Stem (NYSE:STEM) has a very profitable battery energy hardware and storage business that the market does not fully appreciate. Since going public via SPAC (special purpose reverse merger) on April 27, STEM stock has dropped 26% from $26.61 on April 28 to $21.10 on May 20. I think the stock is worth at least 71% higher at $36.12, and probably much more over time.
It isn’t very hard to reach this conclusion. Even a cursory review of company financials shows that they have a very profitable business. As software sales start to kick in within the next four years, revenue will grow 8 times and free cash flow will skyrocket.
Estimating Stem’s Value
Page 31 of the slide presentation shows Stem’s projected revenue and free cash over the next four years. Sales will grow from $147 million in 2021 to $1,167 million in 2025. This works out to 67.9% average annual compounded growth over the next four years.
Moreover, free cash flow (FCF) will grow from negative $49 million in the year ending Dec. 2021 to $381 million by Dec. 2025. That will represent a huge FCF margin of 32.6% (i.e., $381 million FCF / $1.167 billion sales).
To determine Stem’s value we can use a price-to-sales (P/S) multiple method. For example, page 32 of the slide deck shows that there are 135.9 million shares as of the deal close. At $21.10 today that gives STEM stock a market valuation of $2.867 billion.
In addition, given that 2025 sales will be $1.167 billion, this puts it on a forward P/S multiple of just 2.46 times. That seems to be way too low for such a profitable company.
However, we have to adjust the future sales for the time value of money. Discounting those sales at 10% four years forward, results in a discount factor of 68.3%. That means that the $1.167 billion in 2025 sales are worth $797 million today, at a 10% present value discount rate.
Now the P/S multiple in present value is 3.140 times. I would argue that the true or real value for STEM stock should be between 5 and 6 times sales. That gives it a market value of $3.985 billion to $4.782 billion. In addition, we should add back the $525 million in cash sitting on the balance sheet, putting its real value at $4.51 billion to $5.3 billion.
What To Do With STEM Stock
This means that STEM stock is worth between $33.19 and $39.05, or $36.12 at the midpoint. That is 71.2% higher than today’s price of $21.10.
As the software component of total sales rises over the next four years, the market could give STEM a higher valuation.
For example, in 2025 with $381 million in FCF the market could give it a 5% FCF yield valuation. That means the $381 million divided by 5.0% would be worth $7.62 billion. That works to $56 per share, or 165% above today’s price. At a 10% discount rate that is equivalent to a present value of $38.25 per share today (i.e., 68.3% x $56). This is close to our P/S estimate of $36.12 per share.
The bottom line is that the battery energy storage business, especially the software component, is very profitable. This makes it worth significantly more than today’s price.
Recent Results
So far, Wall Street analysts have not come out with any major reports on the stock. However, Seeking Alpha authors have generally good things to say about STEM stock at today’s price. One analyst, says Stem is not at its summit price. He expects the company to be “at the forefront of the hottest sector in this decade.” He bases this on “Stem’s patented Athena AI and machine learning technology.” He does not give a price prediction, however.
My view is that today’s price offers a good entry point, given that it is down from where the stock went public. Stem’s recent Q1 earnings release on May 17 really does not change that thesis, despite the losses that the company reported. These were expected, given its ramp up to growth over the next four years. Analysts will likely look at year-end results to see if the company is on track to produce the results portrayed in its slide deck.
On the date of publication, Mark R. Hake did not hold a long or short position in any of the securities in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.