Enphase is expected to resume growth in the June quarter of 2024, according to analyst estimates. This feels like a long way off to growth investors, yet we’d love nothing more than to enter close to a bottom for this global leader in solar. Interest rates will continue to weigh on the company, yet the difference between Enphase and many other consumer-facing tech stocks is that Enphase is trading at a deep discount. The stock is down (-53%) YTD and is down (-62%) since it’s December high, which was less than a year ago.

The analysis below revisits Enphase given its deep discount. Overall, Enphase is a strong product story, a strong management team, and the fundamentals will (eventually) improve. We are not at an inflection point yet on the financials, they’re still a little messy, but we could be within 1-2 quarters of the inflection point. Also, while the market has been preoccupied with selling Enphase, the margins have been quietly improving. This is not being priced in yet, but once top line growth resumes, Enphase will emerge a stronger company fundamentally.

Interest rates continue to be a headwind, and this is out of Enphase’s control. The systems they provide are pricey in the $10K to $20K range or higher, somewhat similar to an automobile. The overall message from Tesla, Apple, Enphase and others that offer high ticket consumer items is that their products are effectively more expensive when interest rates are high. This results in fewer buyers or results in aggressive price cuts. We outlined this here when a Tesla analysis that stated: “The comment on interest rates is the most important comment from the call as high interest rates mean Tesla must lower prices. In a way, management is agreeing that quite a bit about the current situation is out of management’s control. While some will talk about recurring software revenue from robotaxis as the most important catalyst, the harsh reality is that the FED lowering rates is the most important catalyst for Tesla today.”

The same can be said for Enphase as this company is at the cutting edge of solar technology – but reality is that the FED matters more. This seems simple and straight forward, yet the stock market has rallied in some cases despite a worsening outlook for pricing power. So, it’s important to be really clear about this, and repeat it again, now that tech is trading at high valuations. Except Enphase, which is a rate-sensitive stock that is trading at a 4-year low, hence the reason we are attracted to this stock whereas we are trimming others that have outperformed this year.

Most importantly for Enphase, United States revenue has been declining. Despite Europe reporting hypergrowth, it’s not enough to absorb the losses in the United States. Additionally, the IQ8 microinverter is a steady product in terms of sales, yet battery sales and EV chargers are declining. It’s expected that batteries see a recovery in the second half of the year due to NEM 3.0. We cover this plus more details on IRA, NEM 3.0 and Channel Inventory in the section “Key Metrics” and “Earnings Call Notes” below.

Revenue and EPS:

In the June quarter, Enphase reported revenue of $711 million, for growth of 34%. The company’s growth rate had been decelerating gradually over the past two years from a peak of 97%, and will now enter negative territory.

Next quarter, the company is expected to report revenue of $550 million to $600 million, for a decline of (-9.4%). According to analyst estimates, the revenue decline should bottom in December at (-12.5%). By June, the company will be in positive territory again, and by September, Enphase will see a sizable rebound.

Source: YCharts/Seeking Alpha

The company reported Adjusted EPS of $1.47 compared to estimates of $1.27. Similar to the top line, the bottom line is expected to rebound in H2 2024. In fact, Enphase is expected to go through a period of strong bottom-line growth as the company exits 2024 due to IRA making a substantial impact on the bottom line. By Q4 2024, IRA will be contributing an additional $112.5 million compared to the $157.2 million in net income Enphase reported in the previous quarter, or roughly 58% more income (if we assume all things are equal).

Source: Company IR/Seeking Alpha

Margins:

Overall, the margins are stronger due to reducing component costs and the better margins on IQ8 microinverters. For next quarter, management stated the net IRA benefit will be $15.5 million, at the midpoint, based on estimated shipments of 600,000 units of U.S. manufactured microinverters. So, there is some nominal impact from IRA for next quarter, as well.

