Enphase Deals Excellently With Cost Inflation

Summary

• Enphase Energy is an excellent solar stock with high margins. It focuses on profitable residential solar and energy storage solutions.
• The company performs excellently. It showed it can offset cost inflation with higher prices and expects to continue so.
• Enphase's valuation is reasonable for its growth. It generates significant free cash flows.
• I dig into the first quarter numbers and outlook to dissect its ability to cope with cost inflation.
• This idea was discussed in more depth with members of my private investing community, Green Growth Stocks. Learn More »

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Enphase Energy, Inc. (NASDAQ:ENPH) is a customer-centered solar supplier. Just like Apple (AAPL), Amazon (AMZN), and Tesla (TSLA), Enphase has customer-centricity in its business model. All these companies deliver outstanding experiences and achieve high consumer satisfaction levels. The happy customers make it easier to differentiate from competitors and create strong brands and a business moat.

Enphase doesn't deliver the solar panels, but rather the crucial micro-inverters that improve the safety and performance of the solar system. It also has home energy storage with digital support. Enphase's products outperform the competition, and the shares outperform the stock market.

Data by YCharts

I've written about Enphase before. Consider this an update of my earlier work about its expanding markets and outstanding products.

Great First Quarter And Outlook

The results from Enphase didn't hold any surprises. Enphase beats its guidance once again. It consistently ends up at the top end or above its guidance. Its revenue increased a whopping 46% YoY in the first quarter. The outlook is even better, with $490M-$520M second-quarter revenue expected. The outlook indicates a ~60% YoY growth rate at the midpoint.

Enphase is still more limited by supply than demand. It continues to build out its Enphase Installer Networks around the globe. I expect it will continue its fast, profitable growth for a long time.

Enphase always beats the midpoint of its guidance and often outperforms its high-end.

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Analysts are equally surprised along with Enphase's management. Over the last twelve quarters, EPS was at least 15% higher than expectations.

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Enphase didn't provide a full-year outlook yet. The current growth rate implies that 50%+ revenue growth is achievable for 2022.

Offsetting Inflation

One of the essential arguments for investing in stocks is their ability to increase prices and offset inflation over the long run. Along with economic growth, they provide better returns over the long run than other assets like bonds and cash. However, the current inflation levels are much higher than average, and it may become difficult for some companies to offset cost increases.

U.S. Bureau of Labor Statistics

To offset high inflation, a company needs pricing power. It needs to be able to act fast and change prices as costs increase. Enphase Energy showed its ability to offset cost inflation.

Q1 earnings and the subsequent call showed perfectly how Enphase offsets inflation today and how it will offset inflation in the future.

First, a look at Q1 vs. Q4:

	Metric	Q4'21	Q1'22	Change %
Microinverter Shipments	Units, k	3,034	2,839	-6.4%
Microinverter Shipments	MW - DC	1,082	1,029	-4.9%
Storage System Shipments	MWh	100.2	120.4	+20.2%
Total Revenue	$M	$412.7	$441.3	+6.9%

Click to enlarge

Revenue increased by $28.6M while microinverter shipments slowed. Storage saw a significant increase that could explain the rise. From the analyst presentation, a 10 kWh IQ Battery adds $6.2k - $7.2k of revenue to Enphase. So Q4 had $63M to $73M in Storage revenue, and Q1 had $76M to $88M. Even if the average Storage System revenue went from the minimum to the maximum, this only adds $25M in revenue. A smaller contribution by Storage System revenue is more likely. That means the rest comes from higher-priced microinverters.

Enphase also switches from the IQ7 to the IQ8 microinverter. The average selling price of these microinverters went up since the last quarter, offsetting cost inflation for Enphase.

As CEO Badri Kothandaraman explained on the earnings call, the company increases prices diligently.

Due to the increase in logistics and component costs driven by inflation, we implemented a modest price increase on our batteries in March of 2022.

The company increases prices as soon as its costs increase. It isn't locked into long-term contracts but can act on the go. It does so while increasing its output and battling supply chain challenges.

An analyst asked Badri how Enphase managed the supply chain better than peers and competitors, outperforming others without compromising on quality.

So, to answer your thing, it is upfront product architecture, diligent supplier management, qualification of multiple sources, planning better and some luck too.

Enphase continuously innovates its products. It plans to introduce a next-generation battery in 2023. The battery will cost less, as it reduces the number of boards from seven to one and comes at a larger size with less overhead costs. When asked about the plans with the higher-margin battery, Badri answered as follows.

But you’re right, we may use it for market share gains while still retaining a healthy gross margin.

Enphase can basically choose how it uses its lower cost structure. Does it compete on price and increase revenues, or does it offset inflation and keep a higher margin on its product? This flexibility is an excellent asset in a high inflation environment.

The numbers support the case for Enphase. It kept gross margins stable over the past year.

Data by YCharts

Printing Free Cash Flow

Enphase grows its free cash flow in line with its revenues. The company converted about 20% of revenue into free cash flow over the past year. The ratio could come down slightly as it had tax benefits over the past years that should fade away.

Data by YCharts

The company's free cash flow is used for small acquisitions. These acquisitions need to fit into Enphase's framework of at least 40% gross margin.

It has an open buyback program of $200M. It didn't make any share repurchase recently.

Enphase built a significant cash position over the past couple of years of ~$1B. It has approximately the same amount of long-term debt outstanding. These are convertible notes due in 2025, 2026, and 2028.

The Long-Term View

Enphase performed excellently over the past few years. It grew fast and became very profitable. It's an excellent turnaround story. Looking forward, the company has a lot of going for it still. The home energy storage and management story are probably only just getting started. The company expands into new growth trajectories with home EV chargers and portable energy systems. These ensure the fast growth to continue over the next couple of years.

Beyond that, Enphase also has an enormous software opportunity. It's already working with grid services so homeowners can earn back their investment in solar and batteries. It also uses all its data to improve the customer experience by better managing energy consumption and predicting errors. These software opportunities could become significant revenue drivers in five to ten years.

Valuation

Enphase shares increased 20% over the past year, and the valuation came down significantly. The explanation is simple: the company grows that fast.

Data by YCharts

Enphase is fairly valued for a company with 48% CAGR revenue growth since 2017 and hasn't slowed down yet. The recent interest rate increase and growth sell-off hit the share price.

It doesn't look cheap at a forward P/E of 48.6. That's the price for a profitable, high-growth stock that generates significant cash. It's at one of the most attractive valuation levels over the past year.

Conclusion

Enphase is a fantastic company with great products. Customers and installers love it and promote it. It easily offsets cost inflation, as shown by the Q1 numbers. It's also ready to battle more inflation over the next quarter and year.

Enphase also profits from the secular tailwinds for solar in general.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of ENPH either through stock ownership, options, or other derivatives. 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.

Any investments you would take after an article or discussions with me are your responsibility. You should do your own due diligence before an investment.