Ceres Power Holdings Strengthening customer engagement Interim results Alternative energy During H116 Ceres Power continued to make good progress towards commercialising its Steel Cell technology, which offers a route to economically viable fuel cell-based systems for mass deployment. Noting the intensification of engagement with existing and new partners discussed in the interims, which underpins our revenue growth assumptions, we leave our FY16 and FY17 estimates unchanged. 25 February 2016 Price 5.54p Market cap 43m Net cash ( m) at end December 2015 (including short-term investments) 12.8 Shares in issue 772.5m Year end Revenue ( m) EBITDA ( m) PBT* ( m) EPS* (p) 06/14 1.2 (6.7) (7.7) (1.2) 0.0 N/A 06/15 0.3 (9.7) (10.5) (1.2) 0.0 N/A 06/16e 1.0 (11.2) (12.4) (1.4) 0.0 N/A 06/17e 2.0 (10.8) (12.0) (1.4) 0.0 N/A DPS (p) Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments. P/E (x) Free float 51.5% Code CWR Primary exchange AIM Secondary exchange N/A Share price performance Customer engagement intensifying Ceres s business model is to focus on developing highly efficient, robust and costeffective fuel cell stacks that will be deployed by partners in power generation systems. Earlier this year, Ceres announced two significant customer agreements: one a follow-on agreement with Honda to jointly develop fuel cell stacks for power equipment suitable for deployment in a range of potential applications, and one with a global OEM to evaluate the Steel Cell technology for use in higher power electricity generation systems suitable for commercial applications. Engagement underpinned by technology advances Adoption of fuel cells generally remains limited because although the basic technology is proven, it is not yet cost competitive. Ceres s patented Steel Cell technology is an innovative solution to this cost problem, predicated on using nonexotic materials that can be processed in volumes using conventional manufacturing equipment and techniques. In December Ceres announced that its V3 technology had delivered the electrical efficiencies required to be viable for commercial and light industrial scale applications as well as residential applications. Ceres s high-speed print line has achieved a tenfold reduction in processing times, a key step in realising low-cost, high-volume production capability. Valuation: Long-term value from royalties The long-term value for Ceres lies in potential royalty streams created when energy generation systems incorporating Steel Cell technology are commercialised. We estimate that, if commercialisation is successful, a 40% share of the Japanese CHP market and deployment in 20% of all boilers sold in Korea could generate annual royalty revenues of c 135m. We estimate that deployment in 10% of Honda s gensets and power appliances could add c 65m in royalty revenues annually. Cash consumption during H116 totalled 5.4m, leaving 12.8m at end December 2015. Management intends to raise further funding by the calendar year end to finance the growing opportunity for higher power applications. % 1m 3m 12m Abs (10.7) (9.6) (34.5) Rel (local) (10.3) (3.6) (24.0) 52-week high/low 9.7p 4.3p Business description Ceres Power is a developer of low-cost, nextgeneration fuel cell technology for use in decentralised energy products that reduce operating costs, lower CO2 emissions, increase efficiency and improve energy security. Next event Prelims October 2016 Analysts Anne Margaret Crow +44 (0)20 3077 5700 Roger Johnston +44 (0)20 3077 5722 industrials@edisongroup.com Edison profile page Ceres Power Holdings is a research client of Edison Investment Research Limited
Progress on execution of strategy Ceres s investment proposition is based on achieving its aim of developing solid oxide fuel cell technology that is competitive with other types of electrical generation. This means the technology must be efficient at converting chemical energy into electrical energy, can be manufactured using materials and processes that make the technology cost-competitive and is sufficiently robust to give an adequate payback period for consumers installing products based on the technology. In addition, since Ceres has decided to focus on developing fuel cell technology rather than complete power generation systems, it needs to secure long-term relationships with partners capable of taking complete systems to market in different geographies. At this stage of evolution, progress towards achieving these goals is more significant that the financial results themselves. Technology developments The latest release of the V3 Steel Cell technology platform, announced in December, has improved efficiency and power density to the point at which Ceres is able to address power only applications for the commercial scale market, as well as significantly improving the economic case for the residential market. V4 is on track for release to customers in the summer of 2016. This will incorporate manufacturing advances that reduce