Aspen Aerogels (NYSE:ASPN) has had a wild ride for the last few years. After reaching $60 two years ago, it dropped 90% and is back to its 2019 price when I began to cover it. A lot has changed, and a lot is quite similar. We will go through both the changes and the familiar to explain why I believe it has never had a more attractive value proposition, and while there are significant risks in the future, it is one of my top picks to outperform in 2024.
The changes include expanding the thermal barrier segment, facilities, and infrastructure and progress on the carbon aerogel battery that could replace Li-Ion batteries.
The familiar, the Oil/EV trend, the importance of achieving gross margin, and my bias towards a beautiful technology.
Back in 2020, Thermal barrier sales accounted for less than 1% of revenue for the company. Now, they account for over 30% of the revenue. This is a breakthrough for the company as it diversifies its revenue sources and finally pays off years of R&D.
The thermal barrier is used in electric vehicle batteries as a fire safety measure. While Tesla has stopped using Aspen Aerogel’s products for in-house alternatives, it is likely not the route most EV manufacturers might take, considering the complexity of manufacture and percentage of the cost to the vehicle. The segment has solid prospects for 2024 from GM, Honda, and others. Its Q3 showed YoY revenue growth of almost 100%.
Last year, the reported gross margin for the Thermal barrier segment was negative, so the increase in its revenue was not so noticeable in earnings, but for this year, it is not only positive; it reached mid-20 % levels, which is encouraging. The gross margin in Q3 2023 was 24%, which is higher than the gross margin of the Energy industrial segment and represented more than half of the quarter’s revenue and gross profit.
On the Infrastructure side, Aspen finally completed the initial phase of its “Plant 2”. However, it has spent around 50 million for the past two quarters to close and maintain its 1st phase on standby.
$10 million of our CapEx was spent in closing the main buildings of Plant 2 in Georgia and helping bring the Plant 2 a healthy resting spot while securing the site.
Ricardo Rodriguez – Chief Financial Officer Q3 Earnings call
$40.7 million of our CapEx was spent in closing the main buildings of Plant 2 in Georgia and helping bring the plant to a healthy resting spot.
Ricardo Rodriguez – Chief Financial Officer Q2 Earnings call
The construction of the remainder of phase two would take about a year, and by the revenue trend, it could be needed by some time in 2025. However, this is a risk for the company. If revenue growth flutters and the company has to postpone the completion and ramp-up of Plant 2, it would have to keep maintaining “Phase 1” of Plant 2 or let it deteriorate. This is an issue, especially considering it is still cash-negative.
On the carbon battery. My last article described how a sulfur lithium battery with carbon aerogel would work. Since then, the company has shifted to a Silicon Carbon Aerogel battery, and the company has not provided much detail on the progress besides an ominous call to the project in the Q3 earnings call.
And then on the battery material side, we continue to work on advancing the technology and we are endeavoring to solve a hard problem. And we are making, I think steady and interesting progress on that. We’ve kept quiet on it to a great degree on purpose as we’ve continued to advance that. I think it will be an opportunity for us to talk about it in the coming earnings call or two
– Don Young CEO – Q3 2023 Earnings call
The last time the issue was discussed in some depth was in Q1 of 2022 when the company described the targets for the battery in terms of cost and energy density. The energy density of commercial vehicles, including Tesla (TSLA), is around 270-290 Wh/kg. As the image below shows, Aspen’s battery has a target of 300 Wh/kg, which would be in the top range of that or slightly above; however, on the cost side, it would result in a production cost of two-thirds of a traditional battery, which would be a significant breakthrough.
Sadly, on that call, it was reported that research had hit a wall and would take some time to progress.
The existing approaches to increased silicon content and the anode, have hit a wall, with the only solutions out there being either too expensive or very much in the research phase. For Aspen, over the next 18 months, we anticipate completing the development phase of our silicon carbon anode aerogel platform, and leveraging our relationships with battery and automotive OEMs, to begin rapidly commercializing these materials. 2022 Q1 Earnings Call Keith Schilling – SVP, Technology
It would be tempting to speculate that if the completion of the development phase was supposed to last 18 months, and the Q1 2022 earnings call was done at the end of April 2022, the 18 months would be around this time, which could be a catalyst for the stock if the development progressed in a meaningful way.
As in the past, the key for Aspen Aerogel lies in gross margin and its ability to continue its revenue growth. Back in 2020, scalability was the main issue, but with the new plant and improvement of the Rhode Island Plant, its infrastructure is what they had envisioned, and scaling production should not represent a primary concern anymore. If they designed it right and forecast its revenue accurately, the gross margin should improve as revenue grows; of these two factors, I am more concerned about their accuracy in forecasting revenue and its implications.
