Initial Report: Enphase Energy (NASDAQ:ENPH), 22% 3-yr Potential Upside (VIP, Yougin CHENG)
Yougin presents a "BUY" recommendation based on its market leadership, pricing power, resilience in tough conditions, and strong positioning to benefit from IRA incentives and renewable energy growth.
LinkedIn: Cheng You Gin
Enphase Energy
ENPH is a market leader with strong pricing power, elevated margins due to US tax credits, and growth opportunities in international markets.
Company Overview:
Enphase (ENPH) is the largest inverter supplier for residential (resi) solar in the US and growing share internationally. Enphase is a hardware company that sells microinverters and battery storage systems. In a solar system, inverters are used to convert direct current into alternating current in order to have usable electricity. All solar systems need inverters. ENPH pioneered microinverters, a substitute to string inverters as sold by Tesla and SolarEdge, its main competitor.
Understanding the hardware:
Why is microinverter better?
Microinverters provide flexibility (for panel layout and expansion), increased reliability (no single point of failure), monitoring and optimisation (panel level). Microinverters can easily grow with the solar panel system over the years if the household’s energy demand. More panels with microinverters can be added easily instead of matching the power output of a central inverter with the new system size. Most microinverters are warranted the same amount of time as the panels they're attached to (typically 25 years), so they are expected to last longer.
Cons of microinverter:
Higher costs as expected because of the higher overall system performance. Maintenance is more difficult as microinverters are located on the roof vs strong inverters usually located on the side of a house. Clipping, which is the power losses associated with microinverters when the power output rating of the microinverter is lower than that of the panel itself. As such, the system can’t take advantage of the full power output of the solar panel.
Microinverters convert the electricity from solar panels into usable electricity. 1 microinverter can be installed in each solar panel or multiple solar panels. This is different compared to the centralised string inverters which are typically responsible for an entire solar panel system. The individual nature of microinverters is advantageous for complicated installations or those with shading. Due to its centralization, traditional string inverter technology operates at the level of the lowest-performing panel. With microinverters, solar panels have their own inverters and will continue performing efficiently even if one panel isn't producing as much electricity as the others.
The Solar Market:
Home owners can pay for electricity that they draw from the electrical grid or by installing third-party owned resi solar systems, where the homeowner contracts with a different party — like a solar developer or installer — who owns the solar systems, and then the homeowner pays a fixed rate for energy pulled from the system via lease/PPA.
How does lease/PPA work?
The provider handles the financial and logistical burden of putting solar panels on homeowners’ property, which removes any hassle of installations, leaving them only to pay the monthly payment as part of the terms of their lease or solar power purchase agreement.
→ Homeowners get the benefits of solar energy without the commitment of a system that is supposed to last decades. Lease generally is for a fixed monthly rate and misses out on federal tax credit, PPA is payment based on usage, generally longer term (25 years vs 10 years lease) but receive more savings in the long term.
New Regulations:
NEM 3.0, launched in April 2023, is California's net metering policy, used to dictate the prices that utilities pay for the solar energy produced by homes and businesses. NEM 3.0 features a 75% reduction in export rates (the value of excess electricity pushed onto the grid by solar systems), thereby reducing the overall savings and increasing the payback period of home solar. This new policy was designed, in part, to encourage homeowners to pair battery storage with their solar panels to become more self-sufficient and contribute to a more resilient electricity grid. This reduced the incentive of homeowners to install solar systems as the economic benefit of supplying their excess electricity to the grid.
Why is NEM important?
The California Public Utilities Commission (CPUC) first established a net energy metering policy in 1996, which was later modified in 2016. Net metering compensates solar power producers for the excess solar energy they share with the electricity grid. If solar panels produce more electricity than home consumption, homeowners earn credits on their next utility bill for the power you export to the grid. This plays a significant role in the growth of resi and commercial solar power in the United States.
In both NEM 1.0 and NEM 2.0, the prices that utilities credited for solar exports were based on retail electricity rates. Under NEM 3.0, the value of bill credits for solar exports is determined by the price that the utility would need to pay elsewhere to supply the electricity. As a result, the value of exporting excess solar power to the grid is lower in NEM 3.0 than under NEM 2.0.
