Enphase Energy: Why I Am So Thirsty To Buy Below $100. (NASDAQ:ENPH) - Seeking Alpha

Enphase Energy: Why I Am So Thirsty To Buy Below $100. (NASDAQ:ENPH) | Seeking Alpha

Enphase Energy: Why I Am So Thirsty To Buy Below $100
Enphase Energy, Inc. (ENPH) 14 Comments

Summary

- Enphase Energy, Inc. develops and manufactures support infrastructure for the photovoltaic industry, and was the first to commercialize microinverters.
- With the levelized cost of solar now lower than any other energy source, they face strong long-term tailwinds.
- Short-term headwinds from elevated interest rates are lowering demand and dropping valuation. We may be approaching a buying opportunity.
- I calculated a PEGY of 1.341x and an Inverted PEGY of 0.746x. This implies that fair value is presently close to $103.26 per share.
- I currently rate ENPH a Hold.

kitiwan mesinsom

Thesis

The dramatic price decrease in solar panels over the last several years is shifting demand and forcing us to alter our expectations on how our future grid is powered. Because of a lack of storage in the system, adding solar into our grid nets diminishing returns. The low cost of photovoltaics is spurring the development of iron-air batteries, which are cheap enough to be deployed at scale. The availability of cheap batteries is the last barrier to us transitioning into a grid which incorporates large amounts of intermittent sources.

However, the current state of the industry has me avoiding low margin panel manufacturers, and instead I am looking at the companies which stand to benefit from their widespread adoption.

Enphase Energy, Inc. (NASDAQ: ENPH) is extremely well positioned to benefit from the low cost of solar. I believe they have established themselves as the most dominant player in the microinverter niche, and also offer a robust package of ancillary products. I consider this the single most attractive picks and shovels play in the industry. After looking over their financials and valuation, I currently rate ENPH a Hold.

Company Background

Enphase Energy, Inc. develops and manufactures support infrastructure for the photovoltaic industry. They were the first company to successfully commercialize solar micro-inverters. They also offer a variety of energy storage, monitoring, and control products and services. They were incorporated in 2006, are currently headquartered in Fremont, California, and have operations across the globe.

ENPH Global Supply Chain (Investor Presentation, July 2023, Page 11)

The Best Edge In Solar

Enphase provides semiconductor-based microinverters. These convert energy from DC to AC at the individual module level and are easily installed at the same time as the panels. Microinverters are especially attractive in residential settings where regular maintenance may be sparse and shading is often a problem.

ENPH Products (Investor Presentation, July 2023, Page 6)

With non-microinverter systems, multiple panels are wired in series and then connected to a string inverter. This is a bit of an oversimplification, but string inverters convert DC into a square wave and then uses the interactions between induction, capacitance, and magnetism in a smoothing coil to convert the square wave into sine wave. They also have to synchronize this sine wave with their local grid frequency. String inverters do not raise voltage and are not 100% efficient, so multiple panels must be placed in series so the input from the string of panels into the inverter is higher than the local grid voltage.

All of this works fine until you get some shading on one of the panels in the string. Photovoltaic panels are essentially just really large, highly engineered diodes. With solar panels, the energy needed to open its gate and encourage flow is provided by the sun. Anytime this net energy level falls below a certain threshold, the solar panels transition from being unidirectional voltage sources to semiconductors with relevant resistance values. If the voltage output from the panels to the inverter is not high enough, the inverter's output will not be able to overcome grid voltage and the output of the entire string of panels becomes waste. Back when I was installing panels regularly, I used to tell people that shading even a single panel which is wired in series is comparable to kinking a garden hose; the shaded panel is highly restrictive to flow and cripples the output of the entire series.

In residential settings, it is extremely common for panels to be installed into rooftop locations which are difficult to access to keep clear of debris such as leaves. Couple this with the fact that one has little or no control over their neighbors' trees and the shade they cast, and it becomes clear why microinverters are so popular among residential-scale systems.