the cost of production together with further efficiency improvements. Residential market Following the adoption of a new business model in 2013, Ceres has focused on developing the fuel cells and stacks for partners to integrate into their own power generation systems. However, to demonstrate what is possible to potential customers, Ceres has developed a complete prototype system, the Steel Gen, which has been made available to OEM partners. The system has achieved Ceres s stated target of 50% net electrical efficiency. This will allow partners to create fuel cell power systems for residential use that are more efficient than the best centralised generating plant when operated in power only mode, are at least equivalent to the best systems currently available commercially in Japan and achieve overall efficiency of up to 90% when operated in CHP (combined heat and power) mode. High electrical efficiency is particularly important in the Japanese micro-chp sector, because the spark-gap between gas and electricity prices in the country is small. In addition, the design is one of the most compact residential fuel cell systems available, which is key for penetrating the market for installations in high-rise apartments in Asia where space is at a premium. The system runs on natural gas, so does not depend on ready availability of pure hydrogen to be usable and is fully compliant with all emission standards. Higher power output Higher electrical efficiencies are also important for entering the commercial and light industrial business sectors where fuel cells are beginning to be used for power-only and back-up power applications. During H116 Ceres has developed its first modular stack concept based on the V3 Steel Cell technology. In its initial testing, this achieved 55% net electrical efficiency, significantly exceeding the 50% level at which the technology becomes viable for commercial and light industrial scale applications. This has enabled Ceres to address new market applications and attract new potential partners (see below). Manufacturing Significant progress was made on production scale-up projects intended to provide demonstration and validation of a production process suitable for high-volume fuel cell manufacture at market cost Ceres Power Holdings 25 February 2016 2
points. The key innovation is based on changing the way in which the thin ceramic layers forming the electrolyte layer inside individual cells are laid down. Originally this was done by spraying. Ceres has recently commissioned its high-speed print line, which is used to deposit the thin ceramic layers. The new print line has reduced print cycle time from 30 seconds to three, as management predicted, thus substantially improving throughput. The technique also gives a better-quality deposition layer. Developing routes to market Japan Following a year-long evaluation of the Steel Cell technology, which concentrated on performance, robustness and ability to handle repeated power cycles, in October 2014 Ceres Power signed a JDA with Honda to jointly develop a fuel cell stack using the Steel Cell technology. Stacks have been built in the UK and tested in Japan with the intent to ultimately deploy in 1-5kW systems. The results from this phase met the performance targets, leading to the signature of a follow-on JDA in January 2016. The relationship is clearly strengthening, as this was the first time that the client had given permission to be named. Moreover, this new phase also includes a third party, which is being lined up with the intention that it may ultimately manufacture fuel cells in volume using Ceres s proprietary process. Management notes that this agreement is the first of several key commercial partnerships that it expects to sign during calendar 2016, in line with the target initially stated at the AGM in December 2015 of securing five leading OEMs within the next two years. Korea All the testing undertaken in KD Navien s facility under the Technology Assessment Agreement completed successfully, including aggressive accelerated testing for cycleability and steady-state running. At the partner s request, Ceres provided KD Navien with an additional system on which it has carried out extended validation. All of the performance requirements have been met to date, including the extended validation. Management opened a sales office in South Korea during H116 since the current pipeline of opportunities in Japan is attributable in part to having a sales office in the country. This local presence in Korea, together with the appointment of an experienced chief commercial officer (see below) is expected to help advance the commercial relationship with KD Navien further during calendar 2016 as well as supporting the development of additional customer relationships in the country. North America The US remains an important key market for Ceres because of business and householder concerns about continuity of electricity supply. The newly appointed