ENPH in a Nutshell
Enphase Energy, Inc. (NASDAQ: NASDAQ:ENPH) designs, develops, manufactures, and sells software-driven solutions that span solar generation, energy storage and web-based monitoring/control for household customers. Enphase Energy was the first company to successfully commercialize microinverters at scale. Microinverter systems are plug-play devices that convert direct current (DC) electricity produced by solar cells into alternating current (AC) electricity commonly used in households. Enphase’s system is comprised of four components: the microinverter (power conversion at the individual solar module level), the AC Battery, an Envoy gateway (collecting and sending data) and Enlighten, Enphase’s cloud-based software suite that allows for remote surveillance and control of installed microinverters.
Despite having a global footprint, the United States represents more than 80% of ENPH’s revenues as of 2020. That said, ENPH’s sales outside of the US have grown +35% YoY, while sales within the US have grown by only +21% YoY. With the company planning to continue expanding its focus on European operations, we can expect ENPH international push to continue to expand and accelerate.
ENPH Enjoying Market Share Momentum as Part of the US Residential Duopoly
ENPH alongside close peer SolarEdge Technologies Inc. (SEDG) shares a duopolistic position in the US Residential Solar market with almost 90% of the total market shared between the two players. As Figure 1 below shows, ENPH has been able to slowly grab market share from SEDG’s inverter business since the beginning of 2019. While the steady gain in local market share is the result of multiple factors, one of the more impactful causes is likely that ENPH’s microinverter product offers greater versatility compared to SEDG’s centralized model. Other factors also likely include a shift in SEDG’s focus outside of the US microinverter market to other niches and regions.
ENPH’s US microinverter market share has been rising steadily since July 2020, overtaking SEDG for the first time in October 2020. As of December 2020, ENPH controlled 48% of the market compared to SEDG’s 40% -- coinciding with the launch of ENPH’s Encharge battery product in North America.
Figure 1. Share of U.S. solar inverter market as a percentage for Enphase and SolarEdge. (Source: Ohm Analytics)
Biden Administration’s Push for Greener Energy
Even before President Biden took office, solar stocks were benefitting from the macro tailwinds of a 2-year extension added to the 26% solar tax credit -- now expiring in January 2023. In addition to the tax credit extension, the new legislation guarantees that any solar project put in service after December 31, 2025 will automatically qualify for a 10% investment tax credit (ITC).
The Biden administration has been active in implementing pro-environment public policies that could prove to benefit solar companies:
Unwinding Trump’s Tariffs: ENPH has multiple microinverter supply deals with China-based manufacturers of AC modules and semiconductors – two segments of their supply chain that have thus far been impacted by tariffs. ENPH will also continue to benefit from a robust manufacturing agreement they expanded on with Mexican firm, Flex, in 2019 that has allowed them to mitigate tariffs, increase global output and improve delivery times.
Changes at the Federal Energy Regulatory Commission (FERC): Over Trump’s 4-year term, FERC took a protectionist approach toward legacy fossil fuels, sheltering such generators from competition, and erecting new barriers for clean energy. The introduction of rules such as theminimum offer price rule (MOPR) have thus far stymied clean energy’s encroachment on legacy-fuel powered plants. It is expected that the new administration will push for a change in FERC’s board of directors that will be more likely to carry out pro-environmental policy shifts.
Modification of EPA (Environmental Protection Agency) Rules: Biden’s EPA can revisit emission rules for power plants, oil, and gas operations in an effort to retire the most polluting. EPA could also make changes to fuel economy standards for cars and trucks, incentivizing transportation electrification which could further boost solar implementation.
Solar Retains Renewable Supremacy
Multiple agencies and consulting firms like Wood Mackenzie expect solar generation costs to fall 15%-25% over the next decade. This continued decrease is largely due to improvements in silicon-based modules technology such as bifacial panels and larger wafer sizes. In the US, solar is now the cheapest source of power in 16 states, with an expectation that by 2030, solar will become the cheapest in every state (as well as all of Canada and China).
Recently, the US EIA (US Energy Information Administration) revised its LCOE (levelized cost of electricity) estimates with Solar PV’s LCOE expected to reach $32.8/MWh in 2025, equivalent to a -7.7% CAGR.