Long-Term Trends

The global solar panel market is expected to have a CAGR of 18% until 2030. The global microinverter market is projected to experience a CAGR of 17.8% through 2028.

The low cost of solar is forcing entire industries to adapt. With the levelized cost of solar now lower than any other energy source, we are financially incentivized to keep installing and building solar. We have driven the cost of panels so low that they are becoming commoditized.

Levelized Cost Of Energy (Lazard, Dan Gearino, Insideclimatenews.org)

So far, predictions on the maximum pace of solar adoption have all been limited by our ability to adapt the grid into one better capable of handling the intermittent output that panels provide. Up until now, the high cost of Li-ion batteries has been a major barrier to adding enough storage into the system to mitigate the Duck Curve. Overproduction from panels has the potential to damage portions of our electric grid, so commercial scale systems are frequently forced to disconnect portions of their systems during the middle of the day.

The Duck Curve (Brad Bouillon; Standford University)

Much of the problem so far has been cheaply acquiring enough metal. The recent production wind-up for iron-air means that having access to enough cheap metal to make batteries should no longer be a problem. We have had functional iron-air batteries for several decades now, but they were always overlooked because they do not hold a charge as well and are less efficient than the best batteries we can make. Yet they are now being developed because they can be produced at scale, are very cheap, and are 'good enough' efficiency-wise. If solar panels hadn't become so cheap, we wouldn't be incentivized into a widescale adoption of iron-air. I believe the proliferation of cheap storage will be a further boon to the solar panel industry.

Guidance

The forward guidance in their most recent earnings call transcript was not viewed as favorable by the market. The company was expecting a seasonal rise in demand which did not materialize, so they currently find themselves with excess inventory in their channel. With the demand falling below expectations by roughly 10% for two quarters in a row, the company has shifted its stance and is now operating under the assumption that the lower demand will continue. They attribute this to the present interest rate environment and not elevated competition, so they expect to be able to maintain their high market share.

ENPH Guidance (Earnings Call Transcript, Q2 2023)

Annual Financials

Enphase has been experiencing fantastic revenue growth. In 2013 they had an annual revenue of $232.8M, by 2022 that had grown to $2,330.9M, this represents a total rise of 901.25% at an average annual rate of 100.14%.

ENPH Annual Revenue (By Author)

Their annual margins found a low in 2016 before going through a period of expansion until reaching a peak in 2020. As of the most recent annual report, gross margins were 41.81%, EBITDA margins were 21.61%, operating margins were 19.44%, and net margins were 17.05%.

ENPH Annual Margins (By Author)

Total common shares outstanding was at 42.1M in 2013; by the end of 2022 that had risen to 136.4M. This represents a 224% increase in share count, which comes out to an average annual rate of 24.9%. Over that same period operating income rose from -$22.2M to $453.2M.

ENPH Annual Share Count vs. Cash vs. Income (By Author)

Their debt has been rising significantly. They have also been increasing their short-term investments over the last three years. As of the 2022 annual report, they managed to overcome their interest expenses with their own interest and investment income; they had $4.3M in net interest expense, total debt was $1,314.8M, and long-term debt was $1,199.5M.

ENPH Annual Debt (By Author)

They have almost as much in short-term investments as they do in long-term debt; their cash, investment, and income situation is quite healthy. As of this most recent annual report, cash and equivalents were $473.2M, short-term investments were $1,139.6M, operating income was $453.2M, EBITDA was $503.7M, net income was $397.4M, unlevered free cash flow was $498.8M, and levered free cash flow was $501.1M.

ENPH Annual Cash Flow (By Author)

Their total equity fell in 2016, and then went negative in 2017. It appears to have been growing since then.

ENPH Annual Total Equity (By Author)

Their low equity in 2016 is skewing the ROE value for that year. The following year, both their equity and their net income were negative, so their ROE is incorrectly showing up as a positive.

