Solid Power: A Long And Winding Road For Investors (Rating Downgrade) (NASDAQ:SLDP)

Performance Assessment

In my initiating coverage of Solid Power (NASDAQ:SLDP), I had rated the stock a ‘Buy’ as I thought it was a promising play on a nascent growth industry. This has not gone well so far as it has lagged the S&P 500 (SPY) (SPX) by 26.52%:

There are two main ways of thinking about investing, which have different implications for investment selection:

1. Focus on IRR; with this approach, it is often preferable to invest at higher prices if that results in smoother and faster return generation.
2. Focus on minimizing low purchase cost; with this approach, accumulation at a low price is preferable and there is high tolerance for waiting long periods until momentous rallies in the stock occur.

I am more of an IRR-maximizing investor. Yet, by rating SLDP a ‘Buy’, I believe I veered away from my natural approaching by acting as a purchase-cost-minimizing investor, without having the tolerance for the long waiting period.

Thesis Update

3 quarters have passed since my last update on SLDP. And the developments have been disappointing vs my expectations:

1. Progress is a long and winding road
2. FCF burn is elevated
3. Buybacks without a sustainable business model is questionable
4. Valuations are low and there is sufficient liquidity
5. Relative technicals point to further downside

Progress is a long and winding road

Solid Power’s progress is facing a long and winding road. This journey may be necessary for entrepreneurs and aligned with the risk appetite of startup investors. However, given the lack of a sustainable and scalable commercialization model, I believe SLDP can be a frustrating investment for many public market investors.

Revenue downgrade

At the end of FY23, management had indicated a revenue guidance of $20-25 million for FY24:

Looking ahead to ’24, — we currently expect our ’24 revenue to be in range of $20 million to $25 million.

– Former CFO Kevin Paprzycki in the Q4 FY23 earnings call

This revenue guidance was maintained in Q1 FY24. However, as of the latest quarter, this was downgraded down to $16-20 million:

We are reducing our 2024 revenue guidance to be in the range of $16 million to $20 million.

– CFO Linda Heller in the Q2 FY24 earnings call

Revenues for FY24 till date is $11.1 million. This means the remaining 2 quarters are expected to see only $2.45-4.45 million of revenues on average. This downgrade reflects execution hiccups in both the electrolyte production and solid-state battery design efforts:

Electrolyte production

Solid Power’s clients are demanding a lot of customized iterative cycles of the electrolyte powder before scaling up production:

we’ve been through multiple iterations of sampling with both of them. Then looking at the initial material saying, “I like this characteristic about the electrolyte but could you change this characteristic?” And go ahead and we do our modification or screening or what have you to get to that desired specification. We resample it, they re-evaluate it, taking through their cell lines and then it’s a rinse and repeat from there. We’ve had as many as 5 cycles with one of those 2 OEMs at this point.

– CEO John Scoter in the Q1 FY24 earnings call

Management has expressed that these R&D iterations would continue on for the rest of FY24, which means large-scale commercialization is not expected for at least the next couple of quarters:

We’re not through that process for either of them. I would expect that would continue through the balance of this year.

– CEO John Scoter in the Q1 FY24 earnings call

Moreover, it is clear that Solid Power lacks bargaining power in their partnerships with the OEMs. Not only does Solid Power have to make whatever changes are requested by the OEMs, but the OEMs are also not sharing the underlying designs responsible for the change requests with Solid Power:

We believe that it’s being used in a variety of different anode-cathode combinations at this point. For obvious reasons, these OEMs generally keep those designs pretty close to their chest. So we don’t have a lot of visibility but we get some clues, if you will, based on what they’re asking for in terms of the changes to electrolyte… We do, again, work closely with the customers but don’t have ultimate visibility right now on those designs.

– CEO John Scoter in the Q1 FY24 earnings call

I believe this increases the risk of the EV OEMs using Solid Power for R&D, without necessarily relying on them for larger production. In any case, these iterations have led to an extension of timelines till a larger-scale electrolyte supply agreement is secured, from 12-24 months to 18-24 months:

We have previously, I think, signaled that we thought the whole process from that initial sample through integration to their cell designs and then into actual supply agreement could take between 12 months and 24 months. And I think we’re seeing now that consistently around 18 months to 24 months…

– CEO John Scoter in the Q4 FY23 earnings call

Indeed, the slower progress here has been quoted as one of the reasons for the revenue downgrade in Q2 FY24:

while we continue electrolyte sampling or receiving positive feedback on performance, the uptake in development have been slower than originally forecasted

– CFO Linda Heller in the Q2 FY24 earnings call

Solid-state battery design

This table outlines the key automotive qualification stages for a solid-state battery design to production process:

The A-sample stage has 3 parts. After having achieved A-1 last year with their BMW partner, Solid Power is working on stage 2 A-2 cell design this year:

Our team continues to refine our A-2 cell design with a goal of delivering A-2 cells to our partners by the end of this year.

– CEO John Scoter in the Q1 FY24 earnings call

Unfortunately, progressions along the qualification stages with one EV OEM (BMW) do not necessarily apply in work with another EV OEM (SK):

We will start with the A-1 design as a baseline because it’s the most learned and then build from there.

– CEO John Scoter in the Q2 FY24 earnings call when asked if partnership with SK can start with A-2 design

In my previous note, I had grossly underestimated the time it takes to progress through the different stages of automotive qualification. The reality is the road to scaled-up commercialization is very long, with some timelines extending till 2030.