Figure 2. US Energy Information Administrations levelized costs of electricity by source from 2016-2025 as percent change year over year. (Source: Author Generated with US EIA Data)
Internationally, the IEA (International Energy Agency) has gone so far as to declare that solar PV will be the leading energy source by 2040 with an expected annual output of 4,813TWh and a +10.4% CAGR. Using a more bullish SDS scenario (Sustainable Development Scenario) versus IEA’s STEPS scenario, this figure increases to 8,135TWh per year with a +13.3% CAGR.
Consensus Failing to Account for New Growth Opportunities
ENPH recently reported upbeat earnings that went largely unrecognized – likely overshadowed by the implications of a global semiconductor supply chain shortage that continues to impact a multitude of industries, solar included.
As part of their reports, ENPH announced they expect to expand into enough new markets over the next two years that their SAM (Solar Addressable Market) will expand by a factor of 4x from $3.3bn in 2022 to approximately $12.5bn in 2022. While ENPH’s SAM expansion may not offer immediate rewards, it does offer positive pockets of optionality for ENPH’s growth story.
Figure 3. Enphase’s solar addressable market breakdown by product in 2019 and 2022. (Source: Enphase Investor Presentation)
Growth of the replacement market is yet another opportunity being overlooked by consensus. IHS Markit notes that the solar replacement market is in its infancy, with Europe providing the largest opportunity given its older solar asset base. In total, Europe accounts for nearly 60% of overall replacement demand, equating to 5.22 GW of the total 8.7 GW outstanding demand for 2020. However, replacement demand in the Americas is growing and is forecast to increase at a +130% CAGR to account for 12% of the global replacement demand by 2023.
ENPH will continue to benefit from the expansion of both its US base and its international efforts in Europe over the next two years. In 2020, the firm already began to realize the benefits of an increase in demand for its microinverters in both the Netherlands and Belgium, two markets that proved quite resilient to the impacts of macro shocks like Covid19.
Fortunately and unfortunately, despite these strong growth signals, consensus has proven to be more concerned with the downside impacts of semiconductor supply chain issues when pricing out price targets and estimate for ENPH. This overweight focus on supply chain issues allowed ENPH to quietly and comfortably beat street figures last quarter while bumping 1Q2021 revenue guidance to $280-300mm ($268 prior guidance and $261mn consensus) and gross margin guidance of 38- 41% (39.5% average guidance vs 38.5% consensus). ENPH earnings momentum is increasingly positive and analysts will likely be forced to re-rate should ENPH maintain the upbeat tone. On top of that, if the semiconductor supply problems are fixed earlier than expected, then it is truly off to the races.
ENPH’s Quality Profile is Best-in-Class
ENPH is one of a select few stocks within the solar industry with a truly robust profitability profile bolstered with a knack for generating healthy positive free-cash flow. The company’s balance sheet is healthy with best-in-class fundamental metrics such as ROIC, ROE and Gross Margin alongside superior top-line and bottom-line growth rates. ENPH’s weakness comes down to current perceived valuation when using a standard Forward Price-to-Earnings ratio, which clearly places a premium on it versus its closest competitors like SEDG. That said, ENPH’s PEG ratio (PER-to-Expected EPS Growth) actually reflects a discount relative to its peers (albeit considering the limitations of relying solely on this metric).
Figure 4. Relativity chart comparing metrics of ENPH with its closest competitors (Week of 02/25/2021). (Source: Author Generated with Bloomberg and Company Data) Figure 5. Relativity chart between ENPH and its closest competitors as a percentile heat map (Week of 02/25/2021). (Source: Author Generated with Bloomberg and Company Data)
The superior quality of ENPH’s fundamental metrics is undeniable. Compared to other participants in the PV inverter niche, ENPH’s ROIC is almost 3x higher than the field, while being the only firm to deliver double-digit Free-Cash-Flow margin, all the while alongside a consistently positive EVA spread (difference between ROIC and WACC).
Figure 6. ENPH EVA spread and cash flow-to-sales from 2016-2020. (Source: Author Generated with Bloomberg Data)
ENPH Profitability Profile
What once was an oversaturated growth market, the solar PV inverter industry has matured dramatically over the last decade leaving only the most competitive firms after the ‘culling’ period between 2011-2018. Moreover, the latest PV inverter pricing trends (February 2021) are encouraging and indicate substantial, steady increases. This trend is warmly welcomed by the remaining industry participants that have struggled with negative annual growth since 2014.