ENPH Annual Returns (By Author)

Removing their ROE presents us with a better view of their ROIC and ROCE. As of the most recent annual report ROIC was 18.57%, ROCE was 15.26%, and ROE was at 48.13%.

ENPH Annual ROIC and ROCE (By Author)

Quarterly Financials

I was expecting to see some regular seasonality in their quarterly reports, but they do not seem to experience it. Their revenue was rising at a steep slope until it reached a peak in the last quarter of 2022 and the first quarter of 2023. The shortfalls in demand the company believes is from high interest rates seeming to have temporarily stifled their growth. Eight quarters ago Enphase had a quarterly revenue of $316.1M. Four quarters ago that had risen to $530.2M; by this most recent quarter it reached $711.1M. This represents a total two-year growth of 124.96% at an average quarterly rate of 15.62%.

ENPH Quarterly Revenue (By Author)

This did not show up in as much detail on their annual chart, but their margins experienced a temporary contraction and found a new low in Q3 2021. They appear to have been steadily increasing since then. As of the most recent quarter, gross margins were 45.46%, EBITDA margins were 26.14%, operating margins were 23.98%, and net margins were at 22.11%

ENPH Quarterly Margins (By Author)

The pace of their share count growth was extremely unappealing when looking at it on an annual basis, but it appears to have stabilized about 2 years ago. The average pace of dilution over the last two years is 0.09% per quarter. Over the last year this has dropped to 0.04% per quarter.

ENPH Quarterly Buyback vs. Dilution Rate (By Author)

The income from their short-term investments is currently outpacing their interest expenses. This most recent quarter Enphase had $14.3M in net interest expense, total debt was $1320.6M, and long-term debt was at $1201.1M.

ENPH Quarterly Debt (By Author)

Their overall financial situation still appears quite healthy when viewed on a quarterly basis. As of the most recent quarter, the value for cash and equivalents was $278.7M, short-term investments was $1521.8M, quarterly EBITDA was $185.9M, operating income was $170.5M, net income was $157.2M, unlevered free cash flow was at $121.4M, and levered free cash flow was at $120M.

ENPH Quarterly Cash Flow (By Author)

Total equity found a new low in early 2022, but has been rising since then.

ENPH Quarterly Total Equity (By Author)

Overall, their quarterly returns are quite attractive. Even during the most recent low in Q3 2021, ROIC was 1.29%. It then climbed up to 7.19% in the last quarter of 2022. As of the most recent earnings report, ROIC was 6.86%, ROCE was 5.10%, and ROE was at 16.16%.

ENPH Quarterly Returns (By Author)

Valuation

As of August 9th 2023, Enphase had a market capitalization of $18.46B and traded for $138.46 per share. They do not pay a dividend, so using their forward P/E of 39.61x, and their EPS Long-Term CAGR of 29.54%, I calculated a PEGY of 1.341x and an Inverted PEGY of 0.746x. This implies that fair value is currently close to $103.26 per share.

Risks

Enphase is already suffering from a slacking in demand caused by elevated interest rates. Installing solar has a high upfront costs and is often funded through loans. With the Fed still focused on fighting inflation, they are talking about leaving rates elevated for a prolonged period of time. If inflation does not continue waning, they may even be forced to raise rates further. The solar panel industry, and all of its support industries, can expect demand to stay lower than previous expectations for as long as rates are elevated.

Enphase suffers from a dependence on outside manufacturers. It has formed two partnerships, one with Flex LTD( FLEX) and another with Salcomp. If either manufacturer were to ever have trouble supplying Enphase, they could experience logistics shortfalls until they are able to find a replacement source.

Enphase also depends on a variety of partnerships to distribute and sell its products to regions around the globe. If any of these partnerships fall through, they may be a position where they are faced with excessive shipping costs and delays. If they are unable to effectively meet demand in some regions, consumers will be encouraged to seek other suppliers and the company may permanently lose out on that potential revenue.