Benefits on NEM 3.0:
Enrolling in NEM 3.0 can still allow homeowners to save money on their monthly electricity costs with solar energy. Under the new net billing tariff (NBT) structure, homeowners also have more incentive to consider solar battery storage, as it improves their control over the times and values of their grid exports and imports.
Inflation Reduction Act(IRA):
Solar developers and installers that source iron and steel products and certain manufactured products from domestic producers can receive up to a 10% bonus to the investment tax credit (ITC) or production tax credit (PTC) when completing projects. A product is considered to be “Made-in-USA” under this rule if 40% of the cost to manufacture it (when used on projects beginning construction before 2025) was completed within the United States. That rule increases to 55% for projects beginning construction after 2026.
Nature of the customers:
ENPH does not sell to individual customers but to installers and distributors. If there is a fall in demand for end customers, such suppliers face the brunt of it. This is industry wide. Some installers or distributors include Sunpower (SPWR), Sunrun (RUN), Sunova (NOVA) in the US. These businesses are asset heavy and hence suffer from the high interest rate environment. They aim to reduce cost by putting pressure on component suppliers like Enphase which affects Enphase’s operating margin.
Geographical breakdown:
Most of its revenue is derived from the United States followed by the Netherlands.
Others mainly include Germany and France
Products:
IQ8 Microinverter → up to 384W AC Power handling 14A panel current (resi)
IQP Microinverter → up to 480W AC Power (small commercial market, resi)
IQ Battery 10, 3, 5P (1st, 2nd, 3rd Gen)
IQ EV Charger (not in Europe yet) → integrates into Enphase’s solar and battery system to help homeowners maximise electricity cost savings
Bi-directional EV charger (coming in 2025) → Vehicle to Home (during power outages), Vehicle to Grid (make money selling energy to grid), green charging (solar to house)
Home Energy Management → maximise savings via self-consumption, enables Enphase solar and battery systems to work with 3rd part EV chargers and heat pumps
Industry Overview:
Solar market penetration rate is currently low with favorable government policies to act as tailwinds. Despite accounting for 75% of renewable capacity additions in 2023, solar PVs (yellow line) accounted for only 5% of global electricity generation in 2023. According to the IEA, this figure is set to expand to about 13% by 2028.
Wood Mackenzie expects 15% growth in installed capacity for the national resi solar market in 2025, as the industry recovers slightly from California’s transition to a new framework, and interest rates potentially decline. In the longer term, Wood Mackenzie expects 8% average annual growth between 2026 and 2028 in the US with the IRA fuelling much of the growth.
ENPH’s biggest competitor is Solaredge (SEDG). SEDG and ENPH are the 2 biggest companies in the solar inverter space. Together they have 95% of the global inverter market share, with Enphase holding 48% and SolarEdge 40% of the US market alone. Solar and storage products are highly sensitive to interest rates with demand falling significantly when rates go up. High interest rates suggest a longer payback period for investments into solar systems. Industry wide turnaround expected with interest rate cuts on the horizon. This would reduce cost to installers/distributors and hence end consumers thereby boosting demand for solar installations.
Why Stock Price is down?
Solar firms have been facing rising inventory levels in Europe as well as softening customer demand in the U.S. due to the metering reform in California and high lending rates. Stock price is down recently because the company's EPS are projected to be $0.77, reflecting a 24.51% decrease from the same quarter last year. Meanwhile, the latest consensus estimate is calling for revenue of $394.6 million, down 28.39% from the prior-year quarter.
ENPH’s positioning in the market
ENPH’s microinverters are differentiated compared to its peer solar inverter offerings. Its superior value proposition positions it as a leader in the growing renewable energy market: ENPH’s microinverter produces 5-15% more energy compared to string inverters, reducing cost for homeowners. Microinverters allow per panel monitoring for better power optimisation and better trouble shooting. Installation is simple with no main panel required, it can be done in under 2 hours. Enphase mobile app and software system allows better control to track, analyse and monetise the Enphase energy systems. Additionally, ENPH has over 405 patents to protect its technology.
