Energy Storage: Q3 2012 Winners and Losers
I usually write a quarterly recap to summarize what happened in the energy storage and vehicle electrification sectors, but Q2 was a tough enough period that I don't see much sense in dwelling on the bloodletting. So instead of focusing on the past, I'll offer a quick summary table with lots of red ink and turn my attention to Q3, which is shaping up as a time of bright opportunity for some companies and profound risk for others.
I expect three companies in my tracking group to perform very well in Q3 – Exide Technologies (XIDE), Active Power (ACPW) and Axion Power International (AXPW.OB). All three look terrible if you only look at historical performance, but when you dig deeper into business history and market dynamics it becomes clear why all three have market-crushing potential over the next three to six months.
Exide Technologies has been the Rodney Dangerfield of the battery industry since emerging from Chapter 11 in 2004. The reason is simple. While Exide had solid prospects after its bankruptcy reorganization, it was not a healthy company and it was burdened by a lot of dead weight. During the four years I've been following Exide they've been restructuring their operations, closing marginal facilities and paring fat wherever possible. Over the last five years, Exide has reported total earnings of roughly $35 million after restructuring and impairment charges of almost $210 million. Since its net earnings were so bad for so long, Exide currently trades at a 38% discount to book value, 4.4 times earnings and 8% of sales while its peers trade at 1.5 times book, 11 times earnings and 70% of sales.
Restructuring costs are an accounting oddity. If a company builds a new plant to increase earnings, the costs of that plant are added to the balance sheet and depreciated over time. If a company closes an unprofitable plant to increase earnings, the associated restructuring costs are charged against net income. When a company like Exide embarks on a multi-year restructuring program, the positive earnings impact of the restructuring is not obvious until the restructuring is complete and earnings morph from dreadful to spectacular in very short order. Exide has reached the end of its restructuring and expects to emerge later this year. When the write-offs are old news and the positive impacts of the restructuring become obvious, the market's perception of Exide should change dramatically.
I maintain long-term price tracking charts on all the companies I follow and believe Exide's chart is signaling a sharp turn upward in the third quarter. If you look at the chart you'll see that the 10-, 20- and 50-day weighted moving average prices are clustered in a narrow range below the 200-day average and have already turned sharply upwards. When they push up through the 200-day average, Exide will have a classic golden cross to mark the beginning of a new uptrend. Similar chart patterns existed in the summer of 2009 and the fall of 2010. While I'd be hard pressed to estimate the next peak, Exide's historical price performance is enough to convince me that a double is likely and a good deal more is possible.
Active Power is a classic Valley of Death stock. It went public in 2000 right before the tech wreck and reached a high in the low $70s before falling to its all time low of $0.25 in late 2008. Since then Active Power has been working its way out of the Valley of Death and getting stronger with each quarter. Like Exide, Active Power's chart is right on the verge of a golden cross like we saw in the spring of 2009 and the summer of 2010. While I'd be hard pressed to guess the next top, Active Power's historical stock price behavior is enough to convince me that a double is likely, if not a triple.
Axion Power International is another Valley of Death stock that looks like a very ugly duckling until you dig down into the business fundamentals and understand the market dynamics that crushed the stock price over the past three years. Axion went public through a reverse merger in late 2003 when it was still an early-stage R&D company. During its first five years as a public company Axion's stock traded by appointment and total reported trading volume for 2009 was only 7.7 million shares, or about 3.8 million shares on the sell side and 3.8 million on the buy side.
In late 2009 Axion closed an immense private placement of 45 million shares, or the equivalent of 12 years of trading at historic levels. While I believed that the four anchor investors in the private placement were swinging for the fences with venture capital investments in a stock that offered no reasonable prospect of a short-term liquidity at a decent price, an unfortunate series of events including the death of one buyer, management changes in two more and unrelated financial problems in three legacy stockholders forced huge blocks of stock into a market that couldn't handle the selling pressure.
In addition to price data like I provided for Exide and Active Power, my Axion chart includes a fifth line that tracks 200-day average trading volume and highlights the seventeen-fold increase in daily trading volume over the last three years. When I contemplate the sheer mass of shares that have moved during that period, I'm amazed that the price didn't collapse completely.
In spite of a dismal price chart, Axion's business execution over the last three years has been flawless. Its PbC battery has progressed from a pre-commercial prototype to a production ready energy storage solution that beat all contenders including nickel metal hydride, lithium-ion, sodium metal chloride and fuel cells in two and a half years of testing for battery-powered locomotive applications, was used in the first behind the meter frequency regulation resource in the country, is a front-runner in energy storage for micro-hybrid vehicles and has recently set its sights on hybrid solutions for the long-haul trucking market. I can still account for a few million shares in the hands of likely sellers, but once those shares are absorbed the future market price will be in the hands of the patient long-term investors who have been buying Axion's stock over the last two years and squirreling it away in their sock drawers. Unless trading volume collapses, the selling pressure can't continue for more than another month or two.
After years of supporting a $150 to $200 million market capitalization with a negative stockholders equity it looks like Valence Technology (VLNC) will lose its Nasdaq listing within the next few weeks and be downgraded to the OTCBB. While the listing could be saved with capital infusion in the $60 million range, that possibility seems pretty remote.
While it's riding a wave of euphoria after the delivery of its first Model S sedans last week, I continue to believe Tesla Motors (TSLA) will pass its peak of inflated expectations in Q-3 and begin a dizzying descent into the Valley of Death. I don't want to denigrate Tesla's accomplishments as the first manufacturer of a high production volume electric vehicle and the first fledgling automaker to bring a new car to market since DeLorean, but it seems like all of the possible good news is already priced into Tesla's stock while the bulk of the execution risks and disappointment opportunities have become frighteningly imminent.
I get hundreds of comments every time I mention Tesla's name. The enthusiastic readers I hear from expect rave reviews, expect high reservation conversion rates, expect demand to skyrocket, expect the Model S to perform flawlessly in heavy daily use, expect Tesla's financial resources to be adequate for its foreseeable needs and expect Tesla to avoid the delays, defects and missteps that plague even seasoned manufacturers who launch a completely new product. I may be cynical when it comes to the applicability of Moore's Law in the auto industry, but I'm a firm believer in Murphy's Law, fondly known as the fourth law of thermodynamics, which states: "If anything can go wrong, it will."
Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.