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RGS Energy (OTC:OTC:RGSE) reported roughly a tenfold increase in sales within the first 30 days after the end of Q1. This is in line with the company's assessment that its sales are seasonal, with Q2 and Q3 historically being the most profitable. This also corroborates the company's assessment that its slow start to ramping up the initial marketing of its new product - Powerhouse 3.0 solar shingles - was due to a combination of starting to sell a brand new product during its worst historical quarter combined with the roofing industry's backlog of past orders. The surge in sales shows that the company is now finally set to profit.
This all points to the strong likelihood that RGS' profits will surge throughout the remainder of this Q2 and into Q3. Indeed, the company has agreed to post updated sales information every 30 days on its website. The page discloses a wealth of information usually only available to insiders, including the dollar amounts of signed purchase orders, revenue generated, and sales pipeline, updated every 30 days moving forward.
This level of transparency is a strong statement of confidence. The company is basically showing it has nothing to hide. Such transparency is rare. It thus corroborates the company's assessment that sales will continue to surge as expected throughout Q2 and Q3.
Reduced Operating Expenses
Further amplifying this assessment is the fact that RGS exited from the legacy solar business recently in March 2019. In its March 29, 2019, press release, the company's CEO Dennis Lacey justified the decision on the grounds that it would allow the company to focus exclusively on selling Powerhouse 3.0 solar shingles, and simultaneously cut "approximately $5.5 million" in costs per year.
Seeking Alpha's RGSE Financials data shows the company's yearly revenue and profit (loss) for the years 2014 through 2018. Given that the company's average yearly revenue for the past three years is roughly $15 million, cutting $5.5 million or one-third of costs is significant. Viewed another way, given that the company's average yearly profit (loss) for the past three years is ($4.2 million), the cutting of $5.5 million in costs, alone (forgetting the evidence of increasing sales outlined above), would seem to finally guarantee a profit.
Our analysis of the reduced expenses, and the event that prompted the decision, is bullish. In its March 7, 2019, press release, RGS announced that it was exploring "strategic alternatives focusing on maximizing shareholder value." Typically, this phrase means that management screwed up.
In RGS' case, as pointed out by another Seeking Alpha contributor, it did, in fact, mean that RGS screwed up. Their Q1 results were horrible, with lackluster sales, leading to a $3.3 million offering in April 2019 followed by dilution. So, why is our analysis bullish?
This was a wakeup call to management. And it worked. RGS has historically relied on reverse splits, followed by offerings, followed by dilution, wash rinse and repeat. In other words, RGS gained a reputation for poor management because their officers at least seemed to focus more on selling their stock rather than their product. The benefit was that it kept the company afloat. The downside was that it only kept the company afloat. Then came the Powerhouse 3.0 solar shingles, which represented a growth opportunity.
Exiting the legacy solar business is evidence that management finally learned how to actually manage. Rather than focusing on selling its stock, the CEO did what good CEOs do - he focused on growth.
The company realized that its new product represented a growth opportunity. Q1 taught the company that growth required a change. This prompted the CEO to crunch the numbers. The CEO used the results of the analysis to make a brilliant executive decision designed to turn the company around so it could finally profit and grow. That decision was exiting the legacy solar business, so the company could not only cut costs, but also focus on selling the company's product.
As evidenced by the recent surge in sales, the above series of events was probably the best thing that could have happened to the company. Management has learned how to profit and grow rather than merely tread water - hence our bullish outlook.
Current Price Is a Bargain
In October 2018, when the company did not even have its product certified, the share price oscillated between $0.32 and $0.41. Then, in November 2018, after certification but still at a time when the company had nothing going for it other than hope, the share price hit a high of $0.56. News of insider buys pushed the share price up to $0.88 in December 2018.
Since then, the company increased its outstanding shares by 15.9 million with the April 2019 offering. The dilution effect was roughly $0.10, as the offering increased the outstanding shares from roughly 95 million to 110 million. Factoring this would change the above price oscillation of $0.32 to $0.88, with a mean of about $0.40, to $0.22 to $0.78, with a mean of about $0.30.
The current share price is roughly $0.13. Given that, unlike during the above times, we now actually have evidence of a thriving company, $0.13 is a bargain. It is essentially the equivalent of being able to buy a stock that is about to surge for at least 40% off.
The price target according to one analyst is $2. The estimate was published prior to the April offering referred to above. Even assuming an adjusted estimate of $1.90 after factoring a $0.10 reduction for the dilution, the current price of $0.13 is still far below the price target.
