Enphase Energy - An Overlooked And Undervalued Solar Energy Company

| About: Enphase Energy (ENPH)

Summary

Enphase stock has been pummeled, down 73% in 2015.

Enphase technology and business model are different from that of SolarCity and its partners.

In many ways, the Enphase approach is superior to its competitors.

Investors should realize there will be multiple winners in the renewable energy space.

Enphase should be considered as a great opportunity for value investors.

Enphase Energy (NASDAQ:ENPH) is a small cap company headquartered in California that has been in business since 2007. Its principal products have been microinverter modules that are used to convert direct current (DC) from each solar panel to alternating current (NYSE:AC). As a business, it is often compared to SolarEdge Technologies (NASDAQ:SEDG), the leading maker of power optimizers for solar panels. These components are not equivalent to microinverters, however, because installations using power optimizers must also have a central inverter.

Another technology element that has been in the forefront of business news regarding renewable energy is distributed storage, a future adjunct to distributed power generation. Again, Enphase's approach, their announced AC Battery, is different from that of the main competition, the Tesla (NASDAQ:TSLA) PowerWall, to be used by SolarCity (NASDAQ:SCTY). It is important for investors to understand the advantages and disadvantages of these two offerings for distributed storage. Because solar generation of energy is not constant like fossil fuel-powered generation, distributed storage is expected to be in great demand.

The main point of this article is to contrast Enphase to its main competition. For that purpose, it is useful to consider the technology choices and business strategies of Enphase, not only as a standalone company, but also along with its suppliers, partners and installers. For its main competition, it is useful to focus on a roughly similar group headed by SolarCity. It is the author's belief that the precipitous drop in Enphase stock is largely attributable to its lack of glamour and media attention when compared to SolarCity and the related company Tesla. If glamour and media attention has falsely skewed the stock market's relative valuation of Enphase, then investors may find an opportunity to capitalize on its future success.

As an outline of the key points of this article, please refer to Table 1.

Table 1. Key Points of Comparison between Enphase and SolarCity

Technology/Business Approach

Enphase and partners

SolarCity and partners

Solar panel suppliers

Multiple, including future integration with microinverters

Multiple now, future internal supply from Buffalo fab

Inverter technology

Enphase microinverters

SolarEdge power optimizers + string inverters

Installer(s)

Multiple installers

SolarCity

Storage

Enphase AC Battery

Tesla PowerWall

Storage battery chemistry

Lithium Ferrophosphate (LFP) (Eliiy, Japan)

Lithium Ni Mn Co (NMC) (Panasonic)

Safety considerations

No high voltage DC, non-flammable battery chemistry

High voltage DC, flammable battery chemistry

Utility relations

Collaborative

Adversarial

Click to enlarge

Solar panels. Enphase supplies microinverters to work with many different solar panels. Different part numbers of microinverters are chosen by the installer to match up with the panel technology. Enphase has been increasing the power capability (in Watts) of its microinverters in step with the increase in nominal power output of the panels. Two important recent announcements by Enphase have revealed collaborations to co-develop AC modules for the solar market with two foreign companies, SolarWorld and LG Electronics. These AC modules will integrate the latest Enphase microinverters into the back of the solar panels. SolarCity also uses multiple suppliers in its solar installations currently, no doubt using its industry-leading volumes to obtain the best pricing from Asian suppliers. For the future, SolarCity will be ramping up production of its own panels from a factory in western New York. There has been no announcement regarding future integration of inverters with panels by SolarCity, probably because they have only used conventional, wall-mounted string inverters that obviously cannot be integrated at the panel level.

