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Beacon Equity Research

Market Commentary

 

Capstone Worth Another Look

Thesis

We feel that Capstone Turbine shares will continue to increase with the rising oil prices, the recently passed energy plan bill by the Congress, and the introduction of the Capstone’s Micro Turbines in new markets around the world. As oil prices continue to move north, more and more consumers are expected to become aware of alternative energy sources like the Micro Turbines systems, which can be used as backups to traditional power grids or serve as the direct source of heat/electricity for remote facilities. Though these Micro Turbines run on natural gas, diesel, kerosene, propane or even flare gases produced by landfills, they are very fuel efficient and give produce fewer emissions than conventional methods. Given that the Micro Turbines generate 95% less smog-forming nitrous oxide and use less fuel to produce energy, we expect the demand fo to increase significantly, going forward.

On July 29, the Congress passed an energy bill allowing economic benefits to companies investing in clean-energy technologies. Specifically, it provided a 10% tax incentive for creating and conserving energy by utilizing Micro Turbine generators. In addition, it also provided users of advanced Micro Turbine energy systems with direct payments from the U.S. department of Energy for every kilowatt-hour generated. This bill, in turn has created significant additional economic advantages for consumers investing in Micro Turbines.

Capstone’s management is following a focused approach of becoming the world leader in Micro Turbine and has been introducing its products at a rapid rate around the world. In line with this strategy, the company has recently received orders from China, Russia and Mexico. We believe this will largely help to increase awareness of the company’s products around the world and boost its top line.

Recent Events

On October 10, Capstone Turbine Corporation announced that it will sell up to 17 million shares to fund the company’s long term plans to capitalize on its alternative energy products by investing in opportunities in the alternative energy and secure power marketplace. As a result of this announcement, shares of Capstone declined by more than 17% to close at $2.69. Subsequently, on October 27 Capstone announced that it has completed the previously announced registered offering of its common stocks and has raised $41.4 million from the issue of an additional 17 million shares of its common stock. These funds have helped to significantly strengthen the company’s liquidity position and help in the growth and expansion programs.

On September 14, Capstone filed a Materials Equipment Acceptance (MEA) application with the New York City Department of Buildings for its latest product development for emergency elevator power. This will provide stand-alone emergency power during power failures and site-specific emergency power requirements for elevator installation in New York City and Los Angeles. Capstone, which has spent over fifteen months in developing this application, would be the first in the industry to provide such a solution.

Shares of Capstone also witnessed a one-time gain due to hurricane Katrina on the speculation that the company’s Micro Turbine will benefit from the disaster along the Gulf Coast as they served as a backup system in the blackened out region. As a result, the stock increased by 12% to a three-year high of $5.14 on August 30.

Results for the second quarter ended September 2005, will be announced on November 10, 2005.

Risk

Demand for Micro Turbines is currently at a nascent stage and is expected to grow as consumers become aware of the fuel efficiency of the product, we remain wary that a sustainable market for the company’s products may take longer than anticipated time to develop and mature. Additionally, since Capstone operates in a highly competitive environment (top competitors include Caterpillar, Cummins, and Ingersoll-Rand), it also faces the risk of losing important customers to the aggressive players in the market.

Bulls Say…

Bears Say…

Financial Overview
Growth

Growth is expected to be significant going forward if management can continue to remain focused on providing higher product reliability, enter into new markets around the world, and enhance distribution channels.

Profitability

Capstone has been incurring losses and has not turn profitable as of now. However, the increasing demand for the company’s Micro Turbines (with oil prices treading north and favorable economic advantages of the recent Energy Bill), coupled with the company’s entry into new markets makes us optimistic that Capstone would turn profitable going forward.

Financial Health

The balance sheet of Capstone appears strong, with long-term debt of less than a million and cash and cash equivalents of more than $52 million at the end of the last reported first quarter of 2006. In addition, the company’s liquidity position is very strong, with a liquidity ratio (Current Asset/Current Liabilities) of 4.5x at the end of fiscal year 2005.

Company Overview
Profile

Headquartered in Los Angeles, Capstone Turbine Corporation (Nasdaq: CPST) is the world’s leading producer of low emission Micro Turbine systems. These Micro Turbines, which generate power at the site of consumption and to hybrid electric vehicles not only help reduce energy costs but reduce pollutant emissions as well, generating 95% less smog-forming nitrous oxides. Capstone’s Model C30 and Model C60 Micro Turbines are approximately the size of a large refrigerator. The Model C30 generates approximately 30 Kw of electric power, which is enough to power a typical convenience store and approximately 300,000 kilojoules per hour of heat. Additionally, the company has the ability to vary and modify these Micro Turbines to accommodate a variety of application and needs. These Micro Turbines can operate on a variety of liquid and gaseous fuels like natural gas, diesel, kerosene, propane, and flare gases from landfills and sewage plants. The company is a member of the U.S. Environmental Protection Agency’s Combined Heat and Power Partnership, which is committed to improving the efficiency of the nation’s energy infrastructure and reducing emissions of pollutants and greenhouse gases. Capstone has sales and service centers in New York, Milan and Tokyo.

Strategy

Management is focused on becoming the world leader in distributed power generation. In line with this strategy, the company is aggressively entering new markets. Capstone has been rapidly deploying assets to gain a foot holding in the New York market and has filed an application for Materials Equipment Acceptance with the New York City Department, which will simplify the permitting and installation approval of Capstone-branded Micro Turbines in the New York City. Capstone has also signed an agreement with Shanghai Aerospace Energy (SAE) of China to grow its Micro Turbine sales in the country. In addition, SAE will help support the company’s outsourcing and cost reduction operations in China. Capstone has also received a 1.5 Megawatt order for its new propane-based C60 for the Mexican government, and a total of 1.7 megawatt Russian order for both the C30 and C60 Kilowatt Micro Turbine products.

Management

The company has recently appointed Walter “Chuck” McBride as its chief financial officer and executive vice president. He has replaced Karen Clark, who after having served the company resigned to pursue other interest. McBride has served as an executive vice president and finance chief of First Consulting Group, Inc. a publicly held information technology company. During his tenure there, the company doubled billable resource, acquired several companies and transformed its operating model by cutting costs. We expect his past experience to have a positive impact on Capstone.



Annual Financial Results

Dec-02

Mar-04

Mar-05

Revenue ($Thousands)

19,529

12,607

16,968

Gross Margin %

-122%

-133%

-41%

Operating Income ($Thousands)

(76,812)

(48,839)

(41,120)

Operating Margin

-393%

-387%

-242%

Net Income $Mil

(74,335)

(47,739)

(39,449)

Operating Cash Flow ($Thousands)

(30,739)

(29,512)

(37,439)

Capital Spending ($Thousands)

(2,515)

(1,299)

(1,057)

Financial Health

 

 

 

Working Capital $Thousand

139,948

95,602

61,562

Long Term Debt $Thousand

974

13

64

Debt/Equity

1%

0%

0%



Quarterly Results

Sep-04

Dec-04

Mar-05

June-05

Revenue ($Thousands)

3,925

4,683

5,405

3,807

Gross Margin %

-43%

-37%

-25%

-90%

Operating Income ($Thousands)

-9812

-10149

-10402

-11259

Operating Margin

-250%

-217%

-192%

-296%

Net Income $Thousands

-9,147

-9,770

-9,998

-10,865



Close Competitors

Market Cap ($Mil)

Sales ($Mil)

Net Income ($Mil)

Capstone Turbine Corporation

238

17

-39.4

Caterpillar Inc.

3,634

30,251

2,035

Cummins

402

8,438

350

Ingersoll Rand Company Limited

1,270

9,394

1,219