Washed Out Expectations May Help Maxwell From Here

By Stephen D. Simpson, CFA | September 05, 2012 AAA

The combination of overheated expectations and market weakness in Europe and Asia has done a real number on energy technology names ranging from wind power to solar to batteries. With declining revenue momentum in ultracapacitors, lower overall revenue guidance and worries about both emerging competition and sluggish end markets, Maxwell Technologies (Nasdaq:MXWL) has been no exception - dropping almost 50% over the last year. I'm starting to wonder, though, if this isn't a good time to start reconsidering this name. I think investors have been forced towards much more rational market and revenue expectations, and if anything the market may now be undervaluing the company's long-term potential. While this remains a high-risk name with much to prove, sometimes emerging tech stories work better after a lot of the wide-eyed optimism has been washed out of the stock.

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Second Quarter Results were OK, But Guidance Didn't Help Matters
Maxwell's reported results weren't too bad - revenue did slip a bit from last year (by about $200,000), but grew 10% on a sequential basis. What's more, gross margin of 42% was not bad at all. Like American Superconductor (Nasdaq:AMSC), another energy-tech play with substantial exposure to Asian wind power markets, Maxwell reported ongoing improvement in this end market. Unfortunately, that's about it for the good news. Management lowered third quarter revenue guidance about 7% relative to the prior sell-side average and guided full-year revenue growth towards the low end of its prior range. What's more, sales growth momentum continues to wane in ultracapacitors - from 53% year-on-year growth a year ago to 30% growth in the fourth quarter of 2011 to 3% growth in the first quarter of 2012, and now down to negative 1% for the second quarter.

SEE: A Primer On Investing In The Tech Industry

Maxwell Needs More Automotive Business
One of the largest "shovel-ready" opportunities for ultracapacitors today is in the automotive industry - particularly in start-stop systems that reduce engine idling time, lowering fuel consumption and emissions. While Maxwell does have a relationship with major auto components supplier Continental AG and automaker PSA Peugeot Citroen, these are not great times for European car makers.

What's more, I think it's fair to ask why companies like BMW, Toyota (NYSE:TM), Mazda, Honda (NYSE:HMC) and Ford (NYSE:F) have all moved forward with alternative start-stop options. While the company has talked about discussions with a Detroit-based OEM, it seems clear to me that the company needs to do a better job of selling car makers and suppliers on the benefits of its approach.

SEE: 5 Reasons Old Tech Is Soaring

Reliance on China Is a Risk Factor
Investors should also be a little wary of the extent to which Maxwell relies on China today. More than a quarter of 2011 sales came from China, largely from the wind power and hybrid bus markets. Although China remains an excellent long-term market for energy/pollution solutions, there's likely to be above-average volatility here.

I'm also a little concerned about rumors regarding one of Maxwell's Chinese partners. Lishen has been a contract manufacturer for Maxwell in China for a while now, but there are stories out there that Lishen is looking to sell its own branded ultracapacitors to Chinese customers and perhaps develop its own electrodes as well. Maybe it's just a rumor with no substance to it, but given American Superconductor's miserable experience with a major Chinese partner and the disruptions that it caused, I don't think the risk can be completely discounted. That said, it wasn't as though Maxwell was going to get a free ride indefinitely; if ultracapacitors have real potential, there will be competitors sooner or later.

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The Bottom Line
Wall Street has definitely done a U-turn on this stock. Just six or so months ago, the average sell-side price target was in the low $20s, and now it's just above $9. Say what you will about the worthlessness of sell-side price targets, but it does reflect a significant change in sentiment. That may not be such a bad thing, though. Clearly Maxwell has to show that it can deliver reignited growth, and a major OEM partnership announcement (or two) would not go unwelcomed. Nevertheless, Maxwell currently sports an EV/revenue ratio of about 1.3 - well below the range of multiples common for emerging growth tech stories, even though this company has proven that it can sell its technology and products profitably.

While I realize a discounted cash flow model on a company at Maxwell's stage of development involves massive amounts of guesswork, I nevertheless think these shares ought to be trading in the double-digits ... and if the company can return to high-teens/low 20s growth rates, even more could be in store. Investors should understand that this is still a very speculative story, but in the universe of energy-tech or alternative energy it's at least an idea with solid underpinnings and a real model.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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