ITM Power PLC (LSE:ITM, Financial) (ITMPF, Financial) designs and manufactures products that generate hydrogen gas based on proton exchange membrane technology. It is the very definition of a growth stock. Currently, one could argue the stock market and economic environment are better geared for value stocks, not growth ones.
So why am I pitching a growth stock? ITM is a hydrogen pure play, and the long-term outlook for hydrogen is very strong. This is due to government and society’s pivot toward clean energy, especially in Europe, ITM’s home market, where hydrogen is used in heavy industry and transportation.
The European Commission has mandated for half of all hydrogen consumed in Europe to be “green” by 2030. This will require $110 billion in investment in electrolyser capacity, a product ITM happens to make.
An electrolyser is a unit that turns water into hydrogen using electricity via a process called electrolysis, which separates hydrogen molecules from oxygen.
While there is already strong demand for hydrogen among European industrial players, there is a huge push to ramp up the market to 20 million tonnes a year. Global demand for hydrogen is around 80 million tonnes a year. The infrastructure spend in Europe could easily be worth a trillion dollars. The energy crisis in Europe, thanks to the war in Ukraine, has turbocharged the push for alternative sources of energy.
Green hydrogen is still a relatively small market. According to BNEF, an energy transition research provider, investment spend in clean energy technology was $755 billion, of which only 3% went into hydrogen and carbon capture.
Currently, most hydrogen production is “grey” – where natural gas via a process called steam reforming is turned into hydrogen, carbon dioxide and heat. If you add carbon capture technology to the process, the hydrogen produced is called “blue.”
According to JPMorgan, the European Union’s new target would need 200 gigawatts of electrolyser capacity. Only 50% of the 20 million goal is for European green hydrogen, but even 100GW in electrolyser capacity will need massive investment. The International Energy Agency says worldwide green hydrogen capacity was just 300 megawatts in mid-2021.
Cash-rich ITM Power, which has a market capitalization of over $2 billion, has developed technology to manufacture electrolysis units. It is currently building two new factories to increase capacity to meet demand growth.
ITM will have 1GW annual capacity at the end of 2022 and makes electrolysers in 2 megawatt and 5 megawatt sizes. One megawatt is 0.001 gigawatts. The 5MW unit is sure to be popular because it is the largest and most powerful type of electrolyser. ITM has the most ambitious and aggressive growth plans compared to its global electrolyser manufacturer peers.
Clearly, some of the growth is already priced in to ITM's valuation. The shares have fallen hard in recent months as interest rates and sentiment toward growth stocks has softened. According to GuruFocus, analysts' estimates for revenue are 12 million pounds ($14.76 million) for the financial year ending April 2022. This grows rapidly to 403 million pounds for financial year ending April 2025. These are realistic targests and reflect ITM’s future larger-scale operations.
We need to ask, though, will ITM dilute investors by raising more equity? My view is probably not. The company completed two equity raises last year and balance sheet cash should be enough to get to 5GW capacity by 2025, according to management.
CEO Graham Cooley, who has run the company since 2009, said the figures being talked about by EU regulators indicated how much the electrolyser market is undersupplied in the coming years.
This means probably every electrolyser manufacturer in the world is going to be working at full capacity soon. ITM has the world’s largest electrolyser factory today with a capacity of 1GW, but far more capacity is needed.
Why use electricity to make hydrogen for energy use? It is a fair question if that electricity is itself not zero or at least low carbon. But hydrogen technology can support the renewables market in gaining market share as hydrogen can be used as an energy storage system. It is also easier to store hydrogen than electricity.
Through its Hydrogen Accelerator program, the EU aims to fast-track market reforms to promote development of hydrogen projects and infrastructure such as storage.
ITM also has partnerships with some important companies, including German engineering giant Linde PLC (LIN, Financial) and commodities trader Vitol. It has contracts to sell electrolysers to fertilizer manufacturer Yara International ASA (YARIY, Financial) in Norway, which plans to use green hydrogen to create emission-free fuel for ships and fossil-free fertilizers.
The company's electrolyser production costs are rising, but unlike many other green technologies, they do not use nickel, whose price has become very volatile due to sanctions on Russia.
Valuation
While normally I would value a company on free cash flow or profits, ITM is not expected to break even until 2025. Given the problems in forecasting the long-term economics for the company's various expansion projects means that even if you are bullish on hydrogen, you should still be cautious when investing. An investment in ITM should be a very small part of your portfolio and treated more like a long-term call option.
But why does ITM have a relatively large market capitalization already, given the business is not expected to make profits for several years? The reason is the coming spending the industry will need to make to meet the government's green energy targets. ITM has somewhat of a first-mover advantage in electrolysers. Since industrial companies are going to need to procure small, medium and large-size electrolysers, and there are not many options available, the company stands to benefit.. The company could even be a takeover target for companies like BP (BP, Financial) or Shell (SHEL, Financial), who are ramping up their own green hydrogen businesses.
RBC Capital Markets has a discounted cash flow price target on the stock of 5 pounds. The stock currently trades at less than half of that, implying more than 100% upside.