The solar panel industry and all of its ancillary industries exist in a highly competitive environment. The portion of their business that handles energy storage, and the portion that handles energy monitoring both already face stiff competition from a variety of sources. It is possible that additional competition arrives in the microinverter space and drives prices lower. If microinverters join photovoltaic panels and are also commoditized, then I would expect the moat Enphase enjoys regarding them will vanish.

Catalysts

When interest rates eventually go back down, demand is likely to pick back up. There may even be some pent-up demand waiting to engage once rates fall, so instead of returning to expectations, it is possible demand temporarily exceeds them.

The company exists in an industry with sustained tailwinds. As the cost of grid-scale storage goes down, demand for photovoltaics should rise even further. I believe that demand for Enphase's products should stay correlated with demand for solar, so I expect this to be a boon for them.

Conclusions

Enphase Energy has established itself as a dominant player in their niche. They have already proven they have the potential to produce strong returns and exist in an industry with long-term tailwinds. As they are currently operating under short-term headwinds from the Feds fight against inflation, valuation has been shifting back toward fair value. It may even fall below my calculated fair value estimate of $103.26 per share.

I do not currently own any Enphase (ENPH). I believe the company is presently overvalued and facing temporary headwinds, yet blessed with a deep moat and strong long-term tailwinds. If price falls to or below around $100 per share, I will take a fresh look at their situation and then likely begin dollar cost averaging into a position.

Options Trade

If I were determined to place a trade based on my conclusion that Enphase is likely going to continue dropping as the Fed maintains elevated rates, it would be some form of front put ratio spread. Before I continue, I should warn that new options traders are often caught off guard by their nonlinear behavior.

I looked at several 2-leg strategies, but later settled on this 3-leg strategy as a way of pushing the breakeven lower. There are many ways to set these up, so don't assume the strikes and expirations I chose are the only correct way to do this.

Using options that are more than a year out, this trade purchases a single put with a strike of $115. The value of this put will increase as the share price goes down. It is paid for by selling multiple puts at lower strikes.

Below that, the second leg is selling a put with a strike that is chosen so that its premium is slightly more than 1/2 the value of the put that you purchased at $115. In this case that meant selling a put at $90.

The third leg consists of two puts. The strikes of these puts are chosen so that the premium collected for each of them is slightly more than 1/4 of the value of the put that you purchased. When the premium from these two puts is combined with the premium from the second leg, it should more than pay for the put that was purchased in the first leg. In this case the net premium collected was $263. Assuming these puts are cash secured, entering the position locks up $23K.

ENPH Options Trade Legs (Optionsprofitcalculator.com) ENPH Options Trade Returns (Optionsprofitcalculator.com)
ENPH Options Trade Legs (Optionsprofitcalculator.com) ENPH Options Trade Returns (Optionsprofitcalculator.com)

If the price rises at any point in time between now and expiration, the trade can still be closed for a small profit. If the expiry date is reached and price is above $115 per share, it nets a total of $263. If price lands between $90 and $115, the trade pays an ever-increasing amount as it approaches $90. The trade has a maximum return of $2,763 if the share price lands in a range from $70 to $90. If the share price ends up below $70 on the expiry, profits begin dropping and cross into the red at a breakeven of $56.20 per share.

While options trades can be used purely for the purpose of generating income, or to lower risk, I find selling front put ratio spreads such as this particularly attractive on tickers I want to own shares of. At any point between now and expiration, if a perceived bottom is found, the long put with a strike of $115 can be sold or rolled for a profit and converted into even more shares. Because I believe fair value is slightly above $100, I would view getting exercised on these puts at $90 and $70 as a good thing.

The fact that my estimated fair value for ENPH is 83.7% above the breakeven for this trade gives it a significant margin of safety. However, this does not make it risk-free. Enphase could always suffer a catastrophic change to its fundamentals or financials. If their fair value is lowered, this margin of safety would shrink. I should note, my attitude on this trade is centered around the conclusion that although they are facing short-term headwinds, their long-term tailwinds will eventually overcome them.

This article was written by

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.

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