The price target is reasonable. Again, the company's historical yearly revenue is roughly $15 million. In its May 2019 corporate presentation, the CEO Dennis Lacey calculated that even if RGS is only able to secure business for 1 out of every 1,200 roofing projects - or 0.01% of the market - the company would generate $125 million in revenue.
In other words, the company's minimum estimate of future revenue is a whopping 8.3 times its historical revenue. Assuming, as outlined above, that the company is presently oversold (the 14-day RSI is presently middle of the road at 51.8888), and that the actual fair market value of the stock is at least $0.22 (RGS' adjusted low from October 2019 through December 2019 when it had no evidence of Powerhouse 3.0 sales), then $0.22 multiplied by 8.3 totals $1.83. This is not far off from the $2.00 (or, adjusting for dilution, $1.90) price target.
What About the Bear Argument?
All of the bear arguments hinge on Powerhouse 3.0 not selling. Bears point to the company's troubling history of reverse stock splits, offerings, dilution - wash, rinse and repeat. However, unlike in the past, we now have evidence of two things - substance regarding sales, and intelligent management. These are clearly material changes in circumstances.
Our analysis is again that management had a come to Jesus moment. When Q1 did not go as expected, management woke up and got to work. The result was exiting the legacy solar business in order to cut $5.5 million in costs, and focus exclusively on generating revenue (through the sale of the company's product rather than the sale of the company's stock). What this means is a turnaround for the company. And it is working, as evidenced by their recent surge in sales.
As to substance, the company is posting updated 30 days' sales information on its website. So, unlike in the past, we now have hard, documented evidence that this company is selling its product. This rare form of transparency is basically the company saying that it has nothing to hide, and it anticipates an immediate surge in sales and future growth.
Moreover, we are now in Q2, which is this company's historical spike in sales. This spike typically continues well into Q3. When you couple documented evidence of surging sales with the timing of the Q2 busy season, it would be foolish to be a bear at this time. This stock is in all likelihood going to surge leading up to the Q2 earnings report and continue to climb thereafter.
As to intelligent management, it is simply a glaring fact that the company's history has been an embarrassment. But again, the insiders have been buying, and they are increasing transparency to a very uncommon degree, which shows real confidence in their product.
More importantly, management has finally let go of its legacy solar business, as mentioned earlier. This is estimated to further increase the company's bottom line by $5.5 million, or over one-third of its historical yearly revenue.
In sum, we know for a fact now that Powerhouse 3.0 is selling by virtue of the company's extremely shareholder-friendly transparency. The bear argument hinges on no sales. Thus, while the bear argument was reasonable about two months ago, it is now no longer supported by evidence. After only 30 days into Q2, the company reported that it was already 97% toward breaking even with sales - something it has never done. Thus, there is no apparent need for further offerings of its common stock, and the company is poised to finally turn a profit.
Cash Flow and Balance Sheet
As of March 31, 2019, per its Q1 report, RGS had $2.14 million in cash. In its April 3, 2019, press release, the company reported having received "aggregate gross proceeds of approximately $3.3 million" from its offering. Presumably then, RGS had roughly $5.44 million in cash the first week of April.
Seeking Alpha's RGSE financial data shows that, for the past three years, the average cost of revenue has totaled $19.47 million, and the average operating expense has totaled $9.41 million, meaning the average cost per month to keep the company running is $2.41 million. Now that the company is saving $5.5 million per year from exiting the legacy solar business, meaning $458,333 less per month in expenses, the adjusted cost to keep the lights on is roughly $1.95 million per month.
Per the above calculations, as of the first week of April, the company had enough cash to run (without any sales) for 2.8 months, or until the end of June 2019. But wait, there's more. In particular, sales.
RGS' updated sales information for April 2019 suggested that it had $6,576,507 in its sales pipeline. On the second page of its report, RGS calculated that it was roughly 97% at its "break-even" level from sales alone. What this means is that, further factoring the company's cash on hand, the company may well already be operating at a profit. Investors should review the next updated 30 days' sales report (likely to be reported on RGS' website mid-June 2019) to confirm this assessment.
Risks - What Would Change Our Outlook?
California lawmakers recently approved a measure mandating solar for homes built in 2020 and thereafter. RGS' future revenue estimates are based on the demand for their product that this law creates. As such, one risk is the event that the law could be ruled unconstitutional. This risk is virtually zero.
Another risk is of course the possible failure to increase sales. If the company is unable to sell its product, then it will have to once again sell and dilute its stock via offerings, or obtain toxic loans, in order to forego bankruptcy. We believe this risk is very low because the California solar mandate compels demand for RGS' product, and the company has again already provided evidence of increasing sales.
