SolarEdge - Investors Overreact To A Good Earnings Report

| About: SolarEdge Technologies (SEDG)

Summary

SolarEdge reported fiscal Q3 earnings and revenue that beat the analyst consensus.

The company’s fiscal Q4 revenue guidance was below views and SolarCity’s plunge has adversely affected SolarEdge’s share price.

The commercial side of the business continues to grow rapidly and should reach 50% of total revenues in fiscal 2017.

Last week's plunge represents a solid buying opportunity for long-term investors.

SolarEdge (NASDAQ:SEDG) dropped more than 20% last week. The company managed to beat the fiscal Q3 revenue and EPS consensus, but the fiscal Q4 guidance was lower than expected and SolarCity's (NASDAQ:SCTY) guidance was also weak, prompting a very negative investor response. I think that the market overreacted and that last week's correction represents a solid buying opportunity for long-term investors. The company is still expected to deliver robust top line growth and margins should continue to expand leading to even faster bottom line growth. The company's cash flow is increasing and the company has a very strong balance sheet and a low TTM and forward valuation.

SolarEdge drops on lower than expected fiscal Q4 guidance and reacts to SolarCity's plunge

The two main reasons for last week's plunge are:

  • Weak fiscal Q4 guidance. The company guided for revenues between $125 million and $134 million, while the consensus was at $134.5 million. At first glance, it is rather disappointing, but investors should take note of the company's conservative guidance - SolarEdge's quarterly revenues over the past four quarters came above the high end of the company's guidance range, every time. The company also doesn't expect to recognize revenues on its new HD Wave inverters in fiscal Q4, which has also negatively impacted the guidance. If the guidance was the reason for the selloff, I am not concerned at all.
  • SolarCity plunged 20% last week but recovered some of the losses. This is the more likely reason for SolarEdge's decline. The concern here is more legitimate - SolarCity is a large customer and its guidance points to weakness in the residential solar market, which accounts for a large part of SolarEdge's revenues. However, SolarCity is no longer a 10%+ customer for SolarEdge, having declined below that threshold for the first time in several quarters. I expect this trend to continue given the expected growth of the commercial segment for SolarEdge and think that any further weakness in the residential segment is priced in at this point considering the company's very low valuation.

And while analysts are openly questioning SolarCity's business model, they are mostly defending SolarEdge's:

  • Needham has reduced its price target from $38 to $36. The firm believes that the company's move to the commercial solar market will offset the weakness in the residential market: "we believe the larger players are seeing greater pressure due to the tightening of capital needed for solar leases, and SEDG has done a good job broadening its customer base."
  • Cowen reiterated its outperform rating and the $35 price target. Analyst Jeffrey Osborne thinks that the fiscal Q3 report was strong "in spite a challenging residential backdrop for customers like SolarCity." He also expressed confidence in the company's growth potential in the commercial segment, and that "a more fragmented installer market results in more pricing power for SolarEdge as a component supplier."
  • Goldman was the only firm to downgrade the stock from conviction buy to neutral. The firm reduced its price target form $42 to $25, which still translates to solid upside from the current price. Goldman sees a tougher investment environment and expects limited near-term upside due to the "consistent mis-execution and de-rating in growth prospects at rooftop solar peers."

So, unlike SolarCity, no one is questioning SolarEdge's business model. In fact, the rapid penetration into the commercial market should be very positive in the long term.

Growth should remain strong in the short and medium-term based on the following drivers:

  • Growth in the commercial solar market. SolarEdge is making significant headway and the segment's contribution to total revenues should reach 50% by the end of fiscal 2017. The segment also carries higher gross margins, which should additionally boost the overall margin going forward. And since I am mentioning gross margins, SolarEdge's are expanding, while its main competitor Enphase is seeing rapidly declining margins. Fellow contributor EnerTuition thinks (and I agree) that Enphase has picked an unwinnable war given SolarEdge's significantly better cost structure.
  • Mass production of HD-Wave inverters should start in fiscal Q4, but revenue will not be recognized until fiscal 2017. The company believes that HD-Wave "represents a significant milestone for solar inverter technology, akin to the transition from large glass tube TVs to the flat-screen." The technology is designed to increase reliability and to optimize the performance of solar systems to 99% which will provide more power at lower cost. The 6kw inverter weighs just 9.5kg and uses 2.5 times less cooling and 16 times less magnetic components. The HD-Wave inverter should help speed up the penetration of the commercial solar market.

Click to enlarge

Source: Electrek.co

  • Growing demand for storage solutions. Management thinks that this new segment can become a significant source of growth for the business. The cost advantage that the company has is probably in the 60% to 70% range, according to one of the analysts on the fiscal Q3 call (the company did not confirm the number, but management did say that it's significant). Germany should be the largest market considering the direct 25% subsidy and the company continues to see growing demand in Australia, South Africa and the U.S.
  • The rapid shutdown requirement is expected to be adopted by all states by January 2017. The company expects that its competitiveness will increase and that they will take a bigger market share going forward in the U.S.

All of these growth drivers should help mitigate the potential negative effects coming from the residential solar market.

Growth is slowing down, but SolarEdge is not being valued as a growth stock

SolarEdge's quarterly revenue growth has slowed down over the last few quarters and the growth might additionally slow in the following quarters, but SolarEdge is not being valued as a growth stock. The company's TTM and forward P/E's are 10.5 and 8 respectively. Gross and net margins are expanding and the trend is likely continue in the following years. The TTM gross margin is 30.4% and the company expects it to be in the 32% to 37% range in the long run. Additional scale and a higher gross margin should lead to a 500 to 1,000 basis point expansion for the net margin, which should significantly increase the future earnings even with modest revenue growth. Given the solid long-term revenue growth expectations and the margin expansion potential, I believe that SolarEdge is substantially undervalued at current levels and that a P/E ratio in the 20 to 25 range is appropriate for its growth profile. Most analysts agree and the median price target on SolarEdge is $34.

Additionally, the company has a strong balance sheet with $172 million in cash and no debt and its fiscal Q3 operating cash flow was $15.3 million -- not bad for a rapidly growing company with a $715 million market cap.

Conclusion

SolarEdge is being punished for the sins of other companies (mainly SolarCity) and I think that the recent selloff represents a strong buying opportunity for long-term investors. The growth of the commercial segment and the new HD-Wave inverter should drive solid top line growth in fiscal 2017 and the current valuation is very attractive and rarely seen with companies that have such strong growth profiles. The negative investor sentiment might keep the stock depressed in the near-term and the slowing growth in the residential segment is a risk, but it's a risk that is largely factored into the current valuation.

Disclaimer: This article reflects the author's personal opinion and should not be regarded as a buy or sell recommendation or investment advice in any way.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SEDG over 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.