McPhy - Equity Research

MCPHY RECENT UPDATES

• 03/02/21 : BlackRock declared that it had exceeded the thresholds of 5% of the capital and voting rights of McPhy Energy.

• 03/08/20 : Hyport, a company 51% owned by Engie Solutions and 49% by the Agence Régionale de l'Energie et du Climat Occitanie, announced that McPhy will be its key partner to design, build and integrate two hydrogen stations and one high power electrolysis. The stations will be located close to the airport's runways and roadss. They will enable all types of vehicles to be recharged with hydrogen.

BUSINESS MODEL & STRATEGY

Founded in 2008, and introduced on Euronext in 2014, McPhy is a French industrial leader which operates in the Energy industry and more specifically focused on hydrogen technologies from production, storage and distribution.

McPhy is a new player in hydrogen production and distribution equipment. It aims at contributing to the worldwide deployment of zero-carbon hydrogen as a solution for the energy transition in the industrial, mobility and energy sectors.

The company supervises the design, production and implementation of hydrogen equipment. For this purpose, McPhy relies on 5 centers of R&D, engineering and production in Europe (France, Germany, Spain). To ensure the worldwide commercial distribution of its services, McPhy is supported by many international subsidiaries.

Some key information about hydrogen technologies:

• The main benefit of hydrogen is that it is a clean energy. In other words, once it has been "used", hydrogen reverts to water molecules. Hydrogen is not a primary energy like fossil fuels (oil, gas and coal). Indeed it is an "energy vector" (like electricity) which is produced from another energy source.

• The main way to produce hydrogen is to use organic compounds which consist for the most part of hydrogen and carbon (namely coal or biomass). This method is called “steam reforming”. This currently covers about 95% of hydrogen production. However, this hydrogen is called “grey hydrogen” as it is made from fossil fuels using superheated steam which causes significant CO2 emissions.

• The second way (McPhy's technology) is to produce hydrogen by breaking down water molecules (H20) to retrieve only hydrogen (H2). This can be done either with an electric current for electrolysis, or with sequential chemical reactions. The hydrogen produced using this phenomenon of “water electrolysis” is called “green” or “zero carbon”. The electricity used for electrolysis might be produced with renewable energies, in which case the hydrogen will be considered as “green”, of with some nuclear energy, in which case the hydrogen will be considered as “yellow”. The problem with this “green” and “yellow hydrogen” is its costs of production which exceeds from far the production using steam reforming.

McPhy aims at leveraging hydrogen capabilities to serve as a clean fuel to recharge hydrogen-powered vehicles, as a new input for natural gas networks, as a fluid for industrial purposes or as a storage solution for smart grids. Overall McPhy’s clients can be splitted as follow:

• Industry: Hydrogen is used in diverse industrial processes such as chemicals (refining, methanol, ammonia synthesis), food processing (oil production), jewellery (cutting, soldering), glass production (optical fibre, flat glass), electronic components (quartz fusion), or metallurgy (cutting, welding, brazing, sintering) amongst others. McPhy’s solutions of on-site production enable the decarbonization of these processes, better continuity of supply, control of costs.

• Mobility: McPhy has 35 hydrogen stations as of August 2020, thus becoming a key player in the deployment of hydrogen stations for zero emission mobility. Its solutions range from small hydrogen station for light mobility needs (private vehicles) to heavy mobility needs (trucks, buses, trains). Moreover hydrogen stations’ interface is compatible with electolysers to enable a complete on-site service from production to storage and distribution of hydrogen energy.

• Energy: Grid operators face challenges with renewable energies, which productions are sporadic and unpredictable. Converting the surplus electricity into hydrogen could then allow to store this surplus and thus smooth energy input needed for power grids.

McPhy products and services are divided between:

• On-site hydrogen production with a range of small, large and augmented electrolysers

• Hydrogen supply infrastructures with hydrogen stations

In 2020, McPhy generated €13,7 million revenues, which represents a +20% increase compared to 2019. 60% of the revenues is generated by electrolysers sales (49% large capacity electrolysers and 11% by smaller capacity electrolysers) and 40% by hydrogen stations sales. An interesting point is that about 50% of the revenues in 2020 were generated by the sales of solutions which combines both production through electrolyzers and distribution using stations.

