AFC Energy - Where Next?

Fuel cell developers have had a mixed existence on the London Stock Exchange - their share price action is broadly categorised as experiencing large spikes followed by considerable periods of share price drift. That is largely because there has not been one to experience resounding success, and progress to date has been patchy at best. It's therefore not surprising to see that positive sentiment towards the sector has waned, and the high valuations created by speculation have fallen off considerably. AFC Energy (LSE:AFC) has not been immune to that impact, as it now trades at 24.5p (capitalising the company at circa £55m) having started the year around 10 pence higher. The company's progress since its listing in 2007 has been less than inspiring and director remuneration has been disproportionate to the underlying state of the business. Where next?

The technical position of AFC is weak at the current point in time. The share price is captured in a downtrend that reflects the sector-wide weak sentiment as noted earlier. The rise generated by a Daily Mail share tip in 2013 had continued to be sold down, with the share price now trading at 24.5p, back near multi-year lows. In the absence of further news, it is likely that the share price will drift within the downward wedge, towards the 20p horizontal support. That is a crucial point, as it would determine the medium-term outlook for the share price. If 20p is breached, levels as low as 10p are possible given the lack of technical support between 10p and 20p. Stops would continue to be triggered, and a further share price slide would be likely. On the other hand, if 20p holds up and the shares breakout through the top of the red downward resistance, then as high as 40p becomes the target. In reality, excellent fundamental news would be required to justify that scenario, whereas a lack of fundamental progress would give way to the former scenario. As it stands, the immediate technical picture has a negative bias.

As noted in the chart, one of the spikes was generated as a result of the market's reaction to Roman Abramovich indirectly buying shares in AFC Energy, to the tune of 11% (currently) of the shares in issue - those shares are held by Ervington. The Age of Reason Foundation holds around 10% with SGX listed Linc Energy holding a further ~10%. The latter holding was acquired when Linc, who work with underground coal gasification, took part in various AFC placings. Aside from various nominee accounts holding shares, Non-Executive director Eugene Shvidler holds 5.4% of stock. There have not been any notable recent director purchases.

AFC Energy is involved with the design and manufacture of fuel cells - devices that use a chemical reaction to produce electricity and other by-products. Hydrogen and air is taken in, and electricity, heat and clean water is given out. Fuel cells have long been touted as having the potential to revolutionise a number of industries, including the automotive industry, where car batteries can be replaced with fuel cells, which are cheaper, more durable, and quieter. There have historically been a number of issues, but two stand out. The first has related to the durability of fuel cells, with past concerns revolving around the need to frequently replace them in order to maintain acceptable levels of efficiency. The second concerned the high price tags that fuel cells carried. That was largely because they had to be constructed with precious metals such as platinum, and high value materials. The result was a lack of real industry interest, and little momentum towards fuel cells being used commercially.

A number of decades on and technological advances have changed that situation. Through the development of new materials, and innovation, a whole range of new fuel cells have been developed by a large number of companies across the globe, each seeking to find the key to commercial success. There have still been issues with durability and power output (given the trade-off between those two aspects), but the problems with high costs have been reduced. AFC is just one company that has been developing fuel cells.

Before delving deeper into the details, it is crucial to recognise that AFC Energy is essentially a technology developer that is looking to commercialise its products. As such, it is early stage and is cash burning in nature. Even if sales traction starts to gather, funds would be required to meet the requirements, and that is still the case if the company brings aboard a partner. Administrative costs are high and rising, so at the very least these need to be settled. Since the proposition is relatively speculative as it involves the success of the technology and market acceptance, there is an inherent high risk level carried by AFC. Indeed, since listing in 2007, the company has raised and burnt the vast majority of over £25m in shareholder funds, plus grants on top of that. This continuous, if not frequent, need for cash will only continue and it has been one of the core reasons why sentiment towards the sector has weakened.

