SMALL CAP IDEA: AFC Energy has identified a lucrative niche with its H-Power generators

Rolls-Royce and BAE Systems are the global standard-bearers for British engineering.

These household names dominate their respective global industries (gas turbines and defence) and generate tens of billions of pounds in annual revenue.

However, his status as national champion is not indicative of the wider picture of UK engineering.

Beneath these giants lies a group of companies, once often disparagingly referred to as “metal destroyers,” that have honed their business models to excel in deep, highly profitable niches.

This group includes lesser-known names such as Spirax-Sarco, Spectraland Rotor. PLC Diploma It is another notable entity that has successfully exploited multiple thin but rich engineering veins.

The advantage of the niche market

Conventional wisdom holds that larger industries present superior business opportunities.

But this group of companies has challenged that thesis, knowing that mass markets, with their lower barriers to entry, often lead to intense competition and low profit margins, or at least require massive scale.

In contrast, although they vary in size, niche markets often allow for specialization and dominance by a few players. This specialization creates high barriers to entry, making them less attractive to new disruptive competitors.

Warren Buffett describes this defensive capability as a “moat” that protects companies from modern barbarians at the gate.

For investors seeking the next wave of niche engineers, a screening process could include assessing barriers to entry, market size and trends, scalability, and unique value propositions.

Emerging players in the hydrogen energy sector

Three companies stand out in the booming hydrogen-based energy sector: ITM Power, The power of Ceresand AFC Energy.

As the UK moves towards its Net Zero 2050 goal, these companies are well positioned to benefit from the expected boom in the sector.

Each of them is at a commercial stage of evolution with protected technologies and intellectual property (IP) that would be difficult for newcomers to replicate.

Of the three, AFC Energy stands out for its clear focus on one niche: displacing diesel from construction and other off-grid applications.

In 2020, the UK construction sector used 2.5 million tonnes of oil equivalent (Mtoe) of diesel, generating significant carbon dioxide emissions.

The Zero Diesel Sites Roadmap initiative aims to reduce this volume by 78%, a goal that depends in part on eliminating diesel generators used on construction sites and large infrastructure projects.

AFC Energy’s strategic niche and growth

AFC Energy has identified a lucrative niche with its H-Power generators, which run on hydrogen and are capable of providing between 10kW and 500kW of electricity. Easily transportable by road, these modular units offer an attractive alternative to traditional diesel generators.

Unlike other units of this type, AFC technology can use hydrogen from alternative sources such as ammonia and methanol.

Of particular note is the company’s go-to-market strategy. In the UK, AFC has partnered with industry leader Speedy Hire to develop and market its technology.

In addition, it has signed an agreement with TAMGO, a distributor in Saudi Arabia and neighboring countries that currently supplies generators to Saudi Aramco and megaprojects in the region.

This strategy is complemented by an outsourced manufacturing infrastructure that saves capital and investments in supply logistics.

In a recent move to bolster its coffers, AFC raised £13.8m through a share placement and subscription, with a further £2m coming from a retail offering.

These funds are intended for the development of 30 kW H-Power generators, to finance the commercial launch through the Speed ​​Hydrogen Solutions joint venture and to fulfil TAMGO orders.

Market potential and investment prospects

Research from Panmure Gordon (now Panmure Liberum), the boutique investment bank, highlights that demand for clean energy generation in the UK could be boosted by landmark construction projects such as HS2 (which is due to displace all its diesel generators by 2029) and the Lower Thames Crossing.

The bank expects positive developments from the Speedy Hire Solutions joint venture in the near term, but believes the biggest benefit will be penetration into larger markets, such as the Middle East, through the distribution agreement with TAMGO, which could significantly improve current forecasts.

Investors who took part in AFC’s fundraising in June at 15p a share are already seeing a small profit, with shares trading around 17p.

Analysts are optimistic and expect the shares to be valued between 50p and 125p. Furthermore, the potential value of AFC’s ammonia cracking technology could further enhance the company’s position in the market.

Risk-reward, not risk-free

While the potential for substantial returns is evident, investors must recognize that the path to trading success is rarely linear – there will be setbacks.

As such, AFC Energy’s journey embodies a classic risk-reward scenario, underscoring the need for careful consideration and due diligence.

Despite the challenges, the company’s innovative approach and strategic partnerships position it well within the hydrogen-based energy sector niche, promising a compelling narrative for discerning investors.

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