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Enphase Energy's Current Valuations Discount 2020 Growth Potential

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About: Enphase Energy, Inc. (ENPH)
by: Investing Hobo
Investing Hobo
Long/short equity, value, contrarian, solar
Summary

Although severe, ENPH's 50% stock correction may just be technical in nature after a massive 800% run up.

Fundamental concerns may be overblown since skepticism is currently based on speculation and not from reported results.

Even if constrained to the US solar market, Enphase's dominate position and earnings power make its stock cheaper than the overall US stock market.

enph micro inverter(Enphase Energy's micro-inverters convert DC to AC at each individual solar module instead of at a centralized string inverter.)

One of the hottest sub-sectors in the solar industry this year has been the inverter vertical. Enphase Energy (ENPH) has been without a doubt the hottest solar stock which at its highs returned over 800% for its shareholders since the start of 2019. Despite posting third quarter earnings that topped Wall Street estimates, Enphase shares continued to sell off cutting its market valuation by a half from its August highs. The recent correction in Enphase shares offers an attractive entry for new investors who originally missed out on the stock's summer surge.

Earnings And Expectation

For the third quarter 2019, Enphase posted revenues of $180.1 million and non-GAAP EPS of $0.30. Wall Street expectations called for revenues of $176.5 million with non-GAAP EPS at $0.25. The company's guidance for the fourth quarter were also inline with analysts' expectations but Enphase shares nevertheless sold off by over 25% the day following its earnings release.

Continued downward selling momentum may have contributed to the post earnings reaction since ENPH had already corrected by 30% from its recent highs. Deceleration in growth expectations as well as a general market revaluation probably also played a part in the sell-off. While it is difficult to gauge market momentum that contributed to ENPH's spectacular rally and crash, it is far easier to evaluate the company's current financial status.

ENPH's 50% correction aside, the company's earnings prospects have not turned for the worse. While its third quarter earnings beat would naturally cause full year estimates to be revised higher, analysts also raised their fourth quarter average EPS estimate by over 10% from $0.28 to $0.32. The following table shows Enphase's quarterly earnings year to date and its fourth quarter estimate using midpoint guidance figures. Since Q3 results were all at the high end of the company's prior guidance, midpoint estimates may be conservative.

Q1 2019 Q2 2019 Q3 2019 Q4 2019 EST
Revenues $100.15 $134.09 $180.06 $205.00
Gross Margin 33.29% 33.80% 35.94% 35.50%
Gross Profit $33.34 $45.32 $64.71 $72.78
Operating Expenses $26.21 $27.87 $31.00 $32.50
Operating Profit $7.13 $17.45 $33.71 $40.28
Non-Operating Expenses $4.01 $6.24 $2.34 $2.50
Tax $0.35 $0.59 $0.27 $7.93
Diluted Share Count 115.86 130.74 133.61 136.5
EPS $0.02 $0.08 $0.23 $0.22
Non-GAAP EPS $0.08 $0.20 $0.28 $0.28

(Data from ENPH's quarterly results. Fourth quarter 2019 estimates are based on the company's guidance using midpoint figures and a standard corporate tax rate of 21%. Actual tax rate may be lower since Q1-Q3 tax rates ranged from 1% to 11%. All dollar figures except EPS in millions of USD. Diluted Share Count in millions. Analysts' non-GAAP EPS estimates of $0.32 imply a tax rate of approximately 10%.)

Reasons For Market Revaluation

Although Enphase did not disappoint Wall Street expectations, its stock reaction clearly showed some investors were disappointed. Much of ENPH's rally during the past year was probably in part due to low expectations which were easily topped. As usually the case for any company experiencing high growth, the law of large numbers eventually kicks in. The following chart shows the company's sequential revenue growth rates in the past year.

enph seq rev growth(Data from ENPH's quarterly results. Fourth quarter 2019 estimates are based on the company's guidance using midpoint figures.)

After two quarters of impressive sequential revenue growth averaging 34% in the second and third quarters, fourth quarter midpoint guidance only calls for 14% sequential revenue growth. This may concern some momentum investors because the fourth quarter is typically the strongest quarter for the solar industry. Fourth quarter 2019 sequential revenue growth is also expected to be lower than comparable 2018 levels of 18%.

