ITM Power: challenged hydrogen player – seeking Alpha.
We present our note on ITM Power (OTCPK:ITMPF), a pure-play hydrogen company. We issue a Sell rating due to ITM Power’s execution challenges, sluggish turnaround, and long-term commoditization risks. While multiples have substantially contracted from peak levels in early 2021, we find ITM’s valuation still expensive. We will provide a brief introduction to the company, analyze its recent performance, and lay out our investment case and valuation.
A Brief Overview Of ITM Power
ITM Power is a UK-based pure-play hydrogen technology company. It was founded in 2001, starting at a lab at Cranfield University. ITM designs and manufactures electrolyzer systems that generate green hydrogen, using the proton exchange membrane (PEM) technology.
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The company has a strong technological leadership in PEM. In 2021, ITM launched the world’s largest electrolyzer gigawatt factory at Bessemer Park, Sheffield, and in October 2021, ITM raised £250 million of equity to fund its ambitious expansion plans. ITM Power is listed on the London Stock Exchange’s AIM market and has a market capitalization of ~£555 million.
Hydrogen – A Competitive Industry
We invite our readers to check our note on Nel, which contains a detailed analysis of the nascent hydrogen market. We explore the case for green hydrogen in hard-to-abate sectors, lay out global demand projections, and point out the limited barriers to entry, capacity buildup, and potential competitive pressure from Chinese players – drawing parallels to solar panel manufacturers. We highlight the negative implications of a highly competitive and commoditized industry on equity returns.
FY2023 Results
ITM reported its delayed FY results in August. Revenue came in at £5.2 million for FY2023, i.e., 8% lower vs last year but ahead of guidance. Gross losses came in at £79 million for the FY, more than tripling vs. last year due to customer contracts and inventory losses including write-offs and provisions as a result of product design iterations and products becoming obsolete.
Cash burn for the year stood at £83 million, also better than guidance. ITM also announced its FY2024 guidance which includes a revenue range of £10-£18 million, an EBITDA range of negative £45-£55 million, and a net cash range of £175-£200 million.
ITM is undergoing a turnaround which involves refocusing on core products, i.e., the TRIDENT module. Moreover, second generation containers are being developed and cubes are being phased out. On the investor call, the company announced, that the failure rates of products are improving.
This is a significant step forward towards reaching lower provision levels. It is important to note, that ITM sold its hydrogen refueling station business, Motive Fuels, retiring its cash commitment and focusing exclusively on its core business.
Investment Thesis And Valuation
ITM’s present market capitalization of £555 million, and EV of £200 million implies 14x midpoint sales guidance 2024, vs 3.4x EV/Consensus Sales for peer McPhy, 3.0x for Plug Power, <1x for Fusion Fuel Green, and 6.7x for Nel. Rolling the numbers forward to FY2025, the valuation of ITM stands out as the most expensive once again, by a wide margin.
We expect a significant growth of electrolyzer sales in the following years driven by the push to decarbonize hard-to-abate sectors, however, we find the current valuation expensive, especially given the competitive backdrop of the industry and turnaround challenges of ITM.
As with Nel, for the purpose of our valuation exercise, we assume a 15% target EBITDA margin as the company matures. This margin range could be on the high-end, given the issues discussed above, and ITM has a lot to prove in terms of executing its turnaround plan.
On an FY25 revenue of £60 million (more than 200% growth vs. FY24), This target margin would imply ~£9 million of EBITDA in FY 2025, or an EV/EBITDA multiple of 22.2x. This is purely a theoretical exercise as EBITDA in FY2025 is expected to be negative likely over £-40 million.
Performing the same analysis as with Nel applying target equity IRR vs current market capitalization, implied net income, and sales; we assume a 10% equity IRR and we arrive at a target market capitalization of £1.1 billion in 2030. Given the risk of this investment equity investors should ask for a return in excess of 10%, but we are simplifying the exercise further.
A mature industrial enterprise should trade at around 10x EPS, implying around £110 million of earnings by FY2030. At 10% net margin, that would be $1.1 billion of sales per year. At $300k/MW we could arrive at implied sales of 3.6 GW+ per year. That is excessively optimistic and fails to even take into account the substantial capital required to build up the capacity.
Even though our valuation exercise contains a range of quite optimistic assumptions, it is evident that ITM Power’s equity is expensive and reflects targets that are beyond the reach of the company. It moreover fails to discount the required investments and assumes operational excellence.
We see ITM as another overhyped name in the hydrogen bubble and note its relative overvaluation even vs other hydrogen peers, including Nel. Even with the most generous assumptions, we would see at least 30% downside.
Risks
Risks to our thesis: i.e., upside risks include higher than expected penetration of hydrogen vs CCS and batteries, higher than expected incentives and subsidies, higher than expected penetration of PEM technology, tougher than expected protectionist measures insulating European players from global competition, the company becoming an acquisition target for a major industrial player, integration in big scale renewable energy projects, swift execution of the turnaround plan, major technological breakthroughs, etc.
Conclusion
Given the expensive valuation of ITM shares even in a tough backdrop, driven by overhyped long-term expectations, we rate ITM Power as Sell, and see more than 50% downside.
Summary
- ITM Power, a pure-play hydrogen company, is facing execution challenges, a sluggish turnaround, and long-term commoditization risks.
- The company reported lower revenue and increased gross losses for FY2023.
- The current valuation of ITM Power is expensive compared to its peers, and even with optimistic assumptions, the equity is overvalued.
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ITM Power: Challenged Hydrogen Player, August 29, 2023