Figure 7. Year-over-year percentage change from 2014-2021 of residential, commercial, and industrial inverter prices in dollars per watt. (Source: Author Generated with Bloomberg and PV Insights Data)
Figure 8. Month-over-month percentage change from 2014-2021 of residential, commercial, and industrial inverter prices in dollars per watt. (Source: Author Generated with Bloomberg and PV Insights Data)
ENPH Valuation Upside with a Conservative Base Case
ENPH is an established quality solar player with solid growth potential. As such, a relative valuation ratio could miss non-linear relationships between the firm’s valuation and its fundamentals. Since ENPH has good cash flow visibility, a DCF model has been used to better deduce a fair current value of the shares.
The first sensitivity table in Figure 9 below displays output from a DCF model highlighting share price valuation while Figure 10 displays the percentage upside given a base price of $150 per share. The baseline scenario is at the centre of the table and follows these assumptions:
A WACC of 13.8% is calculated from current debt and equity market values. This is a conservative figure as ENPH recently announced its intentions to issue debt, for which reason WACC could soon figure below 12%.
5-year sales growth of +38% CAGR, which is in-line with consensus expectations for FY21-24 thus representing a conservative figure as consensus has lagged ENPH guidance.
Linear sales growth decline after year 5. This is conservative when considering growth realistically should not slow until 2030 due to the long-term nature of the renewable megatrend.
No margin expansion. The model assumes ENPH experiences neither an expansion nor decline in profitability.
Long-term metrics: growth rate of 2.5% and Equity Risk Premium of 4%.
Figure 10. Discounted cash flow model for ENPH displaying percent change (%) from current share price at various sales growth CAGR and NOPAT Margin levels. (Source: Author Generated with Bloomberg and Enphase Data)
ENPH shares offer a significant upside and limited downside in our DCF model. The most likely scenario of short-term top-line growth (x-axis) and NOPAT Margins (y-axis) are squared and highlighted. Assuming that ENPH is able to continue delivering consensus beating results and the new growth levers materialize successfully (i.e. replacement market, new SAMs, internationalization), shares could re-rate toward the rightward scenarios of the table further increasing probability.
ENPH Key Risks
ENPH is exposed to company-specific and industry-wide risks enumerated below:
Increasing competition: ENPH enjoys a duopolistic position with SEDG in the US residential market. That said, ENPH is exposed to incumbent string inverter suppliers (SMA, Huawei, ABB, etc) with new technology being developed and patented every year.
American focus: While the Biden administration is a boon for the solar industry, a singular geographic focus always comes with less room to manoeuvre in terms diversification.
Supply constraints: recent supply constraints in the semiconductor space might last longer than the two months announced by ENPH. This will have a significant impact on ENPH’s projections.
Lingering Covid19 crisis: new virus mutations have proven to be a problem that could derail the vaccine-driven recovery story for 2021. Virus effects in solar investment were dramatic in the first half of 2020 with a decline of 12% YoY due to auction postponements and delays in project financing. In this way, IMF real World GDP data during 1H20 could be realized as a solar investment sensitivity scale of 2.9% for each 1% of GDP.
Tesla entering PV inverters: both SEDG and ENPH offer more value with their inverters than Tesla’s (TSLA) new products. TSLA’s offering lacks of MLPE (Module-Level Power Electronics) which is an essential component that provides superior energy and cost efficiency. That said, never underestimate the large legion of consumers that adore the TSLA brand.
The recent sell-off precipitated by non-ENPH related issues (e.g. yield rate fluctuation, semiconductor supply chain constraints) has created an interesting entry point to a solar industry offering attractive long-term upside. The firm offers a best-in-class fundamental quality profile relative to its peers, and superior growth expectations justified by multiple verticals like replacement market, new SAMs, internationalization, and the high revenue visibility of the solar energy megatrend. Another interesting note is recent option activity. ENPH options made NASDAQ’s daily list of notable option activity when a total of 16,146 contracts changed hands today – representing 1.6mm underlying shares or roughly 48% of this month’s average trading volume. Specifically, the most traded option today was the $160 strike calls expiring 08/20/2021, in total, 1,344 of these contracts changed hands today. Referencing the options chain, today’s low was $26.47 for these contracts, representing a best case breakeven of $186.47 between now and 08/20/2021.