chief commercial officer, who has been recruited from Ballard Power Systems, is based in North America, though he is also working with potential customers in Asia and Europe. Other As a result of the advances in system efficiency, which position the technology for deployment in higher power applications, in early February Ceres announced that it has signed an evaluation agreement with a new potential customer who is a leading global OEM. Ceres has commissioned a complete Steel Cell system for a period of rigorous testing at the customer s site. Under the terms of an additional Memorandum of Understanding, if this testing proves successful, the two parties intend to enter into a joint development of a multi kilowatt system later in calendar 2016. Ceres Power Holdings 25 February 2016 3
Valuation Ceres has yet to generate commercial revenues, so its value resides in the potential royalty streams generated once distributed power systems incorporating Steel Cell technology are eventually commercialised. In Exhibit 1 we present our scenario analysis which explores potential royalty revenues and profit generated in each of the key markets as commercial partners take significant share in their respective markets. Noting that Honda is active in the genset market, we include an analysis of potential revenues and incremental profits attributable to this partner. Our analysis excludes any potential royalties arising from the agreement with the leading global OEM, which we will add as more information about the potential applications becomes available. Exhibit 1: Scenario analysis showing potential profits attributable to key markets Japan Total number of fuel cell-based CHP systems sold pa 2020-30: 400,000 (government target) Average selling price per unit with Steel Cell technology: 621,000 (government target) Market share for products with Steel Cell technology 10% 20% 30% 40% 50% Royalty revenues 11.7m 23.4m 35.1m 46.8m 58.5m Annual profit after tax 3.1m 8.4m 13.7m 19.0m 24.3m Korea Total number of domestic boilers sold pa: 1,500,000 Average selling price per unit with Steel Cell technology: $5,500 (as per Japan) Market share for products with Steel Cell technology 4% 8% 12% 16% 20% Royalty revenues 17.6m 35.1m 52.7m 70.2m 87.8m Annual profit after tax 7.4m 15.4m 23.3m 31.3m 39.3m US Total number of domestic boilers sold pa: 7,000,000 Average selling price per unit with Steel Cell technology: $4,500 (target price required to be competitive with conventional technology) Market share for products with Steel Cell technology 1% 2% 3% 4% 5% Royalty revenues 16.8m 33.5m 50.3m 67.0m 83.8m Incremental PAT pa 12.4m 23.5m 34.5m 45.6m 56.6m EU Total number of domestic boiler sold pa: 5,000,000 Average selling price per unit with Steel Cell technology: 4,100 (target price required to be competitive with conventional technology) Market share for products with Steel Cell technology 1% 2% 3% 4% 5% Royalty revenues 12.0m 23.9m 35.9m 47.9m 59.8m Annual profit after tax 8.9m 16.8m 24.7m 32.6m 40.5m Global genset replacement market Total number of gensets and power appliances sold per year by partner: 6,000,000 Average selling price per unit: $2,000 Percentage products shipped incorporating Steel Cell Technology 3% 5% 10% 15% 20% Royalty revenues 19.1m 31.9m 63.8m 95.7m 127.7m Annual profit after tax 14.2m 22.6m 43.7m 64.7m 85.8m Source: Edison Investment Research. Note: $1.4/ ; 113.0/$; 0.91/$. Although it is likely that Ceres will adopt a business model in which some of the potential royalties related to single customer engagement are paid upfront as a one-off licence fee, with the payment offset against lower royalty rates, for simplicity our analysis assumes a royalty rate of 7.5% of customer sales, but no upfront licence fees. For the earnings calculation we apply cost of sales as 7.5% of licence revenue, 20% tax and model a base level of operating costs at FY17e levels ( 14.0m) split equally between activities in Japan and Korea. The analysis is the same as that presented in our January note, but with current currency conversion rates, thus giving higher values when converted to sterling. Since it is not possible at this stage to determine the potential dilutive impact of any financing activity, we are not attempting to derive an indicative share price from this analysis. Ceres Power Holdings 25 February 2016 4
