Category: Energy Stocks

Tesla Q4 Earnings: Solid ER and Valuation is Low 

Posted on by io-fund

Given there will be very few perfect earnings reports in the coming weeks, the new macro will force investors to subjectively determine what is a good report and what is not a good report. Before we go into the pros and cons of the report, I want to say that Tesla’s low valuation is a primary reason we entered the stock coupled with a strong earnings report. We covered this yesterday in our notification blog:

“Tesla is trading quite low and has not traded this low since “the new macro.” The forward P/S is at 4.7 and the forward P/E is at 36.15. If you take the tumultuous market of 2022 as a comp, Tesla may have 20% and up to 100% room. For the best case scenario to happen, we need broad market participation.” 

It was not a perfect earnings report – but the point is the stock is not priced for perfection. I think there’s a disconnect basically between the company’s fundamentals and the current stock price (barring any unforeseen black swan macro event). 

The pros are the roughly 30% forward growth rate, no debt, $20 billion in cash on the balance sheet and an expanding operating margin (YoY) and expanding net margin (YoY). The catalyst is the lower prices that allow Tesla’s Model 3 to be included in the $7,500 EV credit. What was a $50K vehicle has now become a $40K vehicle with Tesla only eating $3K of the price as they’ve priced the vehicle at $47K to clear the $50K limitation on the EV credit. We covered this a few months back here.

Here is what the CFO said: “So based upon these metrics here, we believe that we'll be above both of the metrics that are stated in the question, so 20% automotive gross margin, excluding leases and rent credits and then $47,000 ASP across all models.”

The price cuts are between 7% to 20%. For example, a Model Y was originally $65,990 and will now be $52,990. Then, you add the $7500 EV credit and you get about $20K off the price of the smaller SUV.

An additional catalyst for Tesla stock is the manufacturing credits for battery cell packs, that were stated to be $3,700 per Model 3 and Model Y. Tesla’s manufacturing is partly overseas and the credit is only for domestic manufacturing. The CFO stated to expect this: “But we think on the order of $150 million to $250 million per quarter this year and growing over the course of the year as our volumes grow.”

Note: We discussed the credits Enphase was expecting on their microinverters here.microinverters here.

The cons are the free cash flow was down 50% this quarter to $1.4B and the gross margin is a bit softer. Notably, free cash flow increased 50% for FY2022 but it’s certainly something to watch as it’s partly due to higher inventories. However, given the zero debt and $20B in cash (Tesla makes substantial interest on this cash), the company has time on their side to recover the FCF margin.  In other words, to beat Tesla up over this while it’s far and above the better auto OEM on the bottom line, is perhaps lacking perspective. With that said, it’s earmarked as the number one thing to watch moving forward.

Financials:

Given the recent headlines, expectations going into Tesla’s 4th quarter earnings were fairly low. On an adjusted basis, Tesla reported an EPS of $1.19 eps vs consensus of $1.11. With that important hurdle cleared, Tesla’s 2023 outlook was in focus. In a market where companies have been providing dour outlooks based on the macro, there were enough positives to cause us to look closely at valuation.

  • 2023 Production of around 1.8m vehicles, in line with Tesla’s 50% long-term CAGR goal
  • $20b in cash will allow it to execute its expansion plans during uncertain macro environment
  • Although operating margins were down q/q and may stay at these levels in the short term, management stated that the longer-term trajectory was higher as the benefits of greater operating leverage take effect. Even at current levels, Tesla’s current operating margins are 2-3x more than traditional OEMs. 

Revenue came in at 37% growth for $24.03 billion total. Automotive growth was 33% for $21.3 billion in revenue. There were regulatory credits of $467 million. 

The FY2022 revenue came in at 51% for revenue of $81.5 billion. Automotive also came in at 51% for revenue of $71.462 billion. There were $177 million in regulatory credits.

The company reported EPS of $1.19 in Q4 compared to EPS of $1.05 in the third quarter. The FY2022 adjusted EPS was $4.07. The EPS for next quarter is expected to be $0.87 which is lower than the EPS of $1.07 in the year ago quarter.

It’s true that Tesla’s gross margin was soft at 23.80% with an automotive gross margin of 25.9%. This is 150 bps lower and 200 bps lower, respectively, than the September quarter.

It’s also true operating margin of 16% was weaker by 119 bps from the September quarter of 17.19%. However, it was higher than the June quarter at 15% and higher than the year ago quarter at 14.75%. I would consider this strong with anything below 14% to 15% would be contracting. But, this is where an earnings report becomes subjective – and why a lower valuation is helpful especially if a company is not priced for perfection, and rather, is priced for low expectations.

The adjusted EBITDA margin of 22.2% is on the low side for Tesla in FY2022 as the previous quarter was 23.2% and the year ago quarter was 23.1%. My opinion is that it’s not an egregious contraction (especially having a large cash position) and is noted as something to watch.

The net margin was higher than the September quarter at 16.8% compared to 15.30%. This was also higher than the year ago quarter at 13.10%. 

