Tuesday, March 18, 2008

Fuel Cell Science Project

Since one of the studies mentioned in the March 11th post, “Well to Wheel,” suggested hydrogen wins out over other alternative fuels at least for powering passenger vehicles, it seemed appropriate to return to the fuel cell companies.

An update of our index of fuel cell producers and related businesses is available on the Crystal Equity Research web site. If nothing else, the index lays bare the essential truth of the hydrogen fuel cell - it is still a science project. While several of the fuel cell producers have revenue, none are producing profits. Indeed, most are a long way from profitability.

The one exception is Dynetek Industries, Ltd. (DNK: TSX), which produces power distribution systems. Of course, Dynetek is not a hydrogen fuel cell producer exactly. However, since storage and distribution are two of the stumbling blocks hydrogen must overcome, distribution infrastructure could be a solid way to invest in the sector. Dynetek is near breakeven at the operating level and is producing positive cash flows.

Of course, you can also play the distribution angle with Air Products & Chemicals (ADP: NYSE). Air Products is providing distribution and storage infrastructure in both the U.S. and the U.K. It is highly profitable and trades at 19.3 times earnings. However, as a highly diversified chemical company, Air Products is not a hydrogen pure play.

Among the hydrogen fuel cell producers, Ballard Power Systems (BLDP: Nasdaq) and FuelCell Energy (FCEL: Nasdaq) remain perennial favorites mostly because so far they have produced the most revenue. FuelCell’s focus on stationary fuel cells for power generation is appealing since this application does not require a build out of infrastructure as would be necessary for automotive use. The Connecticut Public Utility group just approved projects involving 16.2 MW of FuelCell’s DFC300 Fuel Cells. The four projects include two hospitals and two utilities.

Ballard Power’s position in the power generation market appears to be confined to co-generation projects in Japan. Ballard has teamed up with Tokyo Gas to demonstrate residential co-generation systems. One of the reasons Ballard is not bigger in the power generation market is the inflexibility of its proton exchange membrane (PEM) technology for large scale applications.

While the residential application may have merit, we believe there are greater demand drivers in the utility and commercial markets to produce green energy. Consequently, we believe the penetration rate will be faster for commercial rather than residential power generation.

We note FCEL shares are trading at 7.3 times sales versus BLDP at 5.8 times. That said, when taking a position in the fuel cell sector, we see market position, business strategy and technology as more important factors than relative valuation.

Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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