This demonstrates the significance of McPhy's strategic position on both hydrogen production and distribution segments.

The +75% increase of order intake promise great expectation for future revenues.

In terms of revenues, the geographical breakdown is as follows: France (45.6%), Europe (42.1%), Middle East and Africa (0.9%), Asia-Pacific (0.9%) and the Americas (0.9%).

So as to support its expected growth and strengthen its links with shareholders, especially with EDF and Bpifrance, McPhy raised €180 million in October 2020.

McPhy demonstrated a CAGR of +20,9% between 2012 and 2020.

OWNERSHIP

MANAGEMENT ANALYSIS

McPhy’s governance is splitted between the Board of Directors and the Executive Committee, and is supported by three specialised thematic committees.

The Board of Directors is composed of 10 administrators, of which 4 are independent. The president of the Board is Pascal Mauberger. Three specific committees are in charge of preliminaries researches and works for the decisions of the Board: Strategic and Development Committee, the Executive Committee, the Remuneration and Nomination Committee, and the Audit Committee.

On the other hand, the Executive Committee is composed of 14 members and is in charge of the deployment of McPhy’s strategy. Laurent Carme, former strategy consultant specialized in Energy and Mobility, is the CEO and presides over the COMEX since 2019.

INDUSTRY OVERVIEW

Hydrogen is presented by some industrials and managers as a potential pillar of the ecological transition, in the framework of transport (hydrogen cars, hydrogen trains, hydrogen airplanes...), energy storage from intermittent renewable sources or in the industry (steel and chemical industry). The global hydrogen generation market size was valued at USD 120.77 billion in 2020 and is expected to expand at a compound annual growth rate (CAGR) of 5.7% from 2021 to 2028. However, using hydrogen to decarbonize the economy only makes sense if it is produced in a decarbonized way. However, the so-called "grey" hydrogen, which is the only one that is used on a large scale today (70 million tons are produced per year), is obtained by a chemical process that releases dihydrogen and carbon dioxide, thus contributing to the greenhouse effect and global warming).

Therefore, for the moment, hydrogen, so much vaunted as an alternative to fossil fuels, is not a miracle solution. However, there is a certain type of hydrogen, "green" hydrogen, which does not pollute: it is produced by electrolysis by dissociating hydrogen and oxygen from the water molecule. When the electricity needed for the electrolysis comes from decarbonated sources such as solar or wind power, the hydrogen is said to be "green" and does not produce any CO2 emissions.

Today, the Green Hydrogen Market is estimated at USD 1.01 billion, and is projected to grow at a CAGR of 15.7% during the period from 2020 to 2028. For comparison, McPhy’s Gross Profit has grown at a CAGR of 24% from 2015 to 2020.

By region, the global green hydrogen market has been segmented as North America, Europe, Asia Pacific, Middle East & Africa, and South America. The European region holds the largest share in the global green hydrogen market in 2020 and is projected to grow at a moderate CAGR during next decade. The European green hydrogen market is concentrated in Germany, Spain, France, the UK, and the Netherlands, owning to government initiatives towards clean and environment-friendly energy alternatives in these countries.

Besides Europe, North America has captured a prominent market share in the global green hydrogen market, which can be mainly attributed to the well-articulated and favorable government policies regarding low emission transportation system in the US and progress in carbon neutralization transportation targets. These are some of the major factors that will contribute towards the growth of green hydrogen demand in the coming years.

By end-user, the global green hydrogen market is segmented into automotive, metal & mining, power & energy, and others. The market has been dominated by the automotive segment due to the need for eco-friendly and zero emission vehicles to meet the specific environment-related norms and regulations across regions. Automakers are looking for alternative fuels to comply the global carbon reduction policies and norms, and to achieve that, some automakers are working on green hydrogen fuel vehicles. As a part of it, in May 2020, Daimler and Volvo Trucks unveiled plans to produce hydrogen-based heavy-duty vehicles within the decade.

