In a previous article, I shared what I viewed as the three important factors to watch for in evaluating Enphase (ENPH) as a turnaround investment-cash flow, revenue growth, and AC Modules as a different, perhaps better, business model. Enphase reported results for 3Q2017 on November 7. In this article, I will update what I think we've learned on these three factors.
Cash Flow. Enphase reported $28.9M in cash at the end of Q3, which was down $2M from the end of 2Q, but was $6.7M better than my conservative estimate of $22.2M. The main contributors to the better-than-expected cash situation were revenue, gross margin, operating expenses, and changes in working capital, i.e. accounts receivable, inventory, prepaid expenses, and accounts payable. Revenue at $77.0M and gross margin at 21.4% were at the higher end of the range given as guidance, and operating expenses at $22.4M were at the low end of guidance. Together these metrics resulted in net loss for 1-3Q2017 being $42.3M rather than the $46.1M figure that I used, based on the mid-point of guidance. Changes in working capital were also more favorable by $6.5M than my own estimates. I will not discuss how each component of working capital differed from my estimates except to note that E. James Sackman, in his comment to my previous article, is probably right that attempting to predict these details "is probably an exercise in futility."
It is important, however, that Enphase's cash situation is better than expected and presumably better than was reflected in the $1.49 share price prior to 3Q earnings. Even more important is the expectation by management "to be cash flow positive in the fourth quarter." Several other positive hints about cash can be gleaned from the Q&A. First, 3Q gross margin was "negatively impacted by about 1.8%" because industry-wide component shortages required air shipping to be used. While this situation is continuing into 4Q, it should not be a factor in 2018. Second, the CEO stated, "as our financial performance improves, naturally my cost of capital comes down. I expect to see that reflected in terms not only with my vendors, but also with our lender." The latter point is a critical one for Enphase's turnaround, as the $50M 10% interest term loan is part of what needs to be addressed to alleviate concerns about the company.
Revenue Growth. The reported $77M 3Q17 revenue and the projected $72-80M revenue for 4Q17 do not show the kind of revenue growth that would make a strong case for Enphase as a turnaround investment. The primary underlying factor is average selling price erosion, and Enphase is not projecting ASP to rise because of competitive pressure. Something I was looking for this quarter was a plan to grow revenue, and that plan became clear on this call. Enphase is targeting an expanded addressable market with a three-step strategy. First, the AC Module, with its advantages of simpler rooftop solar system design and faster installation, will expand the market especially for smaller residential applications and small and mid-size installers. Enphase reported that, already in 2Q17, 18,000 units were shipped to its partner LG, and these shipments "increased sequentially in Q3." Another partner, Jinko, will be shipping shortly; and Waaree is an AC module partner in India. Second, its IQ7 series of microinverters to be rolled out 1Q2018 will be a single world-wide SKU, meaning that it can be configured by software changes to work on almost any electrical grid in the world. By expanding their market internationally and reducing costs, they can grow revenue significantly and still increase gross margins to 30%. The scale-up of their international business will also insulate them to some degree from the possible impact of the pending tariff case on panels imported into the USA. Third, co-founder Raghu Belur on the call disclosed the development underway of the IQ8 "always on" product slated for 2019. The IQ8 microinverters will be grid-agnostic, allowing Enphase to reach the under-served market of 1.2 billion people in Africa and Asia where the grid is unreliable or non-existent. The AC battery, which has been slow to ramp so far, is also part of this Ensemble strategy, allowing solar to be used more widely even in developed countries, as utilities recognize the advantages of a smart-grid with distributed generation and storage. So Enphase does have an impressive strategy for revenue growth, though revenue in the near term will probably not be showing more than single digit growth.
Business Model. The change to Enphase business with the advent of AC Modules is still somewhat opaque to me. I haven't been able to learn much from the last two quarterly reports nor from the presentation at their analyst day last June. What is unclear is when Enphase gets paid for their microinverters, after they ship them to LG, Jinko, Waaree and others. These partners clearly will not be collecting until after they ship to installers. On the positive side, Enphase will have reduced inventory since their contract manufacturer can ship directly to the module partners; and, over time, Enphase will have lower costs for sales to, and training of, installers as the module partners take on that role. So this part is consistent with the lean, asset-light strategy Enphase calls their Target Operating Model 30-20-10, i.e. 30% gross margin, 20% operating expense, and 10% operating income. Perhaps the reason Enphase is only projecting $72-80M in revenue for 4Q2017 is a lag between shipping to LG and Jinko and recognizing revenue from those microinverters. The transition from their current business of mostly selling to installers to their future business of mostly selling to module partners may only have a temporary impact on revenue, but Enphase stockholders would prefer that Enphase manage their cash flow in such a way that payables and receivables for their hardware come to be more closely synchronized. Perhaps that is part of what the CEO was alluding to regarding better terms as the company's financial position improves.
Bottom Line. Obviously, investors must decide for themselves whether Enphase deserves a place in their portfolios as a turnaround play. I, for one, am now more enthusiastic about the turnaround at Enphase than I was before the earnings report. I offer two indications that others share my enthusiasm. As of the end of the first day of trading after earnings, ENPH shares were up almost 20% on about 6X normal volume. Second, in the most recent report from Dow Jones dated November 8, 2017, the top 50 institutional investors in ENPH added a net 3.7M shares of stock, with the top purchases from the likes of Goldman Sachs, Electron Capital Partners, Tenzing Global Management, and K2 & Assoc.
Disclosure: I am/we are long ENPH.
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.
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