Inverter technology. Much has been written about the relative merits of microinverters vs. power optimizers with central or string inverters. For readers unfamiliar with the technologies, I suggest reading the product literature on the websites of Enphase Energy and SolarEdge. Then, after you're totally confused by the claims and counterclaims, I'll offer my own opinion, based on personal experience and my own extensive reading. I was an early customer of Enphase microinverters, having them installed on our home in Arizona in early 2009. Their performance in the seven years since has been outstanding. I particularly like the ability to monitor the performance in each of our 43 panels in real time. As a retired chemist formerly working in the microelectronics field, I understand the benefits of thorough accelerated testing which Enphase uses to qualify their products before they warrant them for 25 years. I also dislike the idea of having a high voltage, noisy, heat-producing inverter attached to my home; and I know that electrical failures are driven by high voltage, which is why I'm not surprised that central inverters are only warranted for 10 years. Finally, two major companies, SolarWorld and LG Electronics as mentioned above, have given microinverters a strong vote of confidence. The one major advantage that inverters, with or without power optimizers, have had in the market has been cost. System costs with Enphase microinverters have been more expensive. Last year, Enphase lowered their prices and revealed their plan to reduce their costs by the end of 2017 by 50%, matching system costs of systems with string inverters and potentially undercutting the prices of systems with power optimizers and string inverters. They will do this by the classic method in microelectronics, integration and miniaturization. Such a cost reduction strategy is not really available for the mature, bulk electronics of inverters.

Installer. Enphase supplies their microinverters to many installers, small, medium and large. SolarCity does all its own installations but does not use Enphase. We can only speculate about the reason, the best one I can come up with is SolarCity has been unwilling to pay the extra cost. That may change if Enphase does reduce its costs according to its published plans. Regarding the opinions of installers, I have read many blogs, websites and comment threads where installers weigh in on Enphase microinverters. Most are quite positive about the ease of installation and the support provided. I have gotten to know our installer quite well, and he decided soon after our installation to only do Enphase installations based on the value they provide to his customers.

Storage. Before comparing the distributed storage offerings from Enphase and SolarCity/Tesla, it will be helpful to explain why storage is expected to be a major part of the solar energy market. When rooftop solar was fairly new, many utilities offered net metering, usually because of requirements placed on them by state regulatory agencies. Net metering or net energy metering is very beneficial to homeowners because any electricity from the rooftop panels that is not used during the day is credited in kWh and can be drawn upon to offset kWh needed from the grid in the future. It is important to understand that the credit and debit in net metering is done in kWh, not money. In effect, net metering is equivalent to a lossless, free battery for utility customers with rooftop solar. Many in the electric power industry--including utilities, regulators, and Enphase--recognize that net metering cannot go on much longer. When a significant fraction of a utility's customers have solar with net metering, the utilities have an unmanageable grid and an unprofitable business. The opposite extreme from net metering would be for solar credits to be counted in dollars at the wholesale electric rate and grid-supplied power to be charged at the retail rate. Recognizing the benefit to the grid of having distributed generation, it is likely that most regulators will decide on some arrangement between these two extremes. Regardless of where things settle out, however, the loss-less, free battery of net metering will go away. And the advantage of distributed storage to not only the homeowner but also the utility will become apparent. The homeowner will reduce his retail charges for electricity by storing excess power in daytime and drawing it down at night. The utility will benefit by having a smart grid where load can be balanced. In fact, it is my expectation that utilities will provide incentives to rooftop solar customers to add storage because it will reduce their need for wasteful generation that is only turned on when peak demand occurs.

With that introduction, let us go on to compare the two approaches to storage. Enphase has chosen modular, relatively lightweight, plug-and-play units that can be easily added to a solar installation and scaled up as needed. Their AC Battery has built-in microinverters to manage the interconversion of DC in the battery and AC in the home and on the grid. Enphase has also emphasized the need for intelligent modules to supply data to the grid and allow modern energy management at the home, neighborhood, and grid levels. SolarCity and its sister company, Tesla, are offering a heavy, 7-kWh capacity PowerWall DC storage unit that still needs a conventional inverter to interface with the home, the solar panels and the grid. It's not clear at this point where intelligent energy management will fit in to a SolarCity/Tesla installation. In addition, the inverter must be sized to fit the system, so scaling up may be difficult. If the inverter is too large or too small, the system may be inefficient, and changing an inverter later will be very expensive.

Storage battery chemistry. As a chemist, the battery chemistry is of great interest, but I will spare readers the details. Although both Enphase and Tesla have the ability to change battery chemistry as improvements become available, it is interesting to compare the initial reported choices of the two companies. Enphase has chosen batteries from Eliiy of Japan using Lithium Ferrophosphate (LFP) with two important attributes-very low risk of fire and long life in terms of charge/discharge cycles. The Eliiy battery is certified not to experience thermal runaway if crushed, punctured or overcharged, and it will not catch fire. It is also guaranteed to perform for 10 years (12,000 cycles) under the expected requirements of home storage. Tesla apparently is using several battery chemistries from its partner Panasonic--one for its electric vehicles and grid storage, and another for the PowerWall home storage unit. The latter is reported to be a Li-ion battery with Nickel Manganese Cobalt anode (NMC) with expected life of 5000 cycles. The NMC batteries are reported to be less subject to thermal runaway than other batteries, such as those used by Tesla in its EV, but are less safe than LFP.