In the absence of commercial success (which is typically signified by large orders), you are essentially investing in a company that is promising a bright future on the basis that its technology has intrinsic value. That may or may not turn out to be the case, and investor sentiment is weakened each and every time there is a placing on less attractive terms. ITM Power (LSE:ITM), Ceramic Fuel Cells (LSE:CFU) and Acta (LSE:ACTA) are just three examples of such weakness. On the other hand, if the technology is a success, the market tends to re-rate these high-risk propositions significantly - there are numerous cases of this happening to fuel cell companies in the US. Bottom line is that until concrete orders (not just one order, multiple high-value orders, and preferably repeat orders) are placed, AFC is high risk, and there is definitely no certainty that shareholder value will be crystallised. To that end, there has not been much value creation since IPO.

The years since listing have been relatively turbulent on the board front, with most directors except Chairman Tim Yeo departing from their post. Yeo has actually come under criticism in the past as a result of his pro-green policies when he was an MP at the same time as being heavily remunerated by a number of green technology companies, including AFC. Over the years, there have effectively been 3 CEO/MD changes. Gerard Sauer left as CEO in November 2008, Ian Balchin stepped down as CEO in February 2011 with Edward Wilson coming in as MD. However, he left in May 2011 due to 'differences in opinion regarding the strategic direction of the company'. The only real stability has come after Ian Williamson was appointed CEO in September 2011, although the recent resignation of Finance Director and Company Secretary Jane Dumeresque less than a year since joining AFC, is perplexing. As it stands, AFC have an experienced CEO in Ian Williamson, who had over 25 years experience at Air Products. The board instability is clearly a cause of concern though.

Back to the technology, AFC's aim is to become an industrial scale, low cost generator of electricity, and through that would be its main source of revenue. As aforementioned, the interest surrounding fuel cells has given rise to a large number of fuel cell developers, with Fuel Cell Energy, Bloom Energy, ACAL Energy, Ballard Power Systems and ClearEdge Power just five examples of companies who have already made inroads into the sector. That essentially tells us that AFC is not alone in the fuel cell market.

However, there is a distinction that has to be made. There are many different types of fuel cells, each that has its own merits and demerits. Most of the above companies focus on PEM fuel cells whereas AFC focuses on Alkaline Fuel Cells, hence the AFC initials. In fact, AFC holds a leading position within the development of alkaline fuel cells, which is a good position to be in. Alkaline fuel cells were actually the first type of fuel cells to be developed. Their first major uses came in the mid 20th century when NASA used them for space programmes due to their high efficiency. Nowadays they are cheap compared to other types of fuel cell due to their being few restrictions on the need for expensive materials. For example, there are plenty of other new materials that can be substituted for the platinum in order to bring costs down. AFC's solution was to re-engineer the alkaline fuel cell such that the platinum component is switched for ceramic based catalysts, thus reducing the costs to as little as 5% of the platinum alternative. Other companies have switched that core component for other materials though so there are numerous solutions in that respect. At present, AFC's technology is focused upon stationary applications (i.e. it is not useful for cars etc. Other companies are more focused on portable applications) and encompasses over 30 patents.

AFC's primary market opportunity is to target companies who produce surplus hydrogen (one of the two inputs for fuel cells). They have started addressing that area through a partnership with AkzoNobel, who produce chlorine and caustic soda, giving off surplus hydrogen. That partnership led to the development of the Beta+ System. Elsewhere, they have developed the KORE system, which will target the production of up to 250kW of electricity, and that has been reviewed by Foster Wheeler. Further, they are involved in the EU funded 'Power Up' programme, which is grant funded. The objective of that scheme is to try and produce a system capable of generating up to 1mW of electricity per hour - a working model is targeted by the end of calendar year 2015.