Indeed, during the Nov. 7, 2018, conference call, CEO Dennis Lacey stated that he did not believe future offerings would be needed to commercialize Powerhouse 3.0 solar shingles. Now that sales are proving to be on track, that opinion is once again be relevant. Nevertheless, if the company fails to report increasing sales every 30 days (published around the 15th of each month), that of course would change our assessment.
A final risk to consider is that of tariffs due to the trade war between the U.S. and China. The parts for the Powerhouse 3.0 solar shingles are currently supplied by Risen Energy, which is based in China. However, it is not clear whether the tariffs will have any noticeable effect on RGS' sales. First, the tariffs have been in place for several months, and yet RGS still had a tenfold increase in sales last month. Second, any increase in the cost of Powerhouse 3.0 solar shingles has no effect on the mandatory nature of the California 2020 solar mandate.
The only way to assess whether tariffs will have any effect on RGS' sales is to keep a close eye on the company's monthly sales updates on its website. So again, the only occurrence that would change our assessment is if the company does not continue to report increases in sales every 30 days.
In sum, the only plausible occurrence that would change our bullish outlook would be if the company does not report continually increasing sales on its website throughout Q2 and Q3. We think this is unlikely given that the start to Q2 has already seen a tenfold surge in sales.
One final piece of evidence suggesting that sales are continuing to increase is the company's recent May 24, 2019, registration statement for its preferred stock. The company registered 50 million shares of Series A 12.5% Mandatorily Convertible Preferred Stock. So, how is this a bullish sign?
First, any issuance of preferred stock in and of itself should not have a dilution effect or other effect on the common stock price. They are two different classes of stock, with different attributes. Indeed, per Section 2 of RGS' Sept. 9, 2016, Certificate of Registration, which outlined the terms of its preferred stock, the value of each preferred share is fixed at $1,000. Obviously, RGS' common stock share price has not rocketed to $1,000.
Moreover, pursuant to Section 6b of the 2016 Certificate, the minimum common share price at which a preferred share would be eligible for conversion to common stock is $1.10. As such, an investor who buys now at $0.13 would not have to worry about dilution from the conversion of preferred stock until the common stock price remained at or above $1.10. In our opinion, having to worry about only achieving a 750% gain is not exactly the worst problem one could have.
Second, in the third paragraph under Item 1 of the May 24, 2019 registration statement, the company makes it clear that they are issuing the stock to prevent a hostile takeover. Our take is that this is a bullish sign. We believe the company insiders are concerned that their increasing sales, coupled with their low stock price, will alert others of RGS' huge growth opportunity.
Last, by registering the preferred stock, the company has shown that it believes it can afford the 12.5% dividends per Section 3a of the 2016 Certificate. Assuming all 50 million shares of preferred stock are ultimately sold, that would amount to a yearly dividend obligation of $6.25 million, or $521,000 per month.
In other words, the insiders are presumably confident that their level of sales would allow them to not only keep the lights on, but further afford an extra $521,000 per month in dividends. In our opinion, this is a bullish sign.
How to Play This Stock
Since the present share price is essentially a 40% off sale, investors should buy this stock aggressively up to at least $0.22. Every 30 days, around the 15th of each month, keep a close eye on the company's transparent website report of sales. If sales continue to increase, then continue to buy.
A view of the chart compared to the timing of news shows that positive PR typically catapults this stock upward. The company's sales page will likely generate positive PR every 30 days as Q2 is the start of its busy season, which goes through to the end of Q3. Thus, this stock is a safe hold until the end of Q3.
When should the short-term profit seeker sell? In December 2018, when the stock had nothing going for it but hope, it hit $0.88 ($0.78 factoring the present outstanding shares). The published price target is $2.00 ($1.90 factoring the present outstanding shares). Therefore, further considering that now we have substance - hard evidence of increasing sales - one would expect it to climb much higher than $0.78, and perhaps even hit the adjusted $1.90 price target by the end of Q3.
For longs, whether to sell or continue holding after Q3 depends on whether the company starts to expand. RGS does have an international license to market and sell Powerhouse 3.0 abroad, and most commentators agree that solar is the future of roofing. While an investor should be able to expect a huge short-term gain between now and the end of September 2019, if RGS releases news of expanding its sales capabilities, by either marketing internationally or generally surpassing 0.01% market acquisition, then this stock would become a huge long-term hold.
This company is finally positioned to profit and its stock will likely surge upward prior to and after its Q2 earnings report. Buy this stock aggressively now while it is still a bargain. If the company's website continues to report increased sales, then continue to buy. Consider selling toward the end of September 2019, unless the company releases news of expanding its sales capabilities, in which case continue to hold.
Disclosure: I am/we are long RGSE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.