Enphase Energy: Well Positioned For Long-Term Growth

| About: Enphase Energy (ENPH)


Enphase Energy has made successful expansions into some difficult global markets.

Heavy competition has had only minimal and short-term impact on Enphase sales growth.

Enphase has established strong brand loyalty and a commanding share in an industry that will more than quadruple in the next four years.

Enphase is now on the verge of profitability while their domestic and non-domestic revenues continue to grow.

The micro-inverter market is in its nascent stage and will outpace an already fast growing solar market. A brief look at the competitive micro-inverter market is provided.

Are you up to speed on solar energy technology? If not, don't feel bad. A lot of investors and even many system owners aren't too interested in the details. Even owners of large solar farms are often not aware of what is happening with their equipment. Headlines continue to promise a staggering growth rate in the solar industry but investing in all things solar might not be the best option. I can't cover all things solar in the scope of this article, but I will review a few relevant changes that have taken place over the last few years beginning with an introduction to micro-inverters.

Micro-Inverters 101

A few years ago, Ray Burgess published a revealing article titled, "Solar Panels Don't Work. And No One Knows." What he called a nasty little secret was true. Many solar arrays were shutting down partially or completely and nobody knew why.

At that time nearly all solar-energy systems were central-inverter design. This meant energy from scores of photovoltaic (PV) solar panels that were connected together (an array) was funneled through a single device (inverter) that would take the fluctuating DC voltage coming out of the panel group and convert it into the AC voltage we all use regularly. This AC power could then be connected (sold) to the utility's power grid. By wiring the panels to a single or central-inverter, it meant that if just one of those panels developed a problem, all panels on that array would act in unison and they would all stop producing or reduce production as a group. Most residential systems are made up of one or two arrays. A large solar farm can have hundreds of panel arrays.

When an object (like a large leaf) lands on a solar panel, it can cause it to reduce output or, with some panels, stop producing completely. The central inverter system design forces the rest of the panels in that array to act the same. If there were 20 panels feeding an inverter and the array developed an issue that wasn't visible, then each panel in that array would have to be tested to find the problem because it was the only way to know which panel was failing. This testing process can be costly requiring hours of labor plus time getting to and from the site. Meanwhile the entire array continued to under-produce until the problem was solved. Panel quality was also hard to monitor because if one began to delaminate (fall apart) you might not see it easily. Meanwhile your entire array was affected. System owners were blind. It was and still is a common problem with most central-inverter systems. So even if your panels were very efficient, it wouldn't matter when they were all forced to reduce output because of one hidden troublemaker.

By the time Burgess' article came out in 2011, a small private California company called Enphase Energy had already begun selling smart devices that solved these problems. These devices converted the panel energy to AC grid power at each individual solar panel on a "micro" level. Their new system of connecting panels allowed one panel to shut down without stopping the others from producing. Each panel's inverter also included complex communications that allowed it to report important production and other data over the Internet for the company, installer and owner to evaluate. The Enphase network stores lifetime production data for all of its systems so detailed reports and graphs can be generated by owners, installers and Enphase. So with the new Enphase micro-inverter, if a single panel misbehaved, you did not lose the entire array and you knew exactly which panel had a problem.

Those who have experienced or own these new systems would never consider going blind again. More importantly, connection to the Enphase server networks allows these systems to be monitored from any computer or smart phone. If a large leaf sticks to a panel, you immediately know it and you know which one because the Enphase system shows you on a map of your system's panels if one is under producing. And you didn't need to be standing next to that array. You could be sitting in a restaurant using a smart phone.

Many remained skeptical knowing the technology was new and therefore risky. The hardware cost was slightly higher than a central-inverter but the reduced labor to install made the initial cost a wash. Word not only spread among installers, but word-of-mouth among owners and end users also began to take off. And with a product warranty more than twice as long as the central inverters, Enphase micro-inverters were increasingly seen as a value investment. As sales took off, investors followed and the company went public in early 2012.