The timing for the completion of Plant 2 is crucial. If it is too early, Aspen will incur more extraordinary expenses and likely lower gross margins until capacity utilization improves. Too late, and it may lose momentum and sales.
While the situation and maybe given the margins are comparable to what they were a few years ago, Aspen now is in a much better shape to assume the challenges.
One thing I have always liked about Aspen Aerogel’s stock is its exposure to oil and electric vehicles while keeping its strong sustainability roots. The energy industrial segment is linked with oil production, especially in the sub-sea sector, where competition is scarce to non-existent, while the thermal barrier segment benefits from the switch to electric vehicles and other sustainability developments, especially if the battery materials segment comes to fruition.
Lastly, my bias towards the technology. As an engineer, I love Aerogels for their elegance as materials and the wide variety of their properties. While its production in the past has been costly enough to deter its exploration and development, this is changing, as the company has proven. I believe there are enormous applications for aerogel outside insulation, and Aspen will be at the forefront of this development. This bias creates a soft spot for the technology and its forecast, and to compensate for that, I constructed an especially pessimistic valuation.
The valuation will focus on a Low scenario, where the company never fully achieves its gross margin targets and flirts with bankruptcy for what remains of the decade. The Mid scenario considers a slow achievement of gross margin and forecasts the company to achieve profitability by 2027. The High scenario could be closer to what the company has hinted at in terms of timing and revenue goals but without reflecting either the battery or other new aerogel products coming to significant fruition.
The most substantial jump in the valuation comes between 2022 and 2023, as the three quarters and outlook for the fourth have been substantially above 2022 results, as we have seen from the shift in the thermal barrier segment that went from a negative gross margin to a gross margin above 20% in this period.
The story unfolds in the FCFE chart, with the period from 2023 to 2027 reflecting near zero values supporting growth and capital requirements in the mid and high scenarios, while the low scenario mainly survives the business as usual. After that, the growth reflects the gross margin described above and the economies of scale of SG&A and R&D expenses.
To temper the valuation further, the high and mid scenarios were capped to 2027, and the terminal value was calculated with an H-Model that considered a growth reduction to a perpetual growth of 12% after seven years, while the same approach was used for the low scenario but ending in 2032.
It is important to note that Aspen Aerogels is considered in the valuation to have cash of around $1.3, which the company reported in Q3 of this year, so the low side of the valuation considers the future value of FCFE as $0.2 per share.
The model expects the stock to have around $3 per share in cash by the close of 2023, which is close to what it had at the end of 2022. This is not to be overly conservative but a choice to reflect the company’s risk profile better. The Debt equity ratio of the company is below 0,3, so for now, it is not an issue, although it has negative cash flow.
The last time the stock was priced at this level, the company did not have a new battery technology in progress, the thermal barrier segment was only a seed in the company’s outlook, and the infrastructure for producing its projects required extreme overhauls and expansions.
This makes sense, considering that the closest scenario to the current price is the mid scenario, which does not reflect the possible new battery development or the exposure to new products and assumes slower revenue growth for the thermal barrier than we have experienced in the last couple of years.
This is why the stock is one of my top picks for 2024. I believe the stock was fairly valued the last time it had similar financials, and the market is pricing the stock as if the company had not evolved since then. While there is a strong resemblance between the current financials and the ones it had in 2019, the market is not adequately weighing the significant changes in the composition of those financials and the company’s future prospects.
On the risk side, the near-zero FCFE and Earnings make for a volatile stock. Hence, reviewing proper profit-taking and loss-control points is wise below the animalistic dummy portfolio updates.
The portfolio for the Giant Tortoise has a low tolerance for drawdown and a long-term outlook. However, the stock could warrant allocating risk to the portfolio since it also provides an ESG hedge for oil, which is essential for the portfolio. Immune to the FOMO on battery developments, the portfolio would allocate 1/3 of the position size now and wait to see the Q4 results and guidance, depending on if the position grows, with the idea of slowly building a position depending on how the story unfolds.
The cat portfolio would be fully committed to the stock. However, depending on its movement in Q4 earnings and the development of the battery, it might not be a long-term holding. The upside is substantial for this risk-seeking portfolio, which makes it a prime candidate, and an emotional bias like FOMO and the desire to speculate warrant action now instead of waiting closer to earnings.