ENPH has strong pricing power despite the temporary headwinds in the industry. This is due to its superior value proposition and strong balance sheet to tide through the current macroeconomic environment. Enphase has been able to maintain a strong market share despite industry-wide challenges. ENPH has positive FCF this quarter despite falling net income. It ended the quarter with $1.6 billion of cash versus $1.3 billion of debt, representing a solid net cash balance sheet.
Enphase has a positive net cash position. Net cash has been depleting but it was due to a $1Billion share buyback programme given that it is down 60% from all time high.
Using margin and revenue growth as a gauge of performance and proxy for market share over the last few years, ENPH has significantly outperformed its main competitor, SEDG due to structural differences in their manufacturing capabilities. SEDG has higher SKUs so manufacturing capacity is never really optimally utilized, especially since there will be a lag in implementing increases/decreases in manufacturing capacity following changes in demand.
In the low interest rate environment, ENPH was able to grow at a faster pace than SEDG showing its ability to capture market share with macro tailwinds. Conversely, in the current high interest environment with industry wide headwinds, ENPH is able to maintain positive margins and outperform SEDG even from a revenue growth perspective. ENPH is able to maintain its pricing power despite the poor macro environment, given its significantly higher margins compared to SEDG. Despite ENPH seeing revenues implode over 60% to $263.3 million. Gross margins came in 500 bps higher at 46.2%, and operating margins remained positive at 14.8%. In contrast, SEDG has seen its margins collapsing sharply. In both positive and negative environments, ENPH is set to outperform SEDG. Margins are expected to return from higher operating leverage from cost cutting initiatives. ENPH is positioned to take market share from its competitor as it leans on its financial strength against competitor’s financial weakness as seen from the company’s financial resilience amidst market troughs.
These margins are pre-IRA benefits with expected IRA benefits set to kick in in Q3 2024 thus expecting margin expansions.
Thesis:
1. Wider tailwinds such as IRA benefits and interest rate reductions are set to support the industry turnaround with ENPH best positioned to take advantage of it.
ENPH is working to qualify its microinverters for the 10% domestic content tax credit by Q4 once manufacturing is moved to a US supplier. With ENPH’s U.S.-manufactured components, their microinverters will allow the commercial asset owners and resi asset owners — such as PPA and lease providers — that buy them to qualify for the bonus 10% domestic content credit, which brings the federal investment tax credit for solar systems up from 30% to 40%.There's significant customer interest in obtaining U.S.-made products because the 10% benefit that suppliers receive is more than the cost of an entire microinverter. In the U.S., it costs about $4 per watt to install resi solar. A 10% saving from the domestic content bonus is 40 cents per watt. ENPH’s microinverters cost 30-35 cents per watt — less than the entire saving they can provide. The 10% domestic content credit on solar-only installations could improve resi solar economics by expanding bill savings by 17 % if the full tax credit is passed on to the customer. Given the increase in entrants into the competitive lease/PPA market, PPA and lease providers are incentivise to pass down a larger amount of tax credit. Assuming 50% of the tax credit is shared, resi solar growth could increase by about 10% for lease/ PPA providers. With resi solar growth, there is an increase in demand for solar panels and hence inverters/microinverters. ENPH stands to gain from margin expansion because of its pricing power. ENPH will be able to raise prices without losing competitiveness.
On the company management side, moving manufacturing to US has the advantage of smoothing out supply chain issues and ensuring a more predictable supply chain. ENPH has reorganised its manufacturing facilities to take advantage of the IRA credits. ENPH has set down manufacturing in Romania, significantly reducing it in India, China, and Mexico to move over 2/3s of its 7.25 million microinverter units annual output to the U.S. Additionally, it provides ENPH with quicker market access given that most of its revenue is from the US. Greater production quantity in a centralized location also reduces manufacturing cost due to economies of scale. This supports the margin expansion as well.
While resi solar industry trends remain lackluster for the rest of the year, ENPH’s is able to maintain gross margins superior to peers and positive FCF during the depths of the resi solar industry down-cycle.