Soon Enphase was capturing the lion's share of the residential new-installation market. For obvious reasons, even commercial system installers were beginning to take note. As production increased, unit costs reduced and soon Enphase systems were comparable to the cost of installing central-inverter systems.

Central-inverter manufacturers were amazed at how many new systems were adopting this new Enphase micro-inverter. Big players like SMA Solar (OTCPK:SMTGF) and Power One (previously PWER) were skeptical and warned that this new technology would be short-lived. Their skepticism cost them dearly.

The Competition

Primary competition to Enphase Energy (NASDAQ:ENPH) has historically been central-inverters and SMA Solar is a well-known leader in central inversion products. As word spread of the advantages not only of micro-inversion, but also of individual panel monitoring, SMA had no choice but to try selling a micro-inverter of their own. In 12 months they had lost between $150 and $200 million in sales and $67 million in income to the Enphase invasion. After a long and very expensive period of denial as to the advantages of micro- inverters, SMA finally developed their own version of micro-inverter. But they were late to the market and Enphase already had a substantial share of the market and dozens of patents in the technology. SMA was forced to reinvent the concept with a more expensive product and thus have made minor inroads into the micro-inverter market. One of SMA's marketing claims is that their units are made with hardier internals like liquid-free capacitors. This flies in the face of the fact that SMA offers one of the shortest warranties in the industry. Sales are not helped by the fact that buyers only have a 5-year warranty with a 10-year extension available for purchase.

Power One has long been another primary competitor for Enphase as another leader in central inversion products. Like SMA, Power One was also losing significant revenue to the Enphase micro-inverter discovery and also finally responded by developing a micro-inverter of their own. Just as Power One was launching their first generation micro-inverters into the U.S. market in early 2013, they were purchased by ABB Ltd. (NYSE:ABB) and are no longer independently traded. ABB paid over $1 Billion for Power One based on historic central-inverter sales. Since that time, their micro-inverters have made little or no headway against Enphase. Meanwhile their central-inverter sales have continued to slump as micro-inverters gain popularity. Some installers have noted that it's critical to get their systems' wi-fi communications set up properly since the units will not turn on and produce until they are connected to the internet; no matter how sunny it is. This was at a time when Enphase was already launching its 3rd and 4th generation products with increasing reliability and all Enphase micro-inverters produce as soon as they're connected to the grid. The Power One product only has a 10-year warranty, which also has not helped sales. Now, one year after paying $1,028 million for the company, ABB is selling the Power Solutions portion of Power One for $117 Million to Bel Fuse (NASDAQ:BELFB). This reduces the net acquisition cost of the Renewables division to $911 million and will allow ABB to focus on marketing those remaining solar power inverter products.

Enecsys is the British answer to Enphase. Hoping to get a piece of the micro-inverter market, this private company headquartered in Cambridge developed their own micro-inverter for grid-tie systems. They were already selling their first generation micro-inverter when Enphase decided to target the U.K. market with their third-generation product. Enecsys now has a second-generation model that can be programmed for 240, 260 and 280 watt use. I was one of the biggest skeptics of an expensive U.K invasion by Enphase since Enecsys was homegrown British hardware. Anyone watching Enphase growth in the U.K. can clearly see that this Enphase expansion investment paid off. In spite of competing against this U.K manufacturer on their own turf, Enphase has made powerful gains in that market with over 2500 systems online and producing on Enecsys' home soil.

ReneSola, (NYSE:SOL) is the significant Chinese player in the micro-inverter market. They've established good name recognition in the panel market but can't seem to move their micro-inverters. Their last three financial reports have made little or no mention of micro-inverter sales numbers. It is difficult to find any reviews or known installations of their micro-inverters by installers and or utilities. Their inverters look remarkably like early generation Enphase product and may actually be APS micro-inverters. In spite of any similarities, they will never connect to the Enphase smart network. As an investment, ReneSola is saddled with extraordinary debt that is about three-times market cap. Although they have been trading more than six years on the market, they have spent much of that time operating at a loss.