However, one of the challenges that the Green Hydrogen Market faces is cost. Producing green hydrogen with an electrolyzer costs up to 5 euros per kilo, according to the European Commission, compared to 2.50 euros for "blue" hydrogen (with carbon capture) and only 1.50 euros for "gray" hydrogen (produced from natural gas). Technological advances and early projects with significant resources are steadily reducing the cost of many hydrogen applications. According to the Hydrogen Council, over the next five years, hydrogen could become competitive in transportation, particularly for trains, trucks, buses, cabs and ships, as well as for heating. By 2030, applications are possible for light transportation and industrial heating. By massively increasing investment in the sector, the cost of solutions for the production, storage, distribution and therefore use of hydrogen in a wide range of applications should decrease by 50% by 2030.

The analyst group BloombergNEF, in its first-half of 2021 Hydrogen Levelized Cost Update, forecasts that green hydrogen is on track to be cheaper than natural gas by 2050 : its cost should fall by up to 85% from today to 2050, leading to costs below $1/kg ($7.4/MMBtu) by 2050 in most international markets.

However, due to the current lack of competitiveness of green hydrogen, public authorities in Europe and internationally are obliged to invest huge sums to enable the development of green hydrogen technology. For example, the EU ETS Innovation Fund, will pool together around €10 billion to support low-carbon technologies over the period 2020-2030 and has the potential to facilitate development of innovative hydrogen-based technologies.

It has been observed that the demand for green hydrogen has slowed down during the pandemic time. However, demand is anticipated to grow with a healthy pace from mid2021. To control the spread of the pandemic, many countries across the globe have put strict lockdown norms, which is hampering business activities. Demand and supply of products and raw materials and manufacturing facilities have been completely disrupted, which has weakened product and services demand.

Among various industries, transportation, metal & mining, and electronic industries have suffered huge financial losses. The automotive industry has been completely disrupted due to weak vehicles demand, along with the scarcity of raw materials for manufacturers. This has created a weak demand for green hydrogen from the transportation industry. But government initiatives such as stimulus packages for the manufacturing and automotive sectors and other infrastructure related projects are anticipated to boost the global green hydrogen demand after the COVID-19 pandemic.

Market dynamics and principal actors

The green hydrogen market is witnessing several strategic approaches, such as collaboration, mergers & acquisitions, expansion, and product launches. Leading industry players make strategic investments in research and development activities and foster their expansion plans.

For instance, recently, on Feb. 26, 2021, French cybersecurity and cloud computing specialist Atos SE announced its partnership with HDF Energy, a leading hydrogen-to-power plants developer, to develop an end-to-end, long-term solution for green hydrogen supply to data centers. This partnership would enable HDF Energy to deliver a power plant that provides predictable and firm electricity, using cells powered by green hydrogen derived from solar photovoltaic (PV) or wind farms.

Finally, the Green Hydrogen Market is living a race to gigantism similar to the one affecting the electric vehicle market. This aims at reducing costs by increasing economies of scale. One of McPhy’s competitors, ITM Power, has for example raised 180 million euros in 2020 in order to build a GigaFactory.

Green Hydrogen Systems (Denmark) :

Founded in 2007, Green Hydrogen Systems provides efficient, standardized and modular electrolyzers that produce green hydrogen using renewable energy – at the lowest levelized cost available. Backed by growing revenue and a major investment from Nordic Alpha Partners, the company is aggressively scaling its operations.

NEL (Norway) :

Nel is a global, dedicated hydrogen company, delivering optimal solutions to produce, store and distribute hydrogen from renewable energy. Their hydrogen solutions cover the entire value chain from hydrogen production technologies to hydrogen fueling stations.

ITM (UK) :

ITM Power, which was founded in 2001, has the largest Electrolyzer manufacturing facility in the world. It is one of the main competitors of McPhy.

Engie (France) :

Engie is one of the biggest energy groups in France. Since their entry in the Green Hydrogen market, ENGIE has been positioning itself as a major player, with a presence across the entire hydrogen value chain, from the production of renewable energy to end uses. In 2021, they began the construction of the biggest renewable hydrogen production site in France together with the French group Total.