Safety. Besides the safety of its AC Battery system, solar installations using Enphase modules have another safety advantage over SolarCity systems whether or not they include SolarEdge power optimizers. That advantage is the conversion of low voltage DC to AC at the solar panel by microinverters. Solar systems without microinverters have DC conduits at 600V, or even higher in Europe. Arcing and fires have occurred in some of these installations due to debris accumulation and/or improper connections. Alternating current is inherently safer than direct current, which is why Thomas Edison lost to Nikola Tesla at the beginning of the electricity industry many years ago.

Utility relations. Enphase has positioned itself for the smart grid future in which distributed energy generation and distributed storage play a key role. One of the founders, Raghu Belur, has spoken about the need for the solar industry to stop shipping "dumb boxes." Enphase knows that a key part of the smart grid will be data flow and real-time grid management. In fact, Enphase is already taking the first steps to make this vision real. The state of Hawaii is leading the nation in solar penetration, and grid management became an issue. At a critical point, Enphase's smart microinverters made a large impact. Quoting from Enphase, "our recent collaboration with Hawaiian Electric demonstrates how the use of smart solar and energy management technology can help stabilize and strengthen the grid". Meanwhile, SolarCity seems to have disruption of the utility industry as a goal, striving to put as many solar panels on roofs as possible. They also are fighting to preserve net metering as long as possible because their business model depends on it.

In summary, I think it is clear that Enphase and its partners have a different approach and a different set of technologies from that of SolarCity and its partners. In each of the seven categories discussed above, I have made the case for Enphase superiority over SolarCity. Of course, there will be those who disagree with this argument. After all, free markets function because alternate views get expressed and acted upon. One key point I wish to make to close out this article is that the rapid growth and promising future of solar energy imply that there will not be just one winner. New industries always have multiple companies competing in the market. Solar energy will be no different, so even those who favor SolarCity as an investment can recognize that Enphase is seriously undervalued in the current market if it is at least a credible alternative to SolarCity. To support the suggestion that Enphase stock is a great opportunity for a value investor, I have assembled Table 2, comparing Enphase, SolarCity and SolarEdge (all data from Fidelity Investments).

Table 2. Financial Metrics Comparing Enphase to SolarCity and SolarEdge

Metric

Enphase

SolarCity

SolarEdge

Recent stock price

$2.19

$35.20

$24.96

Market Capitalization

$99.28M

$3.44B

$981.03M

Total revenue trailing twelve mos.(NYSE:TTM) on 9/30/15

$396.83M

$355.9M

$373.2M

Percent revenue growth TTM vs. previous TTM

29.79%

54.41%

119.93%

Gross margin TTM

34.65%

29.59%

29.80%

R&D Expense*

$45M

$19M

$22M

Earnings per share

$-0.13

$-0.69

$0.78

Price/Sales

0.24

9.60

2.61

Price/Book

2.02

4.45

10.45

Click to enlarge

*Annual figures for periods ending 12/31/14 for ENPH and SCTY, 6/30/15 for SEDG.

I will close by highlighting a few entries in the Table 2. Enphase has not shown a profit since going public in 2012, but clearly it is investing for the future, as it should. Its R&D line is more than double that of SolarCity and SolarEdge. The last two table entries are the most telling, in my view. Price/Sales and Price/Book for Enphase are a fraction of the other two companies. If Enphase stock were priced at half of the Price/Sales ratio as that of its competitor SolarEdge, ENPH would be at over $11 per share. As I stated at the beginning of this article, it is my belief that the media coverage is skewing the stock market's valuation in favor of SolarCity and its partner SolarEdge to the detriment of Enphase. Perhaps it's all because of the glamorous association of SolarCity with Tesla and Elon Musk.

Disclosure: I am/we are long ENPH, TSLA.

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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.