After diving into Enphase, the company, I was very quick to realize that it has one of the strongest fundamentals in the markets – yes, up there with the likes of Tesla. It's incredibly strong. We'll go over what they do, at a high level, and then move into the stock and valuations, along with my forecasts. Ultimately, trying to answer for, not if, but when should we buy this stock?
Enphase was co-founded in 2006 by Raghu Belur and Martin Fornage who pioneered the microinverter. You don't have to be an electrician or engineer (I'm neither) to understand this... but the basic idea is that a tiny inverter is placed on the back of every solar panel, making it an "AC panel" – so that it can be used directly with most of the items in your home. The alternative, or traditional use of solar panels is having "DC panels" with the use of larger inverters in your home.
DC (direct current) and AC (alternating current) are just two forms of current. DC is more constant and static, whereas AC allows for voltage to be variable. Most products in your home, with the exception of battery-powered electronics are AC-powered. Apologies to any electricians or engineers if I'm butchering any of this.
The microinverter, though more costly, allows for increased energy production and more. Another benefit, which I found interesting is reducing the impact of shading. If shade is one one panel, it reduces the energy production for all of the panels, whereas the AC panels with microinverters prevents this – since they are each generating their own usable energy-source within the home.
That's it for today's science lesson.
Enphase reports in just one business segment. Its business activity is described as the development, manufacturing and sale of solutions for the solar PV industry. As you can see from the image below, it's a vertically-integration solution for an energy system, including microinverters, battery, storage, EV charger, software and more. Along with that integration, they also identify their production of semiconductors, in these microinverters, as their core competencies.
Enphase has a detailed revenue growth framework from the different segments, which I assume will be broken down in the future. They have clearly identified their opportunities from new services to homeowners, to installers, grid operators, etc.
Though there aren't many highlighted operating metrics, the financials for Enphase are amazing. Not just revenue growth, but also margins, leverage and free cash flow.
They introduced a 35-15-20 baseline financial model where they expect to maintain 35% gross margins, 15% operating expenses, and 20% operating income – arguably my favorite part about this company. It's scaling profitability – which is why I made the comparison to Tesla earlier. Very few companies manage to do this.
Now how is it allocating its cash? It's paying off debt, making strategic acquisitions and stock buybacks. I am really impressed with this team and their execution capabilities... top-of-the-line.
OK, but what is the stock worth?
Valuation & Forecasts
As a reminder, all valuation sheets are available to premium members of The Hawk Letter and Discord. I highly recommend you join, to make your own assumptions and investment thesis :)
Forecasting Enphase's growth does come with its challenges. It's extremely hard to do it reliably. Therefore, any of my assumptions, should be taken with a high degree of uncertainty.
Without any segmenting or extrapolating from key operating metrics, if we assume a 22% CAGR until 2025 – which is slowing down from its current 50% – we get revenues of $4.5bn in 2025. This may be over- or under-estimating... I'm not too sure, but looking at Global Solar PV systems forecasted CAGR of 8%, this is being fair imho.
If Enphase can maintain its margins, which I have confidence they can, then that $4 EPS in 2025.
For my target prices, I typically take the average of a forecasted P/S, P/E, and fair value per share (which I obtained to be $120/share from multiple sources vs my own DCF this time). I then get a target price of $156, which tells me my model is fully priced in... and I have little to no upside or margin or safety.
This isn't an investment I'd make, especially considering some of the risks.
Let's talk about some of them...
1) Supply chain issues have hit almost every industry. But, as we know, semiconductors have been hit hard. We might continue to see this as an issue. Given, literally every Enphase solar panel has a chip, you can see how this can be a big problem. But, Enphase has managed the shortage phenomenally well – which you can see from its numbers. They have a global supply chain and partners they've built up really well.
2) Macroeconomic headwinds are hurting every stock, and potentially earnings – which is why we are seeing compression across the board. With less disposable income and a possible recession, I shouldn't have to say that consumers will likely not be dishing out money for solar installations.
3) Regulations can (sometimes) hurt the industry, as well as help it. Biden has vowed to help make a solar push, but the U.S. Commerce Department recently undertook an investigation on on solar panel coming from Southeast Asian countries... and whether they're getting around anti-dumping rules limiting Chinese imports. This can result in retroactive tariffs of up to 240% – and impacting other solar companies, including Tesla. This can be a big deal, unless Biden steps in.
4) Competition is always a threat, especially with a lack of strong moat. I wouldn't go as far as saying Enphase doesn't have a moat, but there's a lot of alternatives for consumers. SolarEdge is a big one, which is also trading at a lower valuation (though arguably for good reason). One that I found particularly interesting was Generac Holdings.
When I saw it was trading at 27 P/E and grew revenues 50% in 2021, I had to take a deeper dive... they're guiding to about 35% revenue growth this year. If I forecast the same slowdown as Enphase, and exact same modelling, with more conservative valuation targets, I get a 60% upside. Granted Generac is not a solar pureplay. It's more of a turnaround or pivot from generators to solar powered battery storage and panels, it's clearly already successfully on that path. These are the kind of stocks I like (reminds me of Lending Club). I also did some research and found some people actually preferring a Generac system vs Enphase on Reddit. Like I said, though Enphase may have superior technology, it isn't a super-defensive moat that will stop competition. Yes, of course Generac has an uphill battle to steal market share as a new entrant in this category. Yes, it may have a drag on revenue from slowing generator sales (i.e. being replaced by solar and battery storage). This is a buy that still makes sense.
To conclude, I believe Enphase is a great company... but not a great stock. It's expensive AF. And it's a tough environment to be buying these types of stocks or holding them. If you're going to make a bet on solar, it has be calculated and with risk minimized.
So, for Enphase, I would wait for a lower entry. I wouldn't make it here. We'd have to chart it out and see what that could look like. Maybe start at $113.
The alternative to getting Enphase exposure, while minimizing risk through diversification, is buying the Invesco Solar ETF (TAN) which has a 10% weighting of Enphase as its top holding. That makes be a bit more comfortable.
But, I do think Generac has a solid case for being in a portfolio. Maybe we do a 50/50 allocation between Generac and the TAN ETF. That makes complete sense to me from a risk/reward perspective.
But, in either case, I would wait for the decision on the US. Commerce Department and whether Biden steps in to save the solar industry.
Hope this helped! As always, do your own due diligence... and stay subscribed for the next one!
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