This past Sunday I (@slmacro) released an article looking back at a beat down stock, PCT. Since the article was released, the stock has had a large bounce off lows. It is up 33.8% off the close on Friday. In an article last year I discussed how if PureCycle could execute, the stock could be a 10 bagger while if they didn’t it could go to 0. Since I discussed this stock last year, PureCycle has had multiple setbacks and the stock price has been punished as a result. In full disclosure, I have been in and out of this stock a few times since last year. I do carry a core position from March of this year when the stock dipped to the mid-$4s. While I did take some profits after, I regret I didn’t take more when it rose to almost $12. Since then, the company has had multiple delays in opening their inaugural Ironton factory and the stock price has plummeted most recently to $3.25. I added to my holdings as the stock fell under my cost basis.
What is PureCycle?
PureCycle engages in recycling waste polypropylene into virgin resin. The company licensed a patented technology that can separate color, odor, and impurities from plastic waste and transform it to ultra-pure resin.
What Problem Does it Solve?
Today only about 9% of plastic is recycled. The majority ends up incinerated or in landfills. Current recycling is inefficient and any plastics that are recycled are downcycled, meaning they degrade with recycling, making them less and less useful. The process that PureCycle licensed from Proctor and Gamble essentially works like this: feed plastic is subjected to high temperature and high pressure and mixed with butane then run through a process with the end result of pure resin, one that is not downcycled and can be used the same as new plastics. The company claims they can produce virgin resin for cheaper than producing new plastics through petroleum, while also providing a smaller carbon footprint.
Why Has the Stock Suffered?
Long story short, the company has faced multiple delays in scaling their first factory. This past September was when the stock really started to tank because of missing/delaying a bond milestone. The company blamed their inability to meet a bond covenant on an extended power outage that impacted their Ironton Factory. PureCycle reported that on August 7th there was a full power outage that impacted the plant. Two weeks later a mechanical component failed but the issue was corrected, only to suffer complete failure 1 week later on September 3rd. The company declared a Force Majeure, noting an inability to meet a bond agreement requiring 1 month’s production of 4.45MM lbs of ultra-pure recycled resin due to the original power outage. Since then, the company came to an agreement to extend their bond milestone 3 months and withdrew their filing of Force Majeure. There is currently a class action regarding the fact that PureCycle did not notify stockholders of the factory shutdown in August, but instead waited 1 month to disclose a failure event. While these issues were ongoing, the company placed a $250m convertible bond, which was also received negatively by the street. Most recently, the stock has continued to come under further pressure, with PureCycle announcing that they will halt factory production for 2 weeks to change out certain components.
Short Thesis
From the time PureCycle began their quest to produce ultra-pure resin, there have been short attacks. The initial claim was that the technology was a fraud. Shortly afterward, the short thesis morphed into the technology could not be scaled. The recent milestone extension and delays gave further fuel to shorts. In a recent short report from Bleeker Street Research, they presented several concerns about PureCycle.
Essentially the short report noted:
Ex-employees reportedly said the construction process of the Ironton Facility was a mess.
The Force Majeure was an excuse because the Ironton Factory was unable to meet a bond covenant.
Ironton has been unable to and will not be able to scale.
Bleeker Street had a few other comments that were irrelevant, such as saying the process does not have a lower carbon footprint (it does) and that the supposed technology is not revolutionary.
They even noted that they did thermal imaging on the Ironton Factory and claimed the factory was only in start-up or testing mode. They threw in a few other points that were already well known, discussing the delays PureCycle has faced.