Gross margin of 45.5% reflects IRA benefits of $1.6 million. Product mix of increased IQ8 sales also helped the margins, plus negotiations around logistics and pricing for components.
For next quarter, gross margin is expected to be 42.5% before reflecting IRA benefits of between $14.5 million and $16.5 million on estimated shipments of 600,000 units of U.S.-manufactured microinverters.
GAAP operating margin of 24% compares to 17.8% in the year ago quarter. Adjusted operating margin of 32.4% is 365 basis points higher than the year ago quarter.
GAAP net margin of 22% compares to a margin of 14.5% in the year ago quarter.
Adjusted net margin of 28.91% for adjusted profits of $205.6 million reflects stock-based compensation that is 7.6% of revenue. SBC has been ticking downward from the 10% range.

It’s quite rare to expand margins while revenue falls rapidly, which is why I’ve copied the full explanation from the earnings call:

“We have non-GAAP guidance that we gave is 42% to 45%. And like what I said, we – like, for example, I didn't even say this to the gentlemen who asked me the question before. For example, in logistics, last quarter, we saved $8 million. Last quarter. Like we have a lot of initiatives from a world-class cost on saving the cost of a capacitor, resister, parting, semiconductors, ASIC, not only by second source qualification or multisource qualification, but simply, purely by negotiation.For example, in logistics, last quarter, we saved $8 million. Last quarter. Like we have a lot of initiatives from a world-class cost on saving the cost of a capacitor, resister, parting, semiconductors, ASIC, not only by second source qualification or multisource qualification, but simply, purely by negotiation.

So we do that, and we do that on microinverters. We do that on batteries. We do that on combiner buses and accessories. So our world-class cost effort is invaluable and has saved us a lot of dollars. And we are now moving to a higher and higher mix of IQ8, which has got a little bit more gross margin than IQ7.And we are now moving to a higher and higher mix of IQ8, which has got a little bit more gross margin than IQ7.”

It was also mentioned on the call that $1 savings on microinverters leads to $20 million in savings total, assuming 20M microinverters are shipped. This also helps illustrate how Enphase plans to expand margins in the future.

Cash Flow:

Cash flow margins are also strong at 37.9% this quarter for operating cash flow, and 31.7% for the free cash flow margin. Q2 is seasonally higher than other quarters. Free cash flow of $225.2 million reflected $44 million spent on capex for new R&D equipment.

The company has $1.8B in cash and marketable securities with $1.3 billion in debt.

The company recently announced $1 billion additional authorization for share repurchases. Previously, the company had $500 million authorized for repurchases, of which the final $200 million was used in Q2 to repurchase 1.25 million shares at an average price of $159.43.

Key Metrics:

As discussed in the intro, the problem area for Enphase’s earnings reports has been the decline in United States revenue. As a percentage of revenue, the United States has fallen from 80% of revenue in Q2 of last year to 59% of revenue in the most recent quarter. This refers to percentage of revenue, while total revenue in the United States was down 12% QoQ and decreased 1% YoY.

Source: Earnings Call Transcripts

We tried to get in front of this by closing our position in April when regions outside of California reported a 25% sequential decline. This foreshadowed weak price action as the stock was down (-33%) YTD when we closed it, and it is now down (-54% ) YTD. However, through active management, our combined cost basis for the position was around $215, which means we were able to close it for only a ~17% loss. Without our process, we would instead be dealing with a 44% loss if we held onto it. Notably, management attempted to keep investors hopeful by stating Q1 is seasonally weaker than Q2, yet this did not pan out, as Q2 was weaker than Q1.

Per management, non-California states declined (-6%) QoQ on microinverters and (-11%) year-over-year. This is better than the (-25%) QoQ but is suggesting we do not have evidence of a bottom yet.

California revenue was 20% higher QoQ and 34% higher YoY – yet this comes with uncertainty because the sales are coming from a backlog on NEM 2.0 installation whereas we do not know yet how California will perform under NEM 3.0. Per our research notes below, although NEM 3.0 looks like it’ll be a positive outcome, it’s speculative until we get actual results.

Europe is growing rapidly, and is up 25% QoQ and tripled YoY. However, the United States made up 80% of revenue last year (and is now at 59%), and Europe is not large enough to make up for these losses.

Per management: “The overall U.S. market is experiencing a broad-based slowdown due to high interest rates. As I said earlier, our Q2 sell-through of microinverters in the U.S. was only up 2% compared to Q1 and only up 2% year-on-year. The second quarter is typically stronger than the first quarter that did not happen this year due to the market environment.” We covered this last quarter here.