FINANCIAL ANALYSIS

The firm was created in 2008 and faces a strong growth since then. The sales rose by more than 71% between 2015 and 2020. Nevertheless, the firms is not profitable. The net income is -9,3 million euros in 2020. The EBIT and EBITDA margins remain negative but may soon become positive. The EBITDA margin was -207% in 2015 and -57% in 2020.

The company is realising big investments to pursue its growth. The ratio investments/Depreciation and amortization is always between 2 and 3. This shows a growth in the productive base of the company. McPhy has to face big R&D investments (hydrogen stations).

The firm is not indebted. The debt/sales ratio is far below 1. As the firm is still very young and very risky (uncertain sector), the banks will not grant many loans. McPhy uses much more equity. In 2019, they have eight times more equity than debt. In 2020, McPhy had an increase of capital of 180 million euros to pursue the growth and assure the investments.

McPhy has negative free cash flows since its creation and we don’t expect positive free cash flow until 2025-2026.

VALUATION

• The French company McPhy develops and supplies hydrogen production units, hydrogen storage solutions and related equipment for energy and industrial markets worldwide. In this specific typology of business, there are not many firms listed on the stock exchanges, neither in USA nor in Europe. Indeed, the main McPhy’s competitors are private or large firms, that are specialized in the development, production and distribution of hydrogen products and services. Therefore, for our comparable valuation, it was not possible to find a large number of competitors and, indeed, our analysis is based only on the two following ones: ITM Power Plc and Nel ASA. These two companies can be considered as two direct competitors of McPhy, because they are engaged in the research, development, production and sale of hydrogen energy systems and other renewable energy solutions. More specifically, ITM Power Plc operates in USA and Europe, while Nel ASA in Norway, USA, Denmark, and South Korea. Besides, these two firms present some specific characteristics in terms of size, profitability, solvency and liquidity dimensions.

• For the valuation of the firm McPhy, the trading multiple approach is not very relevant, firstly because this company has not many competitors listed on the stock exchanges and secondly because McPhy is characterized by negative EBITDA, negative EBIT, negative Net Income and negative EPS over more than the last 5 years. Only its sales values are positive. Therefore, the comparable analysis is mainly focused on the asset-side trading multiple “EV/Sales”.

• The computation of the median of the EV/Sales multiple among the two selected comparable firms brings to around 56,3x. This value is then multiplied by McPhy’s revenue of $16,2 mln, such that the Implied Enterprise Value is $912,1 mln. The Implied Equity Value is then $1137,5 mln, due to about $234,2 mln in cash. The final Implied Share Price is $40,9 which is greater than the current share price.

INVESTMENT RECOMMENDATION

• We set an underweight recommendation for McPhy stock with a one-year target price of €20.25, reflecting a short-term bearish vision on the hydrogen market. However, on a longer-term outlook, the promising green hydrogen technology will be a valuable asset of the company in more favourable market conditions.

• Europe will inevitably become one of the main disruptive markets for this kind of energy at the beginning of the expansion. But in the short-term, this industry seems to be fulfilled with uncertainties: COVID-19, cost aspect, technological advancements.

• Furthermore, we have seen that competition is fierce, with not only other French SMEs but also bigger companies that are willing to develop their own expertise in that field, threatening McPhy’s technological expertise, which is their main asset.

• Regarding the management of the company, only 4 out of 10 board directors are independent. And regarding their financials the visibility is quite low : the turning point of FCF wouldn’t occur before 2025, and the company has high administrative costs (e.g. salaries) that needs to be maintained (threat of losing its talents to other competitors in the industry).

• Upside risks for the stock include the possibility that McPhy could be acquired by another group (Air Liquide already has a defensive stake in the company), and in this case a high control premium needs to be taken, the more disruptive and developed the industry becomes.

• Overall, the visibility is very low, and the stock is driven by the speculation around the hydrogen industry. The rally on McPhy since June 2020 seems to have come to an end for now and the stock has even been declining quite significantly in YTD (-16%). And since in the short-term, the industry does not present any major catalysts, the downward trend tends to remain our main point of view in this outlook. We think that €20.25, corresponding to the support of the stock price since 28 oct. 2020, is a relevant target price.