ENPH’s road towards qualification for tax credit is imminent:
ENPH’s US-based microinverter manufacturing has capacity for Printed Circuit Boards (PCBs) and electrical parts which provide 17.6 percentage points out of a total of 40% of a customer’s bill of materials that are required to be domestically produced in order for the customer to qualify for the Investment Tax Credit adder of 10% of the system value. Thus, assuming that 100% of the customer’s fasteners and rails are domestically produced, which account for 25.8 percentage points, the customer would qualify for the credit.
By the end of 3Q, ENPH intends to add microinverter enclosure manufacturing capacity, which when combined with a production kicker included in IRS guidelines, would result in ENPH’s product contributing 35.6 percentage points, allowing the customer to more easily qualify for the adder. This advantage over other peers given string inverters without module-level power electronics (MLPE) only contributes a maximum of 7.6 percentage points. ENPH is ahead than SEDG in qualifying for the domestic content benefit and would stand to capture market share from SEDG.
All in all, the domestic content advantage is expected to provide upside to market share and/or gross margin.
2. Destocking seems to be complete indicating a turning point in sales
Undershipment was 113 million in Q1 and 90 million in Q2. Undershipment is the difference in expected product demand and revenue of the company. Essentially, Enphase was shipping fewer products than the market demand to reduce stock. Management expects no destocking in Q3 meaning that this phase of under shipments is over and ENPH is now shipping at levels that align with demand allowing them to capture demand fully. ENPH’s ability to destock compared to its peer, SEDG allows it to capture growing demand in Europe, enabled by increased market penetration by ENPH, and the returning demand in US.
The previous fall in revenue, in the US by 34% was a result of intentional under-shipping to end markets to reduce channel inventory.
Management guidance can be verified by looking at Inventory turnover and Days Inventory Outstanding though Q3 earnings in October will provide better colour on the state of inventory management.
In Europe, sell through rate is expected to return to normal given inventory clearance because of higher demand. Other tailwinds in Europe in key operating markets include Netherlands government approving net metering for the foreseeable future with lead generation much higher in Netherlands. That should start to result in increased sell-through and increased activations in Netherlands. In France, high utility rates, which are costs for homeowners are driving higher solar installations.
Valuation:
Q1 and Q2 revenue came in at $263.3 million and $303.5 million. Microinverter shipped in Q1 and Q2 were 1382 and 1403 k units respectively. Q3 revenue guidance by ENPH is ranging from $370-410 million. Revenue/microinverter has been coming in at $140 for q1 and q2 and i expect it to be sustained given new product releases. I expect further margin expansion due to IRA benefits.
Current trading 25x EV/EBITDA and 30.7x PE. The valuation of the stock is at a premium given its strong balance sheet, margins and ability to maintain its leadership position in the market despite tough market conditions. I believe Enphase will retain its leadership position and further capture more market share with upcoming better macroeconomic conditions. Its closest competitor, SEDG, is not profitable.
Risks:
Macro risks. A macroeconomic slowdown in major ENPH markets (e.g., US, Europe) could negatively impact overall electricity demand and/or demand for rooftop solar vs other energy sources.
Competition. ENPH faces head-on competition from its nearest MLPE rival, SolarEdge, and more oblique competition from incumbent string inverter suppliers. Additionally, ENPH faces competition for its energy storage products from well- capitalized peers such as Tesla (TSLA/Brinkman). The rate of innovation is quite rapid in this space, and there are potentially disruptive technologies on the horizon. Additionally, impacts to other areas of the solar value chain (e.g., panels, labor, financing) may negatively impact the solar industry’s ability to compete with other sources of energy, weighing on ENPH’s growth.
Government and state policy can impact solar. Changes to incentives and the rules governing the attachment of distributed solar to the grid could impact the PV solar industry
*Do note that all of this is for information only and should not be taken as investment advice. If you should choose to invest in any of the stocks, you do so at your own risk.
References:
https://www.energysage.com/solar/microinverters-overview/
https://nrgcleanpower.com/learning-center/solaredge-vs-enphase/
https://www.iea.org/reports/renewables-2023/executive-summary
https://www.iea.org/reports/renewables-2023/executive-summary
SolarEdge vs Enphase comparison :https://nrgcleanpower.com/learning-center/solaredge-vs-enphase/