Financials: Progressing to commercialisation Earnings H116 revenues and other operating income were at similar levels to H115 at 0.5m. It is encouraging to note that revenue primarily generated from customer evaluation and joint development agreements increased from 0.1m in H115 to 0.2m. Operating costs were 17% ( 1.0m) higher than during H115, reflecting the increased number of employees engaged in R&D and initiatives to improve the company s test and manufacturing capability. Reported operating losses increased by 0.9m to 6.2m. Exhibit 2: H116 in context H115 FY15 H116 FY16e FY17e Revenues ( k) 133 324 235 1,000 2,000 Operating costs ( k) (5,605) (12,476) (6,565) (14,000) (14,300) Other operating income e.g. grants ( k) 294 621 218 300 309 Reported operating loss ( k) (5,314) (11,722) (6,235) (13,248) (12,791) Source: Edison Investment Research We leave our FY16 and FY17 estimates unchanged. Our model assumes that engagement with existing partners will intensify during FY16 and that discussions with potential partners will mature into evaluations and development programmes, as discussed in our initiation note, resulting in a strong ramp-up in revenues through the forecast period. We estimate that annual revenues from technology evaluations could be 100-200k per partner, scaling up to 500-1,000k for a joint development agreement. The recent announcements regarding Honda (who has signed a JDA) and the global OEM (who has signed an MoU advising of the intention to proceed to a JDA if the ongoing test programme is successful), support our assumptions regarding revenue development. Clearly any delays in progressing individual customer engagements will have a significant impact. At this early stage, we exclude any potential licence and royalty fees from our financial model, giving scope for substantial upside. We estimate that a single licence fee could be worth tens of millions of pounds. Cash flow and balance sheet H116 cash consumption totalled 5.4m (compared to 4.5m H115, excluding funds raised from issue of shares). This included 1.0m invested in the new print line and additional test equipment. We do not capitalise any of this R&D expenditure. Net cash (including short-term investments) reduced from 18.2m at end June 2015 to 12.8m at end December 2015. Management expects the July 2014 placing, which raised 19.6m (net) and was oversubscribed, to provide funding well into calendar 2016. However, the company intends to raise further funding by the calendar year end to finance the growing opportunity for higher power applications. In the absence of any one-off licence payments, which we treat as upside, our estimates show c 4m funding gap in FY17, which we model as satisfied through debt. Ceres Power Holdings 25 February 2016 5
Exhibit 3: Financial summary 000 2014 2015 2016e 2017e Year end 30 Junel IFRS IFRS IFRS IFRS PROFIT & LOSS Revenue 1,224 324 1,000 2,000 EBITDA (6,663) (9,716) (11,248) (10,791) Operating Profit (pre amort. of acq intangibles & SBP) (7,732) (10,642) (12,448) (11,991) Amortisation of acquired intangibles 0 0 0 0 Share-based payments (856) (1,080) (800) (800) Exceptionals 0 0 0 0 Operating Profit (8,588) (11,722) (13,248) (12,791) Net Interest 73 110 70 0 Profit Before Tax (norm) (7,659) (10,532) (12,378) (11,991) Profit Before Tax (FRS 3) (8,515) (11,612) (13,178) (12,791) Tax 1,122 1,571 1,571 1,571 Profit After Tax (norm) (6,537) (8,961) (10,807) (10,420) Profit After Tax (FRS 3) (7,393) (10,041) (11,607) (11,220) Average Number of Shares Outstanding (m) 536.8 753.2 772.5 772.5 EPS - normalised (p) (1.22) (1.19) (1.40) (1.35) EPS - normalised fully diluted (p) (1.22) (1.19) (1.40) (1.35) EPS - FRS 3 (p) (1.38) (1.33) (1.50) (1.45) Dividend per share (p) 0.00 0.00 0.00 0.00 EBITDA Margin (%) N/A N/A N/A N/A Operating Margin (before GW and except.) (%) N/A N/A N/A N/A BALANCE SHEET Fixed Assets 1,715 2,080 2,380 2,680 Intangible Assets 0 0 0 0 Tangible Assets 1,715 2,080 2,380 2,680 Current Assets 10,084 20,685 9,000 3,062 Stocks 0 0 0 0 Debtors 2,385 2,501 2,423 2,615 Cash 7,699 18,184 6,577 448 Current Liabilities (1,385) (2,013) (1,435) (1,717) Creditors including tax, social security and provisions (1,385) (2,013) (1,435) (1,717) Short term borrowings 0 0 0 0 Long Term Liabilities (2,341) (2,071) (2,071) (6,571) Long term borrowings 0 0 0 (4,500) Other long term liabilities (2,341) (2,071) (2,071) (2,071) Net Assets 8,073 18,681 7,874 (2,546) CASH FLOW Operating Cash Flow (8,252) (9,182) (11,748) (10,700) Net Interest 75 110 70 0 Tax 1,000 1,218 1,571 1,571 Capital expenditure (520) (1,243) (1,500) (1,500) Capitalised product development 0 0 0 0 Acquisitions/disposals 0 0 0 0 Financing (41) 19,569 0 0 Dividends 0 0 0 0 Net Cash Flow (7,738) 10,472 (11,607) (10,629) Opening net debt/(cash) (15,437) (7,699) (18,184) (6,577) HP finance leases initiated 0 0 0 0 Other 0 13 0 0 Closing net debt/(cash) (7,699) (18,184) (6,577) 4,052 Source: Edison Investment Research, Ceres Power Holdings accounts Ceres Power Holdings 25 February 2016 6
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Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE s express written consent. Frankfurt +49 (0)69 78 8076 960 Ceres Schumannstrasse Power 34b Holdings 25 280 February High Holborn 2016 245 Park Avenue, 39th Floor Level 25, Aurora Place Level 15, 171 Featherston St 7 60325 Frankfurt Germany London +44 (0)20 3077 5700 London, WC1V 7EE United Kingdom New York +1 646 653 7026 10167, New York US Sydney +61 (0)2 9258 1161 88 Phillip St, Sydney NSW 2000, Australia Wellington +64 (0)48 948 555 Wellington 6011 New Zealand