They have also developed a partnership with Air Products (probably through Ian Williamson) and have recently commissioned a waste-to-energy project in Teesside where the facility there will be analysed for the use of AFC's fuel cells. To add to their geographical reach, AFC also have an agreement with Waste2Tricity (which shares a number of similar shareholders, and is a 23% owned company), which opens up the South East Asian market to the company. If there is to be future success, that will be incredibly important since the Asian market is where most of the demand for fuel cells currently is. The actual industry backdrop is incredibly positive, but there is every risk that the success will be restricted to the core industry leaders who were the first-movers and who have excellent industry partnerships (such as POSCO and FuelCell). Without those initial partnerships it can be very difficult to gain industry credibility, although Ian Williamson's standing should go some way to plugging the gap. That agreement has seen an initial order secured from Powerhouse Energy (LSE:PHE), but that is only for a test system and is only at a cost of £150,000.

To add to the number of relationships, AFC signed a MOU with Allied New Technologies earlier in the year. This will see the companies undertake a fuel cell system feasibility study. CEO Williamson commented: "This study gives AFC Energy the opportunity to assess the commerciality of its low cost fuel cell technology in the US.  We will investigate whether stored hydrogen can be an effective energy time-shift mechanism, automatically providing varying levels of energy to meet the changeable demand that occurs in the chlor-alkali industry.  The ability to use such hydrogen 'buffer' storage technology is fundamental to all non-baseload renewable generating technologies so that energy can be made available effectively during periods of shortfall or greatest need."

Whilst this is all good for the industry, it is not necessarily good for shareholders. After all, a tangible return on the initial investment is what is required, and all that innovation will lead to is additional cash burn. To cater for future potential orders, the company has been busy expanding its manufacturing facilities at their UK Dunfold site and have been semi-automating the production process. At the same time as expanding the site, the company continued to develop its fuel cells, and reached the milestone of 12 months cell longevity during the year. There is still doubt around that though as it was only announced to be for one fuel cell and for lab conditions - real conditions are likely to be harsher, so that result is not necessarily replicable.

What signs are there that there could be a change on the horizon? The company's comments in its Interim Results are the strongest hit on a change: "AFC Energy has reached a milestone in its lifecycle and is moving rapidly from R&D to the production of a large-scale commercial product for the generation and supply of electricity to the industry". AFC also noted that they were in dialogue with several prospective partners that should see initial sales before the end of 2015. There are always rollout problems to consider though, particularly if rival technologies offer a superior proposition. As it stands, the focus is very much on commercially developing the technologies, with initial geographic focus on Thailand, South Korea (due to domestic incentives and legislation) and Singapore.

As with all stocks that can't be valued on financials, the numbers make for less than pretty reading. The table on the right summarises just the past two years, where revenue figures have been pedestrian. Underlying admin expenses are also high and are likely to rise, whilst R&D spend was fairly flat year-on-year. Of course, there is absolutely nothing in those numbers to justify a market cap over £50m, but you wouldn't expect there to be. The majority of support of AFC's share price is linked to future potential, and that is why sentiment can lead to large swings in share price - there is not really an underpinning of any share price around current levels, hence the potential for a material fall from current levels.

One of the most important figures for these type of stocks is the cash balance, which stands at £4.96m. On that basis, AFC is probably good for just over a year (given they get tax credits and will receive small staged payments from Waste2Tricity). It is not a particularly comfortable position to be in, although the potential backing of Roman Abramovich is once again a topical issue. If he supports the company further, the share price could actually rise upon a placing. If not, the share price is likely to fall materially. Without a cornerstone investor, institutions would not be willing to take a modest discount in the current climate, and given the current market cap - they would want a material discount. Until then, the balance sheet is actually in decent state. Liabilities are low at £0.9m versus total assets of £7.44m (albeit this will have declined due to cash burn). At the time, 86% of the assets were current with 96% tangible, so that is a decent buffer. The problem is that it once again does little to support the current valuation in any shape or form. The valuation remains dependent upon expectation.