If we back out safe harbor sales from customers trying to maximize ITC solar tax credits before rates drop to 26% in 2020 from 30% currently, sequential revenue growth appears to be stalling. From Enphase's third quarter conference call, management noted $8 million of third quarter revenues were to safe harbor customers and this amount would increase to $35 million in the fourth quarter. Excluding safe harbor, Q3 revenues would have been $172 million and the implied Q4 midpoint revenue guidance would be $170 million.

Secondly Enphase recorded an average tax rate of 2.7% for the first three quarters of 2019. While the company still has some operating loss carryforwards remaining from the $193.4 million federal/state levels at the end of 2018, at some point in the next few quarters tax will have to reflect current federal and state corporate rates. Normalizing of tax rates could potentially reduce recent net income run rates by 20-30% from recent low realized rates.

Lastly two key regions saw sequential revenue declines in the third quarter. The European and Asia/Pacific markets were down 21% and 16% respectively. In the conference call, management admitted to poor execution which if the case could be reversed, but these data points only contributed to uncertainty regarding a potential near term peak in the company's business.

A derivative concern linked to regional sales is potential channel stuffing. According to Enphase's 10-Qs, revenues in the US rose by almost 51% sequentially in the third quarter. Backing out $8 million of safe harbor revenues, US sales still saw a 43% sequential gain. The US residential solar market saw an 8% sequential increase from Q1 to Q2 2019 and even optimistic projections do not expect greater than 10% sequential increase for Q3.

This implies Enphase gained a lot of market share in the third quarter, and/or the distribution channels were being stuffed. Based on the company's shipment definition (about 325 watts per inverter), Enphase reached roughly 50% US residential market share in the second quarter. Thus third quarter shipments imply the company's market share increased to as high as 70% market share if channel inventory ratios remained constant. Of course anything is possible but for those already skeptical, this data point is potentially another red flag.

Q2 2019 Q3 2019 Q2/Q3 Sequential Change
US Revenues $99.91 $150.69 50.83%
International Revenues $34.19 $29.37 -14.10%

(Data from Enphase's 10-Qs. All dollar figures in millions of USD.)

The Positives

Momentum might have been kicked out of Enphase's stock, but the company has never been in a better financial and competitive position. Enphase operates primarily in the residential solar space with high US exposure. 83% of third quarter revenues derived from the US. Being a dominant US residential provider of inverters does have a number of advantages:

  • The residential portion of solar installations especially in the US is the least penetrated and thus would likely have higher growth rates moving forward. According to SEIA, US solar installations fell by 7% annually in Q2 2019 but residential solar installations increased by 8% year over year. This secular shift in growth rates within the US solar industry could accelerate in the next couple of years.
  • Federal ITC solar tax credits will be decreasing by 4% annually from 30% in 2019 to 22% in 2021 and finally disappear for residential solar installations after 2021. This could create added incentives for homeowners already interested in solar to install systems before tax credits expire. Diminishing or expiring incentives may sound long term negative but has historically led to short term boom cycles.
  • California's solar mandate for newly constructed housing could increase residential solar demand by 20% alone in 2020. Based on the projected 120,000 combined single/multi-family housing starts for 2019 and an average 4 kilowatt solar array on each unit, 500 MW of incremental annual demand could be generated. US residential solar installations for 2019 are estimated to be slightly over 2500 MW.

Since third quarter residential solar data has not been released, it would be too early to speculate on Enphase's large sequential shipment increase. While channel stuffing should always be a concern, the increased shipments could also be explained by:

  • Last minute increased demand ahead of the year end ITC solar tax credit drop. Policy changes in subsidized solar markets have led to 20-30% surges in second half demand for many parts of the world in the past decade.
  • Enphase was capacity constrained in the first half of 2019. If the company had more capacity, shipments would have been higher and thus the sequential shipment increase in the third quarter would not have been as exaggerated.
  • While exact volumes have not been disclosed, Enphase's partnership with Sunpower (SPWR) could have resulted in large incremental demand shifts.
  • Excluding safe harbor sales, fourth quarter projected revenues are expected to be relatively flat sequentially which could represent a quarterly pull forward to fulfill last minute sales prior to the start of year ITC tax credit drop. When viewed in terms of second half over first half instead of third quarter over second quarter, revenue increases would appear less extreme.