APS (Altenergy Power System Inc) is a private Chinese-American company with a presence in the U.S. and Australia. APS has single panel and dual panel micro-inverters. Both models look remarkably similar to early generation Enphase product. I don't know about the internals, but the dual panel model looks very much like the early Enphase D380 while the single looks like the Enphase M190. These were both learning curve models for Enphase who has moved away from the dual panel micro-inverters completely. APS micro-inverters are also found under the names Greenstar and Blue Frog.

Although there are a few other small players including private micro-inverter companies like Chilicon Power, the major micro-inverter competitors are listed above.

Another Enphase competition of sorts is the panel optimizer or monitoring product. The major players here are Tigo and SolarEdge. (Tigo Energy and SolarEdge are both privately held companies) Solar optimizers are panel monitoring devices for central-inverter systems whose owners don't want to be blind as to problems and where they are occurring. They also must be installed at each panel like a micro-inverter but still require a central inverter for the system. They do some of what an Enphase inverter does and can cost nearly as much but they still do not provide any power inversion and are relatively labor intensive and thus expensive to install. And with warranty life less than half an Enphase micro-inverter, most installers do not see value in designing new systems with optimizers.

Finally, there is the AC panel. In a nutshell, this is a solar panel with an on-board micro-inverter so it has direct AC output that is ready for the utility grid. It still has to be connected via cables to the rest of the panels of an array. The idea of a grid-ready AC panel market is nothing new and Enphase does have a presence in that market. More than five years ago, Enphase teamed up with Akeena Solar for AC panels. Enphase also has partnerships with LG and others for grid-ready AC panels. While it sounds clever, it is a very limited market so Enphase does not focus on it any more than they should. Petra Solar (a small private company in New Jersey) has marketed an AC panel for some time. SolarBridge has multiple brands of AC panels and has recently raised $42 million in new private funds to further develop their AC panel market. Besides the higher cost to purchase these combo units; if any component of an AC panel fails, warranty requires replacement of the entire combination unit. Many installers prefer choice and flexibility when coupling panels to inverters rather than being roped into a certain panel dimension or output level when designing a system.

The Expensive Global Expansion

Spending money on global expansion is not a gamble, it's essential. But breaking into new countries and meeting their various regulatory requirements is a very costly process and it's only possible if you have established yourself as a brand leader. Global brand recognition is the critical goal in remaining a market leader. What Enphase should do and has learned to do, is to continue improving at what they are known for and needed for which is providing the most reliable and flexible micro-inverter products on the market. This effort has given Enphase a clear lead in brand recognition in the micro-inverter market.

Enphase is taking their strong brand recognition and expanding into new global markets that are largely untapped. Those close to the industry see Enphase as one of the most reliable options available for micro-inverters. While Enphase did eliminate the need for a ground wire to save time for installers, in the end, focusing on innovations that improve reliability and user experience will remain the best use of resources going forward. Why is a 25-year warranty so critical for a micro-inverter? Because micro-inverters are coupled to solar panels that have 25-year warranties; and often mounted on a roof.

Can Enphase continue to thrive against its many micro-inverter competitors? We can use central-inverters to answer the question. For the longest time there were dozens of central-inverter companies and yet SMA and Power One became leaders and dominated that market with brand recognition. This provided them with good product and profit margins in a fast growing solar market. We are now watching Enphase do the same in the micro-inverter market that continues to outpace solar growth in general.

The Power of Brand Loyalty

Enphase growth paused briefly a year ago when three companies (SMA, Power One and ReneSola) all launched micro-inverter products in the U.S. at nearly the same time in early 2013.

Shortly after, something very interesting happened. Enphase growth resumed. In fact it bounced back at an even more robust growth rate thus exceeding all expectations for Q4 2013 while its competitors languished. Why did their growth resume? It appears that many installers who tried the competition, ran back to Enphase in the end. That is the textbook definition of brand loyalty. Those who strayed from the brand, found something about the competition that caused them to return to Enphase.

