Selling a product or service for less than it costs to produce isn’t a business, it’s a charity. That’s referred to as a “negative gross margin,” and companies that exhibit this trait are immediately filed in the circular filing cabinet. As time passes, some of these companies manage to achieve a positive gross margin. That’s still not a viable business unless it’s consistent and sufficient to cover variable costs. Still, it’s a step in the right direction, which bring us to Fluence Energy (FLNC).
A few years ago we published a piece titled Fluence Energy Stock: A Global Energy Storage Leader which raised some concerns. While negative gross margins were an obvious showstopper, there was also customer concentration risk, oddly volatile geographic revenue growth and declines, and no revenue segmentations. The appeal was the AI-powered software tools they acquired, like the Fluence Bidding Application (FBA) which promised high margin growth alongside their hardware sales.
What Fluence Energy lacks is any sort of recurring revenue streams that might help offset some of the revenue volatility we mentioned earlier. While FBA may bring that to the table, we just can’t tell unless they provide more granularity when reporting revenues.
Credit: Nanalyze
Several years later, the company has managed to achieve positive gross margins for an entire year, and now provides some much-needed revenue segmentations.
A Vanishing Showstopper
Our biggest concern – negative gross margins – is no longer an issue. Fluence has managed to consistently realize positive gross margins for over a year now, albeit rather small ones that don’t come close to covering their variable costs.
If you’re wondering about last quarter’s gross margin jump to 11%, analysts on the latest earnings call probed that too. Is that indicative of what we can expect to see going forward, or a one-off? Management danced around the question while citing “some change orders that helped.”
In their recent 10-K the company explains their 2023 gross margins of 6.4% (a dismal number, but at least’s it’s a positive one) resulted from “improvement in gross margins on the newer Gen6 solutions projects” and the elimination of various temporary impediments in 2022 (like increased shipping costs from The Rona). While they may have realized $140 million in gross profits for 2023, that was quickly erased by $240 million in variable costs – R&D, S&M, and G&A. We’re told they plan to “begin production of Fluence-made battery packs in mid-2024, which will include battery modules and a battery management system.” That’s good news because a low-margin hardware reseller which depends on someone else’s products isn’t appealing to us.
In industry parlance, Fluence is a “battery energy storage system” (BESS) integrator, and at the top of its peers in respect to installed and contracted capacity in 2023.
While revenue growth is important (more on this in a bit), it doesn’t matter much if a company has single-digit gross margins that can be quickly eroded by someone with cheaper labor (cough, China, cough).
Improving Gross Margins
Fluence says they’ve “burned through almost all [their] legacy lower margin backlog” which means we should see gross margins improve in 2024 and stabilize. Further upside can be realized by selling more “digital applications” which represent the AI-powered FBA software we’ve been hearing so much about. Last year, contributions from digital applications were completely insignificant at just 0.20% of total revenues, though the number has been growing over the past few years.
If they plan to “use Fluence Digital as a competitive differentiator and a margin driver,” we’d like to see that become a much larger contributor. We’re told that digital applications offer gross margins around 70%, while their services business is between 20% and 30%.
Fluence Energy Into Next Year
Note that “digital applications” differ from annual recurring revenues (ARR) which Fluence says were around $54 million (about 2.4% of total revenues) in 2023. That number is expected to increase to $80 million or 2.8% of 2024 revenues which are expected to be $2.8 billion based on midpoint guidance – about 26% growth over 2023. (In 2025, growth is forecasted to be in the 35% to 40% range.) Note that this year they expect a revenue split of 30% in the first half, and 70% in the second half. Gross margins are expected to see double-digits in 2024, and that’s will lead to Fluence having positive operating cash flows in 2025.
Fluence Energy – Other Revelations
Last month the Fluence Energy CFO announced his departure. Says the company, “he received an offer he could not refuse, and more importantly, one that we could not match.” Perhaps the material weaknesses noted in their 10-K – to be resolved next year – had something to do with decision for the CEO to look for somewhere else to work? The earnings call announcing the departure of their CFO also saw the new CFO introducing himself. Seems more like a planned exit than a talented CFO being poached. Nonetheless, now there’s someone they can throw under the bus for any financial problems encountered over the next few years.
Investors who anticipate management being able to do what they say without any unexpected external impediments getting in the way may look to invest in this strong future growth. With a simple valuation ratio of 2 (compared to our catalog average of 6) it’s hard to see Fluence being overpriced. Days ago, it was announced that “certain controlling stockholders of Fluence” plan to sell about 18 million shares in the company which our subscribers asked about. To put that into perspective, that’s about 15 percent of outstanding shares transferring hands between a controlling stakeholder(s) and the public.
In 2023, Fluence Energy’s two largest customers represented approximately 49% of their revenues with “a related party” accounting for 29% of revenues. The latter is going to be either Siemens or AES who each hold 33% of Fluence’s shares. It’s anyone’s guess as to which company is offloading shares, though it could be both. Overall, it doesn’t mean much except for downwards pricing pressure on the stock which is always a good thing – you always want to pay as little as possible for shares of any given company.
Conclusion
Achieving a positive gross margin isn’t some great accomplishment, it’s expected of every company we invest in. Single-digit gross margins don’t give companies much leeway if something goes wrong, and we wouldn’t consider investing in this company unless they can start showing consistent double-digit growth margins. Alongside that we expect to see annual recurring revenues grow to a meaningful percentage of total revenues, reduced customer concentration risk, and ideally some greater contributions from the AI-powered FBA software we’ve heard so much about. Fluence Energy is making progress, but it’s still too risky for our tastes. The future growth story sounds great, but we don’t invest in stories. We’ll check back a year from now to see how they’re progressing.
