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As a follow up to our first article about Enphase (NASDAQ:ENPH) I want to address four items of note:

  1. ENPH made a press release regarding microinverter installation growth which makes me think the company's reported numbers give even less insight into current business than I previously thought.
  2. The SEC is also interested in the company's disclosure (or lack there of) of information about the warranty obligation.
  3. A look at California solar installation data shows that installers that have been using ENPH for over two years have ramped down usage while all the growth comes from installers using the product two years or less.
  4. A recent analysis from Merrill Lynch uses an absurd valuation methodology. Indeed, it was the most disingenuous sell side comments I have seen in a while.

First, ENPH announced this week that, according to a recently released report from GTM Research, U.S. residential installations of Enphase inverters are up 62% year over year, comparing favorably to 49% industry growth. This sounds great. 62% growth in the company's largest market. The only issue is that the company's revenue is up only 4% in the first nine months of this year. And as we pointed out in our previous article, unit sales were actually down Y-o-Y in Q3, which is after the tough comparable from the expiration of the 1603 tax credit had run its course. So what are we to make of this? I can only think of a few explanations: 1) the GTM Research data is off, or 2) ENPH participated in huge channel stuffing in 2012 and is suffering from that in 2013. The company does recognize revenue on a sell-in basis, which would allow them to reap a temporary benefit from aggressive sales into the channel without products actually being used in the field. If the GTM data is right then one thing is clear to me, the company's reported numbers are now even less relevant when trying to analyze the current business. Now I will wonder anytime they have revenue growth whether it is from increased installations or just channel stuffing that will catch up with the company in the future. Add this on to the company giving its best estimate of gross margin that may change dramatically in the future, an issue we previously discussed at length.

Second, please note that some SEC correspondence with the company is now on Edgar. Now I know why we saw more disclosure about the warranty obligation last quarter than we had previously. The SEC asked for it. I would assume they noticed the increasing warranty obligation beginning in 2012 as I did and began to wonder why. Either way it is nice to see a little of what is going on behind the scenes. You can find these documents on the SEC's website. The initial letter from the SEC can be found here :

Third, I spent some time going through California residential installation data. I looked at who was using ENPH microinverters and found something interesting. Of the top 20 California installers of ENPH in 2011, 80% are installing either much less ENPH or none at all by 2013 despite huge overall industry growth in the state. Obviously this could be for a variety of different reasons: Acquired, went out of business, etc. However, could it primarily be that the longer installers use ENPH product, the more they become frustrated with quality problems that tend to occur beyond the first one or two years after a given installation (even if ENPH is subsidizing the installer's cost of running a truck back out, as some have reported)? Our conversations with numerous industry participants indicate that this is a primary driver of this movement. I have included the tables at the bottom of the article because they are fairly large. The first set is the top 2013 installers while the second set is the top 2011 installers.

Finally, I have to comment on a note from Merrill Lynch, released after my original article, suggesting that ENPH is relatively inexpensive. The analyst compares the valuation of ENPH to the ABB buyout of Power-One. I did this in my prior article using a multiple of revenue, an approach commonly used to compare a money losing company to a similar company that is in a similar market selling similar products at similar margins. The idea is that the money losing company will eventually have similar profit margins when they reach the revenue level needed to be profitable. The Merrill analyst, however, uses an EPS multiple for Power-One during a turnaround period, of 35x EPS! He then applies that multiple to ENPH's earnings two years into the future and "discounts it back at 12.8% WACC". This results in a price over $19 for the stock, which he "conservatively" marks down to $12. Why not just put a $1.50 estimate out for 2016 and discount it back three years? Then the stock would be worth over $30. Wait, we do know from statistics that the farther estimates are into the future the more likely they are to be wrong, so why not just use the 2014 estimate? Oh, because that would only justify a $1.05 valuation (consensus of $0.03 with a 35x PE multiple) so he clearly couldn't use that. As noted in my first ENPH article using the Power-One revenue multiple, I calculated a buyout price for ENPH of $3.78 per share. However, with its continuing losses, growing warranty obligation and anemic revenue growth and acquirer is likely to find it less attractive.

The analyst also recognizes that Gen2 failure rates are an issue, but that Gen3 and Gen4 failure rates are lower than expected. I hope Gen3 rates are lower than expected because the company took a nice warranty obligation reversal during Q3 that boosted earnings. Gen4 was announced as shipping to the US market on October 21st. Assuming they tested Gen4 before they shipped any, I find it difficult to believe 2 months of shipments are going to give much incremental information about failure rates.

Conclusion

ENPH is a clear leader in microinverters. I am not arguing that point. The company has done some great missionary/marketing work to gain market acceptance and grow revenue over the past five years. There is a continuing argument over the cost/benefit vs central inverters and a newer, similar argument vs DC optimizers, which provide the same benefits as microinverters at 60% of the cost. I'm not trying to pick sides in that argument. My issue with the company remains the same: it is extremely difficult to determine the true gross profit/operating profit (loss)/ net profit (loss). ENPH is selling products with a 15 year and 25 year warranty that have a very limited operating history. To make matters worse, from examining the warranty obligation disclosure it appears to me that the limited operating history of early generation products has been very disappointing.

ENPH California Customers - *indicates top 20 in 2011 and 2013

Top 20 2013 Customers

2011

2012

2013

American Solar Direct

54

482

VIVINT SOLAR DEVELOPER LLC

1

467

*REAL GOODS ENERGY TECH INC dba REAL GOODS SOLAR

436

326

455

Solar Service Center

17

320

337

*Future Energy Corporation

285

647

320

Killion Energy Inc DBA GCI Solar

12

315

PARAMOUNT ENERGY SOLUTIONS LLC dba PARAMOUNT SOLAR

11

266

Burke Electric

1

157

Complete Solar Solution Inc

6

160

141

A1 Solar Power Inc.

26

141

*Clean Solar Inc

72

85

112

California Solar Systems Inc

7

78

103

Verengo

80

86

Electricare, Inc.

8

83

The Solar Company

2

2

80

Pell Solar, Inc.

34

80

Self-Install (Same as Host Customer)

50

72

77

Stout & Burg Electric, Inc.

13

34

75

Progressive Energy Solutions, Inc.

25

74

73

*Natural Energy

44

85

73

Top 20 2011 Customers

2011

2012

2013

Galkos Construction Inc.

789

696

63

REAL GOODS ENERGY TECH INC dba REAL GOODS SOLAR

436

326

455

Future Energy Corporation

285

647

320

Solar West Electric, Inc.

112

47

41

Skytech Solar

111

276

29

Clean Solar Inc

72

85

112

Solar Network, Inc. DBA Solar Universe

70

81

23

California Solar Innovations

69

18

7

REC Solar, Inc.

61

319

5

Luminalt Energy Corporation

60

54

19

Horizon Energy Systems

51

46

12

Self-Install (Same as Host Customer)

50

72

77

SolarCraft Services, Inc.

49

71

30

Green House Builders

46

3

Natural Energy

44

85

73

Solaire Energy Systems

37

3

Horizon Solar Power

37

19

3

California Solar Electric Company

37

26

11

Global Resource Options, Inc. DBA GroSolar

35

Western Pacific Solar Corp

31

18

9

Disclosure: The fund I manage is short ENPH.

Disclosure: I am short ENPH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Source: Enphase: Part II Of Anemic Revenue Growth With Alarming Warranty Obligation Growth