Management dismissed the possibility of channel stuffing during their third quarter earnings conference call, and a combination of factors noted above could explain the company's second half revenue surge. At face value, Enphase's increasing market share dominance in US residential solar should position the company well entering 2020.

Looking Beyond 2019

Current 2020 Expectations

Current Wall Street estimates call for Enphase to earn $0.97 in non-GAAP EPS on $771 million in revenues in 2020. Considering the company's fourth quarter midpoint guidance could very well be its average quarterly run rate in 2020, current analysts' estimates should be easily achievable if not conservative.

As shown in the table above, Enphase could earn $0.28 in quarterly EPS taxed at 21% based on currently projected Q4 operating metrics. $771 million in annual inverter only revenues would be below Q4's annualized run rate of $820 million, but even under this lower revenue estimate, annual non-GAAP EPS would be about $1.01 at 21% tax rate.

$771 million in annual revenues would simply be second half 2019 annualized run rate, or essentially level shipments throughout most of 2020 from current levels. While the first quarter is typically the weakest for the solar industry, the sequential drop off is much less pronounced for US residential especially when California is the biggest market and is not weather constrained compared to other regions that experience more extreme winters.

In addition, the potential incremental volume from California's new solar home mandate could translate to over 250 MW in 2020 if Enphase maintained at least a 50% market share in US residential solar. This extra volume would easily cover any potential Q1 seasonality and the entire $78 million of announced safe harbor sales in the event this revenue stream were to be non-recurring.

Incremental Storage Revenues

Enphase will be introducing a complete 'home energy management system' named Ensemble early in 2020. The package will essentially manage a home's electrical intake whether it be from solar, grid, or generator and balance it with a battery storage product which is an upgrade to its current entry level storage solution. This downstream offering from its micro-inverters is a natural fit since installers already use similar products from other brands to complete a residential solar installation.

With its already high US market share, Enphase should be able to bundle Ensemble and make it more attractive than having installers cross-brand components. Enphase hopes through bundling, revenues per install can quintuple from $2,000 for just micro-inverter sales to $10,000 for a complete home solution (excluding the solar panels). While 20% attach rates management targeted in their Q3 conference call might be overly optimistic, even with just a 10% attach rate could augment revenues by 50%. Enphase expects this new product line to be fully ramped by the end of the first half next year.

Final Thoughts

Given ENPH's spectacular rally during the past year, the recent sell off from extended levels isn't entirely unusual. Even after a 50% correction, ENPH is still technically in a longer term uptrend as it just bounced off its 200 day moving average shown in the chart below.

enph daily(Daily chart for ENPH with 50 and 200 day moving average represented by green and red lines, respectively.)

On a valuation basis, current 2020 non-GAAP EPS estimates of $0.97 appear reasonable and potentially conservative if the company can successfully bundle its energy management and storage solutions with its core micro-inverter product. Thus at about 18x forward earnings, Enphase is slightly cheaper than the overall market relative to its near term potential growth rate and that of the market averages.

Unlike a lot of upstream solar module manufacturers and downstream project developers, Enphase does not rely on internal manufacturing and thus its business is not capital intensive. By relying on contract manufacturers, the company is positioned more as a technology innovator than a manufacturer. For this reason, an argument could be made the company deserves a valuation premium to most of its peers in the solar industry.

If Enphase is able to upscale its production and lower costs, its micro-inverter technology could potentially be used in larger scale commercial applications. This might be a big if because currently the cost differential limits the micro-inverter market to smaller residential installations and confines Enphase as a small regional niche player. Nevertheless, the potential for broader industry adoption exists and the company's operating model exponentially leverages its earnings power with each incremental step up in market share as witnessed during the past several quarters.

At the very least, Enphase should be well positioned as a dominant player in the US residential market. Enphase's differential product also insulates the company more than the string inverter market which is more commoditized. Outside the US, competition in the solar industry is much more fierce with large conglomerates and top tier panel manufacturers just entering the downstream energy storage and management verticals. While Enphase could still surely compete outside the protected US market, it surely would not enjoy the mid to high 30s gross margin posted in the past couple of quarters indefinitely. At least after the recent correction, investors wouldn't be overpaying for Enphase's potential growth opportunities.

Disclosure: I am/we are long SPWR. 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.