Additionally, management stated that non-California is not likely to resume growth until interest rates are lower: “Yes. I think to answer your question on sell-through for non-California, I mean it has not changed much in Q1 and Q2. In fact, I said Q2 was a little bit worse compared to Q1, about 6% worse and I think it is expected to probably be at this level until the interest rates take a meaningful turn for the better. That in non-California.”

Enphase’s revenue has become increasingly driven by IQ8 microinverters at 78% of microinverters compared to 65% of microinverters in the previous quarter. The company reported 2121 Megawatts DC of microinverters, which was up 74.8% year over year, and was up 8.4% QoQ.

Other segments, such as IQ Batteries are trending down on megawatt hours at 82.3 MW hours this past quarter compared to 132.4 megawatt hours last quarter, for a decline of (-60.9%). The number of EV chargers shipped is also trending down for a decline of (-25%) with 6,600 U.S. EV Chargers shipped compared to 8,250 chargers shipped in the year ago quarter.

Regarding weakness in batteries, there was a suggestion on the call that Tesla is causing a pricing war. However, NEM 3.0 is expected to help accelerate battery growth as the new provisions favor storage.

Update on Net Energy Metering (NEM) 3.0:

Per our previous write-up on NEM 3.0, last year, California passed controversial solar policies that will initially benefit Enphase and other “solar plus storage” companies because the new policies greatly reward solar systems that have storage.

The new policies introduce high tariffs for high-priced evening power whereas rooftop solar systems with storage will offset these prices and potentially export power back to the grid. This was a controversial policy because it benefits utility companies by also slashing the value of solar returned to the grid by nearly 75%.

Another controversial tariff is the grid participation charge, which is proposed to be $8.00 per kW, or $56 a month and $672 per year.

This will initially benefit Enphase as the company sells storage with its comprehensive systems, and systems installed before the new policy takes effect (mid-April) will be grandfathered into the current rates offered for selling power back to the grid.

As discussed in a previous analysis, Enphase’s microinverters use a proprietary ASIC chip to change loads and grid events, which reduces the required size of battery and battery power. The solution that Enphase designed with IQ8 is that the models are “always on” by combining the inverters, batteries, system controllers and load controllers for a mini grid that can produce power from the sun and efficiently store this power at night.

The small upside to the new policy is that over the next 9 years, residential customers can receive credits by using the Avoided Cost Calculator (ACC) to calculate the cost a utility avoids for each kilowatt-hour that it doesn’t buy from the wholesale market. The extra credits will result in residential customers saving $100 to $136 per month on the average electricity bill. There is an additional $630 million in state funding set aside for low-income housing installations.

The reason I use the word “initially” is because solar installations ultimately fell in Nevada and Hawaii after similar policies.

Per SolarBuilderMag, Enphase has previously stated the following:

“Enphase Energy states, ‘Based on data from other states, cutting (the) solar value proposition by more than half — four months from now — will lead to a deluge of installation requests in the first quarter of 2023, followed by a precipitous curtailment. This will not only fail to sustainably grow the solar market, but it also risks debilitating it, exacerbating supply chain issues, disrupting small business cashflows, and jeopardizing roughly 65,000 California solar jobs.”

In December, NEM 3.0 passed with the new policy set to take effect April 13, 2023. Enphase had previously cautioned it will cause a spike in installations because solar + storage that is installed prior to NEM 3.0 can continue to sell to the grid at the higher rate before the policies go into effect.

Fast forward, and today Enphase is saying the following about NEM 3.0 — notably, the tone is more positive today compared to when NEM 3.0 had not passed yet:

“We think NEM 2.0 will continue through Q3. That's what we are hearing from our installers. It will continue through the summer until September. We believe Q4, NEM 3.0 will start. And the anecdotes we are hearing from some of our installers, some of our big installers who say that their battery attach rates are pretty nice, higher than 50% […] So payback comes down from the 7 to 8 years to 5 to 6 years with a high enough battery system. So once the installer has realized that economics, then they are a lot more confident of selling them NEM 3.0.”

