Enphase Energy Is A Superior Solar Company
Summary
- Enphase's margins are significantly higher than those of its peers.
- Margin expansion will most likely continue going forward.
- At current prices, the company is trading at a premium.
There's no doubt that the future of energy is heading towards renewable sources. Solar, in particular, has become much more cost-effective in recent years. In fact, solar energy is actually cheaper than fossil fuels. Electricity from fossil fuels costs between 5 cents and 17 cents per kilowatt-hour whereas solar energy costs average between 3 cents and 6 cents per kilowatt-hour and are trending down. The only downside is that solar power has higher upfront costs, although the price of solar panels has decreased by more than 20% in the last 5 years and 70% in the last decade.
As a result, it makes sense that some investors want to try and profit from this new shift especially since we are still in the early days. However, not all solar companies are equal and not all will enjoy the same level of success. That is why Enphase Energy, Inc. (NASDAQ:ENPH), would be our top pick if we were to bet on solar.
Industry Analysis
The solar industry employs over 230,000 Americans and is expected to grow at a CAGR of 6.9% from 2021 to 2028. Growth is driven by government initiatives and incentives aimed at facilitating the transition to a carbon-neutral economy. In addition, it is also much more logical to use renewable sources that will never run out as opposed to relying on a limited resource. In 2019, the solar industry generated more than $25 billion of private investment in the American economy. Given the amount of capital thrown at solar over the past decade, it's no surprise that many companies have popped up. Let's take a look at how Enphase stacks up to some of the main players in the industry:
Source: Author
As you can see, despite Enphase having the lowest amount of revenue, its margins are significantly better than its larger peers. The gross profit margin of 44.6% is 12.4% higher than SolarEdge Technologies, Inc. (SEDG), which is the second-highest. Similarly, the EBIT margin is 8.2% greater than its nearest competitor which in this case is First Solar, Inc. (FSLR).
Free cash flow margins don't even come close. Enphase has a margin of 25.9% with SolarEdge and SMA Solar Technology AG (OTCPK:SMTGF) the closest at 1% and 1.7%, respectively. SunPower Corporation (SPWR), First Solar, and Sunrun Inc. (RUN) have negative free cash flow.
Furthermore, return on invested capital and cash return on invested capital paint the same picture - Enphase is still way ahead. These metrics all imply that Enphase is much more efficient at using its resources to generate profits. It also means that its growth is much more sustainable because it doesn't have to rely on outside capital to fund its expansion. The companies with negative free cash flow are much more likely to issue new shares which would dilute shareholders, or, increase debt which would impact profitability.
Another way to measure efficiency is by looking at the cash conversion cycle. CCC compares the number of days it takes a company to sell inventory and collect receivables relative to the number of days afforded to pay bills. It is defined as: days inventory outstanding + days sales outstanding - days payables outstanding.
Source: Author
As you can see, Enphase's cash conversion cycle is the lowest. With the exception of Sunrun, it takes roughly double the time for competitors to convert inventory into cash. This is mainly attributable to its very low days inventory outstanding. Where its peers take 3 to 4.5 months to turn over its inventory, Enphase only requires 26 days. As a result, Enphase has much superior inventory management.
Growth Catalysts
The obvious underlying driver of growth is the growth of the industry. However, we believe one of the main company-specific growth catalysts for Enphase is margin expansion.
As revenue grows, the company's gross margin continues to increase. In Q1 2018, the gross margin was only at 26.5% whereas it is now at 41.1% in its most recent quarter which has allowed operating margins to increase. Higher margins will permit Enphase to reinvest more money and potentially translate into higher revenue growth that can be sustained for a longer period of time.
Valuation
To value Enphase, we will use linear regression in which we will compare price to sales versus expected 3-year revenue CAGR growth. This approach is similar to the popular PEG ratio except we will be using sales instead of earnings and is somewhat more scientific given the use of the linear regression.
The results are as follows:
Source: Author
Based on a sample of 643 tech stocks, the line of best fit was:
Fair Value = 22.5(expected growth) + 5.53
With an expected growth rate of 40.6%, Enphase's fair value relative to its peers is 14.65x sales versus its current multiple of roughly 28x sales. As a result, the stock is currently trading at a premium.
If the company can sustain an elevated growth rate for an extended period then it might justify this multiple if everything goes smoothly. This is especially true when combined with margin expansion. However, this opens up the stock to the potential of big drawdowns in the event of a sales or earnings miss which would cause unwanted pain for investors with a high-cost basis.
Final Thoughts
Enphase is a superior solar company with great margins and efficient operations. Without a doubt, solar energy is the future as costs continue to fall and it becomes more economically viable. Enphase is at the forefront of investors' minds considering it has had a very strong runup in the past year and a half. Nonetheless, the stock is trading at a premium that is too high for our personal preference, and we'll watch from the sidelines for now.
This article was written by
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.