Enphase (ENPH) is arguably the hottest stock in the Solar industry right now. After facing an existential threat in 2016 with a staggering net loss of $67 Million, Enphase managed to turn its business around by reducing production costs and emphasizing profitability. As gross profit margin increased from 2017 to 2019, Enphase finally reached profitability in 2019 with an EBT of $90 Million and the stock has returned 148.78% since July 2019. Solar industry is expected to grow at a CAGR of 20.5% to 2026. While COVID-19 has halt residential and commercial projects , we believe ENPH’s growth indicators suggest it has plenty of room to run once the solar industry bounces back.

Reaching Economies of Scale

Enphase has considerably improved its performance metrics in the past few years. As revenue and volumes rose 48% and 4% from 2017, revenue/volume also increased by 4%. In the same period, gross profit margin increased by 35%, while COGS, SG&A and R&D decreased by 10%, 13% and 25% respectively. ENPH’s good unit of economics paired with improving financial performance show signs of economies of scale.

Performance Metrics (2014-2019):

Source: Company’s filings

In Q1 Earnings Call, Badri Kothandaraman, Enphase’s President and CEO, stated pricing management, cost management and design changes to the AC system contributed to the product’s competitive price:

Pricing management, we’re very disciplined in pricing. We have a pricing team, which I established a couple of years ago, and they do a great job optimizing every transaction. That’s extremely important for us and we do value-based pricing.

The second is cost management. Cost management comprises into a lot of tactical pieces and a few strategic pieces. Tactical pieces are blocking and tackling in order to do supply chain optimization, finding second sources here and there, dropping costs, negotiation with customers. The second piece is tariffs.

When it comes to cost reduction, we have an ASIC strategy. In the ASIC, we have basically the digital portion. And then we also have the analog integration of the ASIC. We are able to integrate analog chips that we use in the microinverter on to the AC. Even if it means $0.20 cost reduction, $0.20 multiplied by, let’s say, 8 million units a year, that big deal, $1.6 million. So, every cent for us that we can take out of the micro by integration into the SIC is extremely critical.

Leader in Microinverter Market

Enphase and SolarEdge (SEDG) are domestic duopolies in the US residential solar inverter market. Although SEDG controls 60.5% of this market, ENPH is a leader in the microinverter market.

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Arguments on which types of inverter to use depend on your requirements and budget. However, Enphase has found its niche market and is diversifying its products to storage market, where it will compete with Tesla and SolarEdge. Considering percentage of solar systems paired with energy storage is poised to increase to 25% by 2025 and increasing blackouts in California due to wildfires, the market is big enough for all these players to enter.

Source: SEIA/Wood Mackenzie Power & Renewables U.S. Solar Market Insight 2020 Q2

International Market Penetration

Historically, ENPH’s sales was 84% from United States and 16% from international markets. One of ENPH’s strategy is to enter new geographic markets and further increase market share in Europe, Asia Pacific and Latin America. In Europe, Enphase has tripled their sales force in the region and working on partnerships with installers to distribute their product. In Australia, the company is establishing its distribution network by partnering with Rexel, a leading wholesale electrical supply distributor.

Source: Enphase Investor Presentation

As Europe and Australia are recovering from the pandemic at a faster rate than the U.S. is, Enphase’s strategy to enter these markets will prove fruitful.

In Q1 earnings call, the CEO also mentioned how the Mexico’s supply chain has aided in improving gross margin:

“The second is cost management. Cost management comprises into a lot of tactical pieces and a few strategic pieces. Tactical pieces are blocking and tackling in order to do supply chain optimization, finding second sources here and there, dropping costs, negotiation with customers. The second piece is tariffs. We have systematically designed the supply chain such that microinverters produced in Mexico do not require a tariff and we are extending the same to accessories in the future. That’s two.”

Quality of Management

Management has done incredibly well in terms of customer service support. Customers can now expect an average wait time of under 1 minute, compared to 2 mins in 2018 and 10 mins in 2017. Moreover, ENPH improved its Net Promoter Score, a management tool to gauge customer’s overall satisfaction with a product and the customer’s loyalty, from 37% in 2018 to 52% in 2019. Enphase’s understanding of value in customer support may lead to higher customer retention rate.

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Source: Enphase Investor Presentation

On April 2021, Board of Directors also authorized a share buyback of up to $200 million and plan to keep doing repurchases until 2022:

“The purchases will be completed from time to time in the open market or through a structural repurchase agreement with third parties. Such purchases are expected to continue through March 2022 unless otherwise extended or shortened by our Board of Directors. This adds another tool to our toolkit to increase shareholder value when management believes the market value of the stock deviates materially below the conservatively calculated intrinsic value.”

Source: Q1 Earnings Call

The attempt to minimize shareholder dilution is proof of management’s commitment to returning value for shareholders for the near future.

Risk

COVID-19 has definitely hit the solar industry hard, resulting in 114000 job losses and work stoppages in the distributed generation sector. As people and businesses shift priorities and recover from the pandemic, uncertainties in demand projects under development can cause lower growth projections for the solar industry.

On a macroeconomic level, federal regulations can negatively affect revenues. While some states such as California provide economic incentives for on-grid solar electricity applications, the current U.S. presidential administration imposed 10% tariffs on certain solar products manufacturing in China including ENPH’s microinverters. These tariffs then rose to 25% in May 2019. Such actions can decrease demand for the solar industry sector and ultimately hurt the clean energy sector.

Valuation

Our revenue forecast is based on ENPH’s assumption that its Served Addressable Market will increase from $3.3B in 2019 to $12.5B in 2022 or a CAGR of 56%.

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Source: Enphase Investor Presentation

As the solar PV industry grew immensely last year, ENPH and SEDG are the main beneficiaries with both stocks up 144% and 128% from last year, respectively. Our trading multiples table shows that ENPH is trading at a premium compared to SEDG.

Source: Capital IQ

Financial Projection (USD Mn; 2019-2024E):

Source: Author

Our DCF analysis using a 5.6% WACC and 23x EV/EBITDA (in line with competitor’s latest multiple) resulted in an implied fair value of $61 USD; a 30% upside from current level.

Free Cash Flow Projection:

Source: Author

DCF Valuation:

Source: Author

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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