Despite these positive comments, I think the reality is that nobody can accurately predict how NEM 3.0 will impact Enphase. Management at one point acquiesced that it’s an unknown right now. I will also add that when we closed the position in Q1, management had provided comments that Q2 will be seasonally stronger but this was not the case. Although management has been reliable in the past, interest rates and consumer behavior is out of their control; this is compounded by the new legislation.

“On NEM 3.0, I mean, we only have anecdotal evidence right now. The channel is still NEM 2.0. And NEM 2.0 installations are happening. Many – some of our distribution partners said that a few installers may even do NEM 2.0 until October or November. We are hearing that for most of Q3, it will be NEM 2.0. And we will start getting data on NEM 3.0 sell-through data only in Q4.”

Takeaway: We are at a speculative juncture for how NEM 3.0 plays out, however, because Enphase is the premiere “solar + storage” company and has been preparing for NEM 3.0 with the third-generation battery (available now) and fourth-generation battery (available soon), the most likely outcome is that Enphase does well. There could be a bumpy transition around Q4, Q1, etc. However, with the stock down 50% YTD and down 60% since the December high, one could argue a bumpy transition is priced in.

Third-Generation and Fourth-Generation Battery:

The third-generation battery was released in the second quarter. This is the battery that is expected to support a softer landing from NEM 3.0. Per management: “The higher charging and discharge rate of our third-generation battery will be uniquely beneficial for NEM 3.0 systems in California through its ability to generate revenue by exporting into the grid at appropriate time.”

The battery has 5KW modularity and 2X the power of the existing battery plus 3X the peak power. Due to this, management has stated “we expect our battery business to perform well in the second half of the year.” Notably, battery sales were weak this quarter as management cut pricing on the second-generation battery during the third-generation battery launch.

The benefit to being modular is that if the battery fails, a homeowner can replace parts that cost about $40 instead of the entire battery, which costs about $3,000. In this case, the third-generation battery allows for only those parts that have failed to be replaced, such as the power electronics.

Enphase will improve margins with the fourth-generation battery by reducing the number of components and costs. The 4th Gen battery is due over the next 9-12 months.

Notably, analysts on the call commented that their channel checks have stated that Enphase is under pricing pressure from Tesla. This is something to monitor as the third-generation rolls out in H2.

Inflation Reduction Act (IRA):

We’ve written extensively about IRA which you can reference here and also here.

Based on an analysis by McKinsey and Company , IRA will direct nearly $400B in federal funding to clean energy, with the goal of substantially lowering the US’s carbon emission by the end of this decade. The funds will be dispersed via a mix of tax incentives, grants and loan guarantees. Clean electricity and transmission will receive the highest funding, followed by clean transportation, including electric-vehicle (EV) incentives.

In the past, the US has generally relied on imports for solar equipment. This law will encourage more production at home with incentives for domestic solar panels and inverter manufacturing. It is also designed to support the construction of renewable electricity plants.

Enphase has been moving its manufacturing over to United States soil in order to capture the IRA credit. Although Q2 impact was nominal at $1.6M, we are starting to see this ramp for Q3. Management expects to ship 600,000 units from United States manufacturing facilities in Q3 for an estimated IRA benefit of $14.5 million to $16.5 million. Calculating per unit comes to about $24.17 to $27.5, with management guiding for $24 to $28 per microinverter sold. The net benefit per unit will differ each quarter as the company manufactures high-power products in certain quarters and low-power products in others, depending on customer demand.

The management expects robust demand of 4.5 million US shipments in Q4 2024. However, this could change depending on the macroeconomic conditions over the next year. Per management: “Well, it all depends. That is why we qualified it with saying pending robust demand. And if that demand is, for example, let us say we go through another recession next year, then I mentioned earlier that we would look at how to balance this out between U.S. and international, and we will give you the appropriate guidance at that time.”

At an average of $25 per unit, they expect a net IRA benefit of $112.5 million in Q4 2024. This has led analyst consensus to see EPS of $1.97 by Q4 of next year. Assuming there are no changes, Enphase will see 76% and 66% growth to its bottom line in Q3 and Q4 of next year. From there, EPS continues to grow.