This strong brand recognition and reliability are why those Q4 numbers are not likely an anomaly going forward. The Q1 2014 financials will also likely provide a better-than-expected revenue number for Enphase. A recent benefit of having a brand that is recognized for reliability is that Enphase is gaining brand-new market share in Australia.

Australia's micro-inverter world is an APS dominated market. Launching into new countries has been expensive for the company, but once they've established a presence, Enphase has typically taken off. Enphase already has over 360 systems installed and online in Australia. This surprising success coupled with their successful British invasion have convinced me to invest in the company.

The Short Story

It's no secret that there is an exuberant level of short-interest in Enphase stock. There are 4.8 million shares sold short with a short-ratio of over 17. Given the small float, these are hardly the kind of metrics an investor should overlook. This short interest likely accumulated on the expectation that the competition would be too much or that micro-inverter growth would stall and fall back to central-inverters. Neither has happened and in fact, quite the opposite has occurred. This immense short interest means you should expect to hear increasing bearish noise levels as revenues grow and the company approaches profitability.

The higher than expected warranty replacements of early generation Enphase product necessitated higher cash reserves on the books. News of this may have also generated an increase in short interest.

As an investor, focusing on the warranty obligation of Enphase's early generation M190 units could cause one to lose focus. This should be viewed as an R&D expense. Those early fails and the information gained from the analysis of those early generation fails were critical to the successful development of the later generation Enphase products like the M215, M250 and whatever will be next.

The resulting design improvements also allowed Enphase to extend the warranty from 15 to 25-years. This was critical since the devices are each mated to panels that carry 25-year warranties.

The Biggest Share of a Long-Term Fast Growing Market

The likely growth of the global solar market has been headlined many times. But even with global installations gaining, solar is still only 0.85 percent of total electrical production. With $86 billion solar revenue market predicted for 2014, Enphase brand loyalty looks to provide a big payoff going forward.

Lux Research predicts a $155 Billion solar P.V. market by 2018 with energy produced to be at 61.7 gigawatts. That means that all solar energy achieved to date will be doubled within the next four years. The solar industry is decidedly not at a plateau. Why the growth in solar?

Solar panel efficiencies are continuing to improve. This means more energy is produced from a given size of panel under the sun. Typical numbers are anywhere from 12 to 17 percent. SunPower (NASDAQ:SPWR) recently announced panels with as high as 21.5 percent efficiency. Shortly after, a private upstart Semprius claimed that they will be able to mass-produce panels with efficiencies higher than 35 percent. New high-efficiency panels aren't cheap, but as they come to market, prices of conventional solar panels continue dropping to record low levels while the market expands. I receive e-mails on a regular basis from distributors offering quality conventional solar panels at ridiculously low prices.

Lower solar prices mean that installations are less dependent on feed-in tariffs and more attractive to an ever-increasing number of businesses and homeowners. This may hurt the margins of panel makers, but it will continue to expand the micro-inverter market. This is only good for Enphase since the Enphase product will mate to most any manufacturer's solar panel.

And now for the most important message to investors. While the overall solar industry should double by 2018, IHS expects the micro-inverter market to quadruple by 2017. That's more than twice the growth rate of the solar market. With that kind of growth rate, Enphase can afford to lose some of its leading micro-inverter share to new competition and still enjoy a robust rate of growth.

The Bottom Line

In Summary, focus on sales growth. With product margins over 30 percent, profit will come soon enough. The micro-inverter market will likely outpace the rapid growth predicted for the overall global solar market. Enphase now has over 50 international patents in this technology with many more pending. With a majority share and strong brand recognition for micro-inverters, Enphase has secured solid long-term growth potential.

Enphase's Q4 2013 revenue surprise was likely no anomaly. Their cash reserves went up nicely and their revenues were almost certainly a result of brand loyalty. I would not be surprised to see another upside revenue surprise for Q1, their slowest quarter of the year with YOY revenue growth in excess of 20 percent for Q1 2014. But be aware, expanding into new markets has indeed been expensive and Enphase energy is still aggressively expanding.

Disclosure: The author is long ENPH. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.