Plug Power’s (NASDAQ:PLUG) Q3 financial report was a disaster. The company mentioned ‘unprecedented supply challenges’ and even needed to include substantial doubt about the company’s ability to continue as a going concern. This underlines that Plug will very likely need to raise capital soon. As analysts have downgraded the stock, estimates about Plug’s needed capital vary and depend on its expected future cash burn.

The main problem of Plug Power is its deteriorating margins, which were at a staggering -69% during the next quarter. Plug outlined a roadmap for improving margins, but government programs such as hydrogen tax credits are likely to have the most beneficial effect on Plug’s margin metrics in the end.

The Production Tax Credit in the Inflation Reduction Act promises a bright future for hydrogen in the US, but it is not certain that Plug Power has the capital to survive until its hydrogen infrastructure investments start bearing fruit. The company has a couple of options to raise cash, all of which are suboptimal for the company and its shareholders. Plug seems to be going through an existential crisis right now, and its shares are a very uncertain investment at the moment.

Q3 results

Two fellow Seeking Alpha contributors already wrote reviews about the Q3 results, which can be found here and here, so I will not delve too deep into Plug’s results but only highlight the most important aspects and my interpretation. Most relevant were in my opinion:

• A large revenue miss, revenue for the first three quarters is $669M, compared with an original full-year guidance of $1.2B – $1.4B for 2023. Revenue growth has decelerated.
• Net income was a negative $283.5M, and free cash flow was a negative $411.7M, which is a lot of money to burn in only a quarter for a company that is likely to reach an FY revenue of around $1B.
• Liquid assets of Plug still amount to $567.4M, but if profits and cash flow do not improve, the company will burn through this sum in less than half a year.
• Gross margins were -69%, more about this later in this article since I believe improving these is key to Plug’s survival as a company.
• Earnings per share were at -$0.47 for the quarter.
• Almost all of the financial metrics were worse than expected.

So, all in all, financial results were terrible, and my own personal belief is that the company is in a very bad place right now. But let us first look at the reaction of analysts to this financial report before we zoom in more closely on the margins of Plug and the ways in which the company can raise more capital.

Downgrades

Quickly after the release of Plug’s quarterly results, four analysts cut their ratings, namely J.P. Morgan, RBC Capital, Oppenheimer, and Northland Capital. The average price target which these analysts put on Plug was $6.

Lately, another analyst from Citibank estimated that Plug will need to raise $500M in cash during the next six months, and even more in the third quarter of 2024. Most notable was the sentence “Although there is a narrow way out of the near-term issues, the margin of error is small”. At Citi, Plug’s rating was cut and the price target was simultaneously reduced to $5.

Investors should be careful with interpreting these price targets as positive. Although the targets of $5 and $6 are higher than the current share price, this does not mean that these analysts expect Plug’s share to reach this value quickly. Also, most of the time price targets of Wall Street analysts tend to be lagging. Citi for instance reduced its price target for Plug from $12.5 to $5 only after the release of Plug’s Q3 financial report.

Margins – this situation cannot continue

In my previous article about Plug Power, I put much emphasis on the bad, and actually deteriorating margins of the company. If we extrapolate the graph below, which lists Plug’s cash from operations on a quarterly basis, the company is burning through almost a billion dollars a year, and the TTM values confirm this.

Graph 1: Plug Power quarterly cash from operations over the last 5 years

Since 2020, Plug achieved a total net loss of $2.5 billion, which is more than its current market capitalization. The company spent much more money during this time period, but a large part of this money was spent on investments, mainly in production facilities.

Now let us look at the margin numbers of Plug over the last four quarters:

Table 1: Margins of Plug Power over the last 4 quarters (Source: Plug Power quarterly reports)

It goes without saying that these margin numbers look awful, especially the latest drop to minus 69 percent. Note that the values in this table are a bit different from the ones reported on the stock page of Seeking Alpha, I took them directly from the quarterly reports of Plug and these include provisions for loss contracts related to service. For the most recent quarter, the extraordinarily large loss was partly caused by such a provision of $41.5M, but even without this, Plug’s margin would have been abysmal at -48%.

It should be clear to any investor that Plug needs to improve its margins as quickly as possible to stand a chance at weathering this storm. In its investor letter, the company actually mentions ways of doing this as ‘margin enhancement roadmaps’, which I pasted below: (edited by the writer by cutting out some parts for brevity):

● Hydrogen Generation: Fuel margin rate improved by 21% sequentially from Q2 2023.