The management also gave more clarity on how the manufacturing production credit from IRA is reported in the company’s earnings. They expect the production credit to be a reduction in the cost of goods sold. The company’s CFO, Mandy Yang, said in the recent earnings call, “We had originally thought that the production credit will be reflected in income tax expenses. But based on the latest guidelines from the U.S. Treasury, we expect to claim the production credit by direct pay, and therefore, account for the production credit as a reduction in cost of goods sold.”we expect to claim the production credit by direct pay, and therefore, account for the production credit as a reduction in cost of goods sold.”

IQ9 and IQ10 Microinverters:

For the IQ9, Enphase plans to increase the power of the microinverter by 50% from 320 watts to 480 watts DC in the same footprint. This is made possible by gallium nitride (GaN), which has the thermal characteristics to withstand high power. GaN also allows a higher frequency, so what operates at 100 kilohertz today in the IQ8 will operate at 200 to 300 kilohertz on the IQ9 and 1 megahertz in the IQ10.

The other major benefit is that the footprint of the transformer size will be the same despite a much more optimized system. At one point, it was stated the IQ9 would arrive in 2024. There have not been any new comments on the launch date, so we will need to wait for confirmation if 2024 is still on track.

Launching later this year, the small commercial microinverter IQ8P supports 480 watts of AC power, yet has a larger form factor. This will also be used in emerging markets, such as Brazil, Mexico, India and Spain. For the IQ9, gallium nitride makes it possible to shrink the form factor while achieving 480 watts of AC. The IQ8P was discussed on the most recent earnings call and is generally understood to be warm-up for the 480-watt IQ9s.

Channel Inventory:

Enphase’s ideal channel inventory pipeline is 8 to 10 weeks. Europe is currently at the high end of this at 10 weeks. However, management comments on the call that “we are now left with two quarters of inventory that is added on. And meaning two quarters of extra inventory” would imply 34 weeks of inventory in the United States. If ever there was a comment to get a stock to drop, it is a comment like this — that inventory is 3-4 times higher than average.

Julien Dumoulin-Smith

Excellent. Thank you. Good afternoon, team. I appreciate it. Can you talk a little bit more about the inventory levels and any write-down risk here? Can you talk a little bit about just the backdrop on that front? And more importantly, just the normalizing functions as you think about these different inventory levels across geographies, especially thinking to continued European growth, what might be implied by inventory levels, et cetera?

Badri Kothandaraman

Yes. I just now answered the question for Europe. The inventory level in Europe is a little bit normal, although it's on the higher side at about approximately 10 weeks. And that is why we said Q3 is a seasonally down quarter in Europe, and we expect to be slightly down in revenue as compared to Q2. But then I talked about we are introducing several new products […] Our sell-through rate was the highest, and our channel inventory was very healthy at the end of Q4. What happened is the sell-through rates declined overall in the U.S., 20%, with respect to Q4, for Q1 and for Q2.

And therefore – and in response to that, we did throttle our shipments into the channel, but we didn't throttle it enough because we assumed Q2 will be a seasonally good quarter, which turned out to not be the case.

So therefore, we are now left with two quarters of inventory that is added on. And meaning two quarters of extra inventory. And we are also assuming, going forward, we are not making any aggressive assumptions. We are saying the demand will be at the same level as it is today. And therefore, we are taking a onetime correction for shipments into the channel. And that is why our guide is light for Q3.”

Valuation:

Enphase is cheap right now. While other tech stocks have participated in the rally this year, Enphase has not. What is pictured below is a time stamp that shows the last time Enphase traded this cheap was at the end of 2019.

With earnings, it was during Covid that Enphase traded this cheap.

Conclusion:

If we do enter Enphase, it’s not because the fundamentals have bottomed, as the next one to two quarters could show further sequential decline. Rather, it’s based on a combination of getting a solid company at a deep discount with the idea that the fundamentals will be much better in time, as well as technicals.

According to the I/O Fund Portfolio Manager, Knox: “We are seeing very bullish momentum patterns, while ENPH is basing in price. It is setting up for a nice bounce, which could signal the low. My base case is that this bounce will fail and we will make one more low; however, if the bounce breaks above $167, the odds will favor a low being in.”

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