Rebuttal
Overall, the short report was quite disjointed. The input from ex-employees is irrelevant. It is a well-known fact that PureCycle has faced delays in the construction of the Ironton plant. They have been transparent about the fact that this is a first of a kind factory, and this has required some trial and error. Likewise, the Force Majeure is not as big of an issue either and was withdrawn by PureCycle because it was not needed. It makes logical sense that bond holders do not wish for PCT to fail. It is in bond holders’ interest to extend covenants if they believe PureCycle will ultimately be successful. The thermal imaging pictures Bleeker Street released were quite comical for a few reasons as well. Bleeker Street tried to point out thermal images did not show enough heat being produced from Ironton. Cursory knowledge of factories in general would demonstrate the need for insulation for processes that require high temperatures. Furthermore, they claimed the factory was not truly functioning, while in their own pictures a truck that was loaded with ultra-pure resin was visible.
Ultimately the short thesis on PureCycle is that they will not be able to scale and produce enough feed to meet their covenant. The thought is they will not be able to meet the 4.45-million-pound deadline by Dec 31st or the 8.9m pounds/month by April 30th 2023.
Long Thesis
The Ironton factory, as discussed above, had been hit a number of delays but one has to keep in mind that this is a brand-new process. There is no framework to build the factory off of. This is a one-of-a-kind factory that has never been built. In my opinion, it is not unexpected to run into issues. What is encouraging to me is that PureCycle has already been able to process 410,000 pounds of feedstock. They are already producing ultra-pure virgin resin. This is enough, in my opinion, to prove that the technology works and can be scaled. As the company has gone down this road they have identified bottle necks that are impacting run rates. Most recently they announced the need to change some factory components, and the stock has reacted negatively. In my opinion, the decision to solve bottlenecks will ultimately help PureCycle meet their bond milestone and future production goals. The main bottleneck that was identified was associated with adsorbent bed leaks, which resulted in bead contamination. This was resulting in an inability to run the factory continuously at capacity. PureCycles plan is to install an automated screen changer which will allow their factory pelletizer to filter bead contamination and run continuously. While Ironton is shut down 2 weeks to install the screen changer, they will take the opportunity to change out and optimize a few other components as well.
PureCycle has been working though many problems this past year, but they are now producing product. They completed commercial shipments to both Formerra and Milliken and have proof of concept. The next step is meeting their 4.45-million-pound goal. We will know in very short order if they are successful or not. If they are then it is full steam ahead, likely with an Antwerp factory and Augusta factory next. PureCycle will be able to take learnings from the Ironton plant and apply them to subsequent factories, making future factory construction more efficient. They currently have $211 million in liquidity and $150 million in revolving credit available. I believe once they meet their Ironton milestone, they will be able to secure the remaining funds needed to build out the larger Augusta plant. From there partnerships in both Antwerp and South Korea are on deck. In my opinion, the company will have a 40-50% profit margin and be able to completely fund future factories without any dilution once Augusta is complete.
Place Your Bets
Within the next 1-2 months we should know if PCT is a hero or a zero. If they are able to meet their 4.45-million-pound goal, I expect the stock to respond positively. Even updates of production before the deadline could cause the stock to react positively. If PCT is unable to fulfil their bond milestone, the stock likely goes to $1 or lower. Small caps are extremely volatile and small movements in share count can have outsized reactions. We already know the process works. The last part to scale production has to do with palletization. I think the company will solve this issue within the next 2 weeks. I expect the stock to go higher rapidly once scaling is evident, as shorts rush to cover positions. If/when scale is proven, I also expect more institutional involvement. Throughout the last year I have been in and out of the stock, but I have held a core holding from the dip back in March. With the recent dump in stock price, I have added to my holdings significantly. Most recently last week, I also added some common stock as well as March calls and may consider adding more. Small caps such as PCT are not for the weary. I am cognizant this stock could potentially go to zero. My loss though is capped on the downside to my cost basis around $4 vs an upside that is multiples higher. This stock could 10x, 20x, and maybe even higher if PureCycle is successful. This is an appealing risk/reward in my opinion, and I am prepared to accept any outcome. When I first presented this stock last year, I mentioned this was ultimately a 5-year hold for me. We likely find out much sooner than that if I was right or wrong.
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