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

Rolls-Royce and BAE Systems are global leaders in British engineering.

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

However, their status as national champions is not representative of the wider British engineering landscape.

Behind these giants is a group of companies, often disparagingly referred to in the past as “metal bashers,” that have honed their business models to excel in deep, highly profitable niches.

This group includes lesser known names such as Spirax Sarco, SpectrisAnd Rotork. Diploma PLC is another notable entity, which has successfully exploited multiple thin but rich layers of engineering.

The Niche Market Advantage

The common perception is that larger industries offer better business opportunities.

However, this group of companies has refuted this assertion, knowing that mass markets, with their lower barriers to entry, often lead to fierce competition and small profit margins – or at the very least require enormous scale.

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

Warren Buffett describes this defense as a “moat,” which protects companies from modern barbarians at the gate.

For investors looking for the next generation of niche engineers, a screening process may include evaluating barriers to entry, market growth and trends, scalability, and unique value propositions.

Emerging players in the hydrogen energy sector

In the growing hydrogen energy sector, three companies stand out: ITM power, Ceres powerAnd AFC Energy.

With the UK aiming for its Net Zero target by 2050, these companies are well positioned to benefit from the sector’s expected boom.

They are all in a commercial stage of evolution, with technologies and protected intellectual property (IP) that are difficult for newcomers to copy.

Of the three, AFC Energy distinguishes itself through its clear focus on a niche: replacing 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, resulting in significant CO2 emissions.

The Zero Diesel Sites Route Map initiative aims to reduce this volume by 78%. This target is partly dependent on eliminating diesel generators from construction sites and major infrastructure projects.

Strategic niche and growth of AFC Energy

AFC Energy has identified a lucrative niche with its H-Power generators, which are fuelled by hydrogen and are capable of delivering between 10kW and 500kW of electricity. These modular units, which are easily transported by road, offer an attractive alternative to traditional diesel generators.

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

The company’s go-to-market strategy is particularly notable. In the UK, AFC has partnered with market leader Speedy Hire to develop and commercialise its technology.

In addition, the company has entered into an agreement with TAMGO, a distributor in Saudi Arabia and surrounding countries that currently supplies generators to Saudi Aramco and mega projects in the region.

This strategy is complemented by a capital-efficient, outsourced manufacturing infrastructure and investments in supply logistics.

To boost its coffers, AFC recently raised £13.8m through a share issue and subscription, with a further £2m raised through a retail offering.

These funds are earmarked for the development of H-Power 30kW generators, financing the commercial roll-out through the Speed ​​Hydrogen Solutions joint venture and fulfilling orders from TAMGO.

Market potential and investment prospects

Research by investment bank Panmure Gordon (now Panmure Liberum) shows that demand for clean energy generation in the UK could be boosted by ground-breaking construction projects such as HS2 (which is due to replace all diesel generators by 2029) and the Lower Thames Crossing.

The bank expects positive developments from the Speedy Hire Solutions JV in the short term, but sees the bigger prize in penetrating larger markets such as the Middle East through the distribution agreement with TAMGO. This could significantly boost current forecasts.

Investors who took part in AFC’s June fundraise at 15p per share are already seeing a small gain, as the stock trades around 17p.

Analysts are optimistic, with price valuations ranging from 50p to 125p per share. In addition, the potential value of AFC’s ammonia cracking technology could further strengthen the company’s market position.

Risk-return, not risk-free

While the potential for significant returns is clear, investors should realize that the path to commercial success is rarely linear: there will be setbacks.

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

Despite the challenges, the company is positioning itself well within the hydrogen energy niche sector with its innovative approach and strategic partnerships. This promises to be an attractive story for discerning investors.

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