governments have pledged their support for green hydrogen, the rubber has been slow to meet the road. The IRS only recently released its guidelines for clean hydrogen tax credits under the Inflation Reduction Act , around three months later than initially expected, and while the draft guidelines are basically in line with what investors had come to expect (up to $3/kg in production subsidies), there are a lot of details yet to be finalized, including how hydrogen production is matched to the production of clean energy.
In the EU, more than a few projects have been suspended, deferred, or outright canceled due to what many participants have categorized as a long process with low visibility. Eventually, there may be enough irritation and political motivation to cut through some of the red tape, but it’s a challenge likely to remain for at least the next few years.
Progress On Orders … But Delivery Dates Delay The Benefits
At a time when rivals like ITM Power and NEL have been announcing some order cancelations and pulling back on capacity expansion targets, McPhy has actually had some good news on the order front.
Back in mid-October, McPhy announced that it had been notified by Siemens Energy ( SMNEY ) that the suspension of the CEOG project had been lifted. McPhy will initially be supplying a 16MW electrolyzer but the delivery isn’t expected to take place until the second half of 2024. Likewise, the company announced an award in December from HMS Oil & Gas for four electrolyzers (64MW in total) for its Radeland compression station in Brandenburg, but the first electrolyzer isn’t scheduled for delivery until 2025, with the other three shipping in 2027.
That matters, as the clock is ticking on McPhy’s liquidity. The company ended the first half of 2023 with EUR 97M in cash (the company reports financial numbers twice a year) and a first-half burn rate of EUR 38M. At some point, reining in operations to reduce costs will also start compromising business development, putting the company in an unenviable “rock vs. hard place” position.
The company is taking steps to improve its liquidity and cash burn situation. The company announced in mid-December that it was in exclusive discussions with Atawey to sell its hydrogen fueling station business. I consider this business to basically be a distraction for the company at this point, and if the company can simultaneously reduce costs/cash burn, generate some sort of cash for that business, and refocus around its electrolyzer business, then so much the better.
The company has also recently announced a renewed equity financing line with Vester Finance to raise funds through equity issuance. The financing line is limited to a maximum of 4.8M shares over the next two years, with management committed to a EUR 2M minimum drawdown. While the terms seem okay given the circumstances (with the issuance price based on the average price of the shares immediately prior to a drawdown, a 5% maximum discount, and a 2% variable commission), there is a real risk of the company having to issue significant share capital (equal to around 15% of the existing share count) at low prices – even the full designated amount doesn’t come close to getting the company to free cash flow breakeven in my model.
The Outlook
As I said above, McPhy’s challenges aren’t unique, and the company hasn’t announced any major cancellations. I also like the move to divest the fueling station business, as I view this as non-core to the long-term business. Even so, the fact remains that the environment for green hydrogen projects has become a lot more challenging in the last 12 months, and it seems as though many would-be users of the technology are pulling back to either wait-and-see how previously announced small-scale pilot projects work out (like McPhy’s project with ArcelorMittal (MT)) or wait for more clarity on subsidy/incentive programs.
McPhy could still become a billion-dollar revenue generator in the future, but the company has to find its way through an increasingly challenging liquidity situation in a market that has definitely soured on emerging hydrogen companies. At the same time, higher rates and costs seem likely to push out more project timelines, only adding to the stress on this sector.
If the industry sees some combination of lower rates, lower capex costs, and more clarity on subsidies and incentives in 2024, McPhy could double. Likewise, the company could certainly benefit from reduced cash burn, new funding on reasonable terms, and new order announcements. On the other hand, there’s a real risk that prospective adopters of green hydrogen stay on the sidelines for a while longer and that McPhy can’t sustain the ongoing cash outflows to build the business and survive to the point where hydrogen projects really start moving (not unlikely, how the global LNG capacity buildout saw years of hope and disappointment before a surge in projects).
The Bottom Line
Suffice it to say, McPhy is now a “consenting adults” type of stock that is really only suitable for investors willing and able to take on significant risk in the pursuit of above-average returns. Although I do think McPhy has a product lineup that can make it a player in green hydrogen generation (as well as improving capacity), liquidity is a real concern now that the bloom is off the rose for green hydrogen, and it may take some time before would-be producers and investors come back with renewed enthusiasm and capital.
For further details see:
McPhy Energy: Weakness In The Green Hydrogen Market Is Hitting At A Bad Time