The one point that leaves a sour taste has been the director remuneration since inception. Being a company that is not cash generative, you'd expect modest salaries for the top directors, yet YEO, who is a non-executive, has taken payments (salary+wages+share based payments [SWS]) totalling £559k, whilst the CEO salaries have been far higher, averaging £343k across the three readings. That has been increasing too, up to £378k in SWS compared to £309k in SWS a few years before. There is potentially a mis-alignment of interest here, especially given the lack of directors buys. If the directors truly believed that AFC would be commercially successful, they should demonstrate that through buying shares in the market - they have had ample time to do so, but instead they have been well remunerated.

Looking forward, there are no clearly available broker views, and that is likely to be related to past broker notes which have been far off the mark. For example, in 2012, Allenby expected £1.2m in revenues in 2012 versus £0.36m in reality. Zeus Capital expected £1.1m of revenues in 2013, versus £0.77m in reality, and Peat&Co forecast explosive growth, starting with £4.4m in 2014, a target that will not be met unless a large number of high value contracts roll in during H2. Since all those targets were missed, it's probably best that brokers stay away from forecasting ahead. It is simply too difficult to forecast future revenues when the company is so early-stage in commercial rollout.

So what is next for AFC? It's particularly difficult to tell. If the past is anything to go by, the shares are likely to drop to 20p and fall below, potentially signalling much larger downside. On the other hand, if the company deliver on their contract expectations in H2, then the current share price may find support if sentiment remains, and if large orders are received, the share price could well rally to 40p. That said, the company remains to prove its technology to the industry as demonstrated by the test orders and feasibility studies being undertaken.

Cash will be required at some point, and the method of raising it will be crucial. In light of the technical and fundamental outlook, I would be inclined to be slightly bearish on AFCs prospects looking forward, and believe the £50m+ valuation is likely to come under further pressure unless management start to deliver meaningful commercial progress. It is early days, but as noted many times, the current market cap is resting on positive market sentiment. If either boredom sets in or expectations are not lived up to, the share price could well slide lower. That all said, AFC have previously the backing of Abramovich (and potentially still do), so betting against the shares and putting a sell tag is not attractive, despite the bearish inclination. Bullish investors would probably be better off waiting for the first signs of significant commercial orders before taking a material stake in AFC. If orders do start to roll in then AFC is worth a further look as upside could be material, but jumping the gun on these sorts of stocks, especially in a downtrend, rarely pays dividends. After all, the two previous spikes were generated by a Daily Mail share tip and Abramovich buying in - these can be deemed exceptional events. I have therefore put a No Rating tag on AFC at 24.50p.


  1. Good analysis. I hold afc and have done for 2 years now. I am very bullish because we can produce power at very low costs but there are nagging doubts in my mind

    This made me look at it more balanced. Thank you!

    1. It is always interesting to get a fresh set of eyes on a company.

  2. A well considered article. It is always good to temper even the most optimistic of expectations and these clean tech plays usually take a good 6-12 months longer than expected to come about. peat & cos financial forecasts for 2014 onwards look horifically optimistic so no surprises that they have been dumped on the side


  3. and so it looks like Afc will be reliant on linc stepping up to the task or the public's wallet. Abramovich failed to fund even a measly £1m to Clear air power this morning even though he has a stake from before. So it looks like he may not want to back afc further. So cap did a placing at a giant discount!

  4. This company is the typical AIM cash cow for the directors, milk it to the max and give out optimistic forecasts for johnny AIM punter that amazingly never materialise.
    What have they actually achieved in all this time that couldnt have been done in 2 years by a focused competent university team at a fraction of the cost.
    Mr Williamson has always said they would not rush things, they have done exactly as he said, delaying everything for as long as possible to milk as much salary as possible.

  5. I doubt if Ervington Capital (Abramovich) will invest in AFC again; the company are an R&D organisation and have no products to sell. The company lives by generating expectation and grant funding is the only revenue......

    The next funding round will be very like CAP; at a huge discount.