As an additional spanner in the works, BMW has paused future deliveries of Solid Power’s cells for its demo car:

BMW has paused future deliveries of cells for the demo car program

– CEO John Scoter in the Q2 FY24 earnings call

This undermines a key bullish catalyst for the stock.

FCF burn is elevated

After Q3 FY23, I had anticipated lower FCF burns in the future. However, this has not played out:

Q3 FY24 and Q4 FY24 are expected to see more elevated FCF burn levels too:

With respect to the overall cash flow guidance, we are reiterating our expectation that total cash investment for ’24 will be in the range of $100 million to $120 million

– Former CFO Kevin Paprzycki Q1 FY24

The company’s total liquidity today is $359 million. A rate of $31 million quarterly cash burn therefore implies 11-12 more quarters of reserves remaining. So there is no major concern about a lack of funding.

Buybacks without a sustainable business model is questionable

Earlier this year, Solid Power’s board authorized a $50 million share repurchase program. I didn’t think much of it at the time, since authorizations happen all the time without necessarily leading to executed share repurchase operations. However, I had made clear that I would view share buybacks/repurchases unfavorably:

Given that the company is still burning cash and has its full focus on commercialization of the business model, I would be very shocked if the company does repurchase its shares. This would be cause for thesis re-evaluation as it would make me doubt management’s capital allocation decisions.

– My earlier comments on potential share buybacks for SLDP

This is because I believe buybacks for a company without a sustainable business model, with high reliance on both the outcome of successful R&D efforts and the ability to win production contracts, increases risk for investors. If there is spare liquidity that is unused, I would rather the company keep it in cash and short-term investments, or return the capital to shareholders as dividends.

However, Solid Power has chosen the path that I had feared as they have conducted $8.8 million in buybacks over the last 2 quarters, and this is expected to continue:

Valuations are low and there is sufficient liquidity

Solid Power currently has $359 million of liquidity in the form of cash and investments:

Its market capitalization is $256 million. This corresponds to a discounted P/Liquidity valuation multiple of only 71%; i.e. the current market capitalization is worth less than the liquidity available in the company (SLDP has 0 debt). Thus, there is deep value in the stock.

However, I believe there are risks of a value trap so long as the FCF burn and steady liquidity erosion continues without scaled commercialization fruition of the business model. As mentioned earlier, assuming the expected rates of FCF burn over the next 2 quarters continue on, Solid Power has 11-12 quarters till it runs out of liquidity.

Relative technicals point to further downside

If this is your first time reading a Hunting Alpha article using Technical Analysis, you may want to read this post, which explains how and why I read the charts the way I do. All my charts reflect total shareholder return as they are adjusted for dividends/distributions.

Relative Read of SLDP vs SPX500

On the relative technicals of Solid Power vs the S&P 500, I see a major break and retest structure, indicating a resumption of the broader downtrend. This would correspond to underperformance of SLDP stock vs the broader market.

Investor update in H2 FY24 is a key event to watch

Solid Power management has said they will give longer-term guidance in their investor update later this year. Their last investor update beyond the earnings calls was in October 2023. I will be keenly tracking this, as it would be a key checkpoint at which my thesis would likely need to be re-evaluated if any meaningful data or narrative changes my future expectations for the stock.

Takeaway & Positioning

I had previously rated Solid Power a buy and 7 months later, it has lagged the S&P 500 by 26.52%. I believe I grossly underestimated the nature of this investment and the time it would take for Solid Power to prove its business model and generate sustainable free cash flow.

The past 3 quarterly updates by the company have also not been very encouraging. Revenues downgrades in the most recent quarter reflect delays in a highly customizable R&D iterations process for which Solid Power lacks visibility of the OEMs’ designs, indicating a weak bargaining positioning vs the OEMs. I believe this increases the risks of OEMs using Solid Power for R&D, but not necessarily choosing them for mass production and commercialization.

On the solid-state battery design’s qualification process, this year, the company is expected to only complete Stage 2, Step 2 out of the 6 Stages required for full commercialization of the business model. There is a very long path ahead, with some commercialization timelines extending till 2030. Recently, BMW has also slowed down collaboration efforts with Solid Power, leading to further delays.

Contrary to my earlier expectations, FCF burn is expected to increase, which is another negative point for my earlier bullish thesis. I also don’t like the company’s decision to conduct buybacks, as I believe this increases risk for investors. On the valuation side, the stock still trades at a 29% discount to the total liquidity in the balance sheet. However, without a sustainable business model, FCF burn and reliance on successful R&D and production scale-up, I recognize the possibilities of this being a value trap. Technically vs the S&P 500, I see a bearish setup, indicate more underperformance ahead for the stock.

Rating: ‘Sell’

How to interpret Hunting Alpha’s ratings:

Strong Buy: Expect the company to outperform the S&P 500 on a total shareholder return basis, with higher than usual confidence. I also have a net long position in the security in my personal portfolio.

Buy: Expect the company to outperform the S&P 500 on a total shareholder return basis

Neutral/hold: Expect the company to perform in-line with the S&P 500 on a total shareholder return basis

Sell: Expect the company to underperform the S&P 500 on a total shareholder return basis

Strong Sell: Expect the company to underperform the S&P500 on a total shareholder return basis, with higher than usual confidence

The typical time-horizon for my views is multiple quarters to more than a year. It is not set in stone. However, I will share updates on my changes in stance in a pinned comment to this article and may also publish a new article discussing the reasons for the change in view.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.