Bitcoin has surged nearly 89% in 2023, which is an astonishing return, but shares of Riot Platforms (RIOT, Financial) have done even better, generating gains of nearly 500% year-to-date, which is truly magnificent in a year when the U.S. economy is marked by weaker consumer purchasing power, higher interest rates and a stock market that isn't doing particulary great.
However, I don't share the market's enthusiasm for Riot. In fact, I think chasing this stock is just gambling with low odds of success. There are a couple of reasons that make me have a bearish outlook on Riot Platforms: namely, the "fear of missing out" (FOMO) effect and the 100% reliance on Bitcoin prices for revenue.
FOMO is when investors buy stocks purely because of recent gains due to fear of missing out on the next 500% rally. This outlook is not supported by fundamentals, and such speculation can turn sour quickly.
Bitcoin is highly volatile. As Riot is a Bitcoin miner, if Bitcoin prices continue to rise, it could continue generating high revenue. On the other hand, at some point, negative Bitcoin news has a high chance of sending Riot stock into a steep freefall.
Core business risks
Riot Platforms is a company engaged in cryptocurrency mining and blockchain-related activities. The company has three major segments: Bitcoin Mining, Data Center Hosting and Engineering. It generates the bulk of its revenue from the Bitcoin Mining segment.
The cryptocurrency market is highly volatile, with significant price fluctuations. This volatility can impact the profitability of Riot Platforms’ mining operations and the value of its cryptocurrency holdings. Additionally, the regulatory environment surrounding cryptocurrencies is still evolving and can pose risks to the company's operations if new regulations are implemented or existing ones become more stringent.
Blockchain technology is constantly evolving, and there is a risk that Riot Platforms’ mining hardware and infrastructure may become obsolete or less efficient over time. The company needs to continuously invest in upgrading its equipment and infrastructure to remain competitive. As a company operating in the cryptocurrency space, Riot Platforms is exposed to cybersecurity threats, including hacking attempts, ransomware attacks and theft of digital assets. A successful cyberattack could result in financial losses, reputational damage and disruption of operations.
Cryptocurrency mining requires substantial computing power and energy consumption. Rising energy costs can thus impact Riot Platforms' profitability. Additionally, there is growing concern over the environmental impact of cryptocurrency mining due to the high energy consumption associated with proof-of-work mining algorithms.
The cryptocurrency mining industry is becoming increasingly competitive, with numerous players entering the market. This heightened competition can put pressure on Riot Platforms' profitability and market share. The company needs to differentiate itself and continually adapt to changes in the competitive landscape. Running a mining operation involves managing complex hardware, software and logistics. There are risks associated with equipment failures, maintenance issues, supply chain disruptions and operational inefficiencies.
It's important to note that these risks are not exhaustive, and there may be other specific risks that could impact Riot Platforms' business.
Profitability and valuation
Riot Platforms trades at a price-sales ratio of 12.07 and a price-book ratio of 3.1. It gets a high rank for financial strength from GuruFocus at 8 out of 10, but at the same time it gets a very low rank for profitability at 3 out of 10. The GF Value of $19.48 indicates that the shares are now fairly valued based on the GF Value model.
This mining company has been unprofitable over the past five years. In 2022, the net loss of $509.55 million was much wider than the net loss of $15.44 million in 2021. The Piotroski F-Score of 3 implies poor business operation, and Riot Platforms' net margin for the quarter that ended in March 2023 was -76.04%, ranked worse than 93.53% of 757 companies in the Capital Markets industry.
Another negative factor to consider is that the company announced in its June 2023 production and operations updates that it has a rather questionable competitive advantage. Jason Les, CEO of Riot, said, “Our long-term, fixed-price, power contracts provide Riot the ability to curtail our Bitcoin mining operations and sell large blocks of power back into the grid during periods of peak demand, ensuring power is available to Texans while generating economic benefits to the Company. This power strategy is a key differentiator for Riot as it supports our low cost of production and is made possible by our vertically integrated structure and unmatched balance sheet strength.”
I say this is questionable because, despite such a great competitive advantage, the company is still unprofitable. Clearly it's not much of an advantage from an investor's standpoint. I imagine that things could have been much worse without these contracts, as electricity costs are a top expense for the company’s operations.
Another key metric that does not excite me is the negative free cash flow trend for Riot Platforms. The company is burning cash and investing heavily in capital expenditures. As free cash flow is a key driver for valuation purposes, I am not thrilled to see that Riot Platforms only generated negative free cash flow for all past five years despite often high Bitcoin prices.