● Manufacturing Scale: Plug has already established a world-class manufacturing presence with the ability to meaningfully expand manufacturing capacity with minimal or no additional capital expenditure. This sets the stage for continued cost reduction.

● Simplifying Designs and Improving Performance: Service cost improvements remain a key focus area for the Company in order to drive overall margin within the material handling business. Plug continues to target 30% per unit service cost decrease over the medium-term.

Let me briefly comment on this:

• The fuel margin rate might have been improved, which could be a real feat since the company seems to be proud of it, but when looking at the quarterly report we can see that the costs of hydrogen generation and shipment were $59.0M versus $19.4M of revenues this quarter. Plug might have improved its margins, but the company is selling hydrogen at a third of its cost.
• The manufacturing scale bullet sounds promising, though it is very hard to verify or measure it. But being able to increase manufacturing capacity without additional costs sounds good, given that Plug is currently making only a relatively small loss on the sale of its equipment. If Plug truly achieved an economy of scale in production, this could mean the company starts making a profit on the sale of equipment.
• Service improvements are good, but this is a relatively small cost at $18M per quarter. I am not sure if Plug includes the provisions for loss contracts related to service in its service cost improvements, because if it does, improvements here could have some material impact.

All in all, Plug’s margin improvement plans sound logical, but at the moment the company is selling its equipment at a small loss, and its fuel at a very large loss. Improving margins might solve the equation with regard to its equipment, but its losses on fuel are so high that this will not be enough. On the other hand, the large losses in the fuel category might be further reduced in the future by tax credits for hydrogen production (more about this later).

How can Plug raise more cash to continue its operations?

In its Q3 report, Plug Power mentions the following three “Future funding roadmaps”:

• Corporate debt solutions
• US Department Of Energy (DOE) Loan Program
• Project Finance and Plant Equity Partners with Fortescue Metals (OTCQX:FSUMF)

I will look into the first two solutions right now, the Fortescue solution will be discussed later in this article, since it’s not a direct way to gain access to cash.

Debt and loans

Corporate debt seems like the most straightforward option to raise additional capital for Plug. But there are two main problems here: Interest rates have quickly risen over the last couple of years, and Plug will have to convince the lender. The second aspect might be difficult, and I estimate that Plug will have trouble taking on corporate debt, which (if succeeded) I believe will be far from investment-grade.

Debt with a debt rating of B currently yields about 9%, and borrowing $500M will cost Plug an annual $45M of interest (if the company can even issue debt with this rating, of which I have no idea, I’m not a rating agency), increasing its costs and worsening its balance sheet. Borrowing $1B means 90M of interest each year, which already is about 9% of the total 2023 revenue, so it adds up quickly.

A different option for Plug would to be apply for the DOE loan program. The interest rates for this program range from 0.375% to 2.0% above the interest rate for Treasury securities with a similar average life. The US 10-year treasury currently yields 4.45%, which means that this is likely to be a much more attractive option for Plug. Still, a presumed 5-6% interest rate does still cost the company some serious money.

Currently, Plug is “working towards a conditional commitment from the DOE Loan Program Office to finance plants in our green hydrogen network.” This means that the DOE loan program will likely not fix all of Plug’s cash problems, but rather finance some plants. I cannot estimate if Plug is likely to succeed with its application. I believe a commitment from the DOE would improve the financial situation of Plug, but not completely erase the need for an additional capital raise.

Issuing equity

Although Plug did not mention the option of issuing more equity, this might be the most realistic possibility for the company to get more cash to fund its operations. Of course, this means dilution for existing shareholders.

The biggest problem with this is that issuing equity is best done at times when a company’s stock price is solid, and preferably not after a large downturn. Right now, Plug’s market capitalization is about $2.4B, so issuing shares for $500M would dilute current shareholders by at least 21%, assuming that the share price does not drop much further after an announcement of such an action.

Graph 2: Plug Power’s share price and market capitalization over the last 5 years

But as Citibank also mentioned, $500M will likely only be enough to last until the third quarter of 2024. I estimate that, in order to not leave existing shareholders in too much short-term uncertainty, Plug would do well to raise more than $500M at once.

In 2020/2021, the company was able to raise almost $5 billion of capital by issuing new stock. But as you can see in the price graph, this was done at much higher valuations. If the company tries to do the same right now, it will face much more headwinds because of current economic conditions.

If Plug needs to issue enough equity to compensate for an annual $1B cash burn, this would dilute current shareholders by an annual 42% using current share prices. I believe this is not something that the company can