Stem Is a Promising Business Opportunity, But Looks Too Expensive Here

Energy storage specialist Stem (NYSE:STEM) is a bet on sustainability that recently came public through a combination with Star Peak Energy Transition, a special purpose acquisition company (SPAC). In late November 2020, the SPAC shares traded at $10, and they reached a 52-week high of $51.49 per share. But with STEM stock at $25.85, is this the time to buy shares?

Battery concept powering electric vehicle.

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If you ask a few investors about this, chances are you will get multiple answers. One might say yes, this correction of 50% makes for an excellent entry point. Another investor may say based on the technical analysis, it now seems oversold. Then the investor who follows stocks based on hot trends may say it is now the time to buy the stock.

Lastly, the rational investors will say: hold on, need to analyze more why this surge and dip have occurred.

So what is the real story behind Stem now?

Do Not Get Excited Without Research and Due Diligence

Another investor may have read that news that “Star Peak Energy (STPK) Will Dominate Tesla in the Energy Storage Game’ Says Citron Capital” from Insider Monkey. They may get further impressed by commentary mentioning that Citron’s Investor Letter called STEM stock’s predecessor “a future $800 billion, Tesla like boomer, in the US markets.”

But when you read research like this, be very cautious — not because the conclusion is not plausible, but mainly because it may be too optimistic.

Consider that the current market capitalization of Star Peak Energy Transition Corp is $1.136 billion as of the close on April 23, 2021. So this 800 times increase in market capitalization seems too optimistic now.

STEM Stock: The Positive News to Consider

President Joe Biden’s administration has decided to invest in modern, sustainable infrastructure now and deliver an equitable clean energy future.

An investment of a $2 trillion accelerated investment to meet the ambitious climate progress that science demands. They’re looking for a green future with an emphasis on the power sector to achieve a carbon pollution-free power sector by 2035. They also want to fight climate change. And interestingly enough, Stem is “the world leader in AI-enabled smart energy storage.”

What does Stem do? “Stem delivers and operates smart battery storage solutions that maximize renewable energy generation and help build a cleaner, more resilient grid.”

Stem’s customers include Fortune 500 companies, and the company has its focus on revenue. Unlike other SPAC mergers, that have often elevated companies with almost non-existent sales, Stem in its investor presentation shows that its business model can bring in three sources of revenue.

These sources of revenue include:

  • Hardware + Network Integration
  • Software Market Participation
  • Market Participation

The margins look good. The Hardware + Network Integration has the lowest gross margin of about 10%-30%, while the other two business segments have gross margins of about 80%.

I also like the fact that Stem has about $525 million net cash, available for growth, and on a Pro forma for transaction $0 debt on the balance sheet.

The leadership team has a lot of experience and the marketing material uses words such as disruption and exponential growth, lowest cost generation, rapid cost reductions, significant scale, and visible growth. But these are marketing materials. It should be analyzed with caution and skepticism, plus an adequate degree of doubt.

Investors should not make well-informed decisions based on the prospects themselves without ignoring one key parameter: valuation.

Negative News to Analyze Further

The investor presentation data that Stem has used shows a few significant concerns about valuation. Yes, the company highlights its robust revenue growth until 2026, but these are purely the company’s projections. They can vary a lot from real numbers.

The free cash flow estimates indicate positive numbers starting in 2023. The projected revenue for 2020 is $33 million, and the projected revenue for 2021 is $147 million. With a recent market capitalization of $1.136 billion, this implies a ratio of about 7.72 times of market capitalization to revenue. For me, this is too high.

Next, there is a pro forma gross profit, not net profit. Due to the capital expenditures, the net profitability may be negative. And there is an estimate of 348% growth in revenue for 2021 to $147 million compared to the estimate of $33 million in 2020, but then the following years there is a decline for revenue growth. In 2022, 2023 and 2024 the estimated revenue growth falls to 115%, 67%, 42% and 26% respectively.

The company estimates revenue of $748 million in 2024 which seems too optimistic now.

Stem stock is an interesting stock to monitor. But its valuation, even at this recent 50% correction, is too high. Do not get excited yet, wait for projections to turn into real money. Perform further due diligence, crunch the financial numbers to become official earnings reports, not just marketing presentations that show only the best side of business expectations.  This is the rational way to invest.

On the date of publication, Stavros Georgiadis, CFA, did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Stavros Georgiadis is a CFA charter holder, an Equity Research Analyst, and an Economist. He focuses on U.S. stocks and has his own stock market blog at thestockmarketontheinternet.com/. He has written in the past various articles for other publications and can be reached on Twitter and on LinkedIn.   


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