Katrina Sparks Power Play

Shares of Capstone Turbine (CPST) climbed 12% to a three-year high of $5.14 Tuesday on speculation that the maker of electricity- and heat-producing microturbines will benefit from the disaster along the Gulf Coast. Not only do the Chatsworth, Calif., company's power generators serve as backup systems, an attractive prospect in the blacked-out region, but they also run cleaner and burn fuel more efficiently than traditional energy sources. Capstone's stock rose 10% Monday.

"The issue I see is that the higher the price of oil gets, the more folks begin to think alternative energy sources like Capstone's microturbines will be cost-effective," says David Kurzman, managing partner of Kurzman Partners, a New York hedge fund. (Neither Kurzman nor his hedge fund own shares of Capstone Turbine.)

Oil futures jumped $3.65 to $70.85 a barrel on Tuesday, an intraday record on the New York Mercantile Exchange. By the close, the benchmark October light sweet crude futures gained $2.61 to an unprecedented settlement of $69.81. Heating oil and gasoline futures also rose to record levels. The Bush Administration said it would consider releasing oil from the country's strategic petroleum reserves to offset the lost production caused by the hurricane. Officials in Louisiana and Mississippi warned that it could take weeks to get rigs, pipelines and refineries back up to full speed. Damage caused by wind, waves and flooding is still being assessed.

Capstone specializes in microturbines for commercial markets. The systems can be used as backups to traditional power grids or serve as a primary source of heat or electricity for remote facilities. While the microturbines require natural gas, diesel, kerosene, propane or even flare gases produced by landfills to run, they make better use of the fuel sources and give off fewer emissions. Even before Katrina, Capstone's technology was garnering attention from Wall Street as new orders came in and federal legislation made microturbines more attractive financially.

"Three things are driving the stock: rising oil prices, Congress's recently passed energy plan and the one-time boost due to Katrina, the last of which will probably dissipate pretty quickly," says Kurzman.

A week after closing at a 52-week low of 92 cents on June 8, Capstone received orders to supply and service 2.4 megawatts of its 60-kilowatt microturbine systems for customers in New York and New Jersey. In early July, the company announced a follow-on order from Russia for a total of 1.7 megawatts of both 60- and 30-kilowatt microturbines. Then, on July 29, Congress passed a bill providing economic benefits to companies investing in clean-energy technologies. Specifically, the legislation gives a 10% tax incentive for businesses to purchase microturbine generators. Capstone's stock has has rocketed 459% from its June 8 low.

"It offers users of advanced microturbine energy systems direct payments from the U.S. Department of Energy for every kilowatt-hour they generate," said Capstone Chief Executive John Tucker at the time the bill was passed. "This policy, and others in the energy bill, will create significant additional economic advantages for customers who invest in microturbines, beyond the everyday savings and energy reliability inherent in microturbine technology." Capstone didn't return phone calls seeking comment on Tuesday.

A few days later, the Mexican government gave Capstone an order for more than 1.5 megawatts of propane-fueled microturbine systems. Plans call for the installation of the generation systems at three government office buildings in Mexico City.

"While the shares have appreciated meaningfully, we believe further upside potential remains," wrote First Albany analyst Sanjay Shrestha on Monday in a note upgrading Capstone's stock to Buy from Neutral. "Management's clear focus on providing an economic value proposition with higher product reliability, targeted end markets and enhanced distribution channels should lead to meaningful growth over the next several years." (Shrestha doesn't own shares of Capstone Turbine; First Albany doesn't have an investment-banking relationship with the company.)

"We believe this growth trajectory is also well supported by the large distributed generation market potential in just major metropolitan areas," wrote Shrestha, adding that, "the New York market could alone represents a 10-gigawatt opportunity."

In the meantime, Capstone is losing a lot of money. For its fiscal year ended March 31, Capstone reported a net loss of $39.4 million, or 47 cents a share, vs. $47.7 million, or 58 cents, for the previous year. Revenue increased 35% to $17.0 million. For the first fiscal quarter ended June 30, the company lost $10.9 million, or 13 cents a share, compared with $10.5 million, or 13 cents, in the same period last year. While revenue leapt 29% year-over-year to $3.8 million, sequentially sales fell 30% from $5.4 million in the fiscal fourth quarter. Capstone has $50 million in cash, but no positive cash flow and a cash-burn rate of about $10 million a quarter. For the current fiscal year ending in March, the company is projected to lose 50 cents a share.

"It looks like Capstone will burn through all its cash in five quarters. That means it has a year and a half left unless it makes some money," says Peter Cohan, president of Peter S. Cohan & Associates, a management-consulting and venture-capital firm in Marlborough, Mass. "Meanwhile, it's trading at a price-to-sales ratio of 22, which is 10 to 15 times greater than the industry ratio. People think events like a hurricane will transform a money-losing company into a gold mine, but at some point the hype has to turn into financial reality, and it doesn't look like that will happen in the next year." (Cohan doesn't own shares of Capstone Turbine; Peter S. Cohan & Associates doesn't have a business relationship with the company.)

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"I think this is more hype than reality, and I'm uneasy with the valuation at these levels," says Kurzman, the hedge-fund manager who is also a former alternative-energy analyst. "The microturbines are good technology, but I'm not convinced they are cost-effective. And it doesn't appear that Capstone offers anything substantially better than other types of back-up power. To its credit, Capstone has garnered some contracts recently, but there is nothing in the energy bill that will benefit them directly. Meanwhile, you have a $430 million market cap for a company burning cash and that hasn't generated any gross profits yet."