The operating cash flow and free cash flow is where the concern is with this particular earnings report. Operating cash flow of $3.27B was down from $4.58B in the year ago quarter. The Free Cash flow of $1.4B was down 49% YoY compared to $2.775B in the year ago quarter. Both were down sequentially as well with the September quarter reporting Op Cash Flow of $5.1B and FCF of $3.29B.

Looking closer, there were two line items weighing on cash flow:

· Change in operating assets and liabilities at ($2.191) billion

· Purchases of Investments ($4.368) 

The change in operating assets and liabilities points toward an increase in inventories and account receivables. Where the bears may have a good point to consider is the inventory supply has been steadily increasing since Q32022. This is reflected in the $2.191B.

Tesla Inventories

Where the bulls may win, is that the typical response to increased inventory is to lower prices. Not only is Tesla going to do this (with the idea it will increase selling volume) but is assisted in doing so with the $7500. 

As long as current stockholders understand that this is where the speculations remains – will the lower prices help to lower global inventory and days of supply, and meanwhile, can the management keep operating margin steady while doing so?and meanwhile, can the management keep operating margin steady while doing so?

For the purchase of investments of $4.36B, we may need the 10-Q as there weren’t questions on the call from the sell-side analysts to know exactly what this refers to.

Earnings Call:

Management has stated that operating margin is what to watch:

“The second comment I wanted to make here is that as a management team here, we're most focused on what our operating margin is. And so as other areas of the business become more important, particularly the energy business, which is growing faster than the vehicle business and as we're heavily focused on operating leverage here, improving efficiency of our overheads, we think the right metric for us to be focused on is operating margin.”

Short sellers will certainly ignore this comment, and it’s up to each investor if a consistent operating margin is enough to overlook the FCF this past quarter and the softer gross margin. 

The comment that has ruffled some feathers is this from Elon Musk:

“The most common question we've been getting from investors is about demand. Thus far — so I want to put that concern to rest. Thus far in January, we've seen the strongest orders year-to-date than ever in our history. We currently are seeing orders at almost twice the rate of production. So it’s hard to say that will continue twice the rate of production, but the orders are high. And we've actually raised the Model Y price a little bit in response to that.”

The first question on the call questioned if this statement was true or not:

Martin Viecha (moderator)

Thank you very much, Zach. Let's now go to investor questions. The first question is, some analysts are claiming that Tesla orders, net of cancellations, came in at a rate less than half of production in the fourth quarter. This has raised demand concerns. Can you elaborate on order trends so far this year and how they compare to current production rates? I think…

Elon Musk 

We already answered that question.

Martin Viecha

Yes, exactly.

Elon Musk 

Demand far exceeds production, and we actually are making some small price increases as a result.”

 

My take: I think they’re talking about two different things here. The question is asking about Q4 and Elon Musk is talking about January. With Q4 behind us, the January comment is more important but there's no evidence to back it yet. 

Notably, orders won’t move stock price, rather it will be if Tesla can meet the guide of 1.8M on production, for the 28.8% growth. It was mentioned on the call that Tesla can produce 2M this year barring any unforeseen “force majeure” such as an earthquake or a tsunami.

Secondly, and perhaps most importantly, deliveries are what will also move the price. However, if we assume the January comment is accurate, then production will be equally important this year to meet the demand.

Regarding the operating margin, the company is taking cost reduction efforts. However, the company did state there would be an impact to operating margin in the near term that will level out over the year.

“Second, on cost reduction, we're holding steady on our plans to rapidly increase volume, while improving overhead efficiency, which is the most effective method to retain strength in our operating margins.

In particular, we're accelerating improvements in our new factories in Austin, Berlin and in-house cells, where efficiencies are the highest. But we are attacking every other area of cost and unwinding cost increases created for multiple years of COVID-related instability. This includes logistics, expedites, accumulation of material buffers, part premiums, productivity and overheads as an example […] In that, we've priced our products with a view towards a longer-term cost structure. Thus, there will be an impact on operating margin in the near term. However, we believe our margins will remain healthy and industry-leading over the course of the year.” 

It's also important to note that deflationary pressures on Tesla’s supply chain will help the operating margin. The issue that is riling up the bearish thesis is that by cutting prices to $47,000 while the cost of goods (COGS) is at $42,000 will very little margin. Tesla’s answer to this is that COGS should go down as $42K is the peak, and $36K is the bottom, so somewhere in the middle is where it will land this year.

The company is working to optimize the supply chain and to also optimize the vehicle design, such as the powertrain. 

Here is what was said on the call:

“And we're gathering a lot of data out of that fleet to understand how we can sort of bring some margin that we didn't know we had out of the product. So, over the course of 2023 on the powertrain side, we're actually going to go after sort of some materials where we're paying for more performance than we need, or we have more content than we need, without impacting reliability at all.”

Valuation:

If I were to choose one thing to talk about with Tesla stock (in a 1-minute elevator ride), it would be the valuation. I do think there’s some weight to the $7500 tax credit and the fact a Tesla will be priced competitively with mid-range sedans, like Toyota or Acura. There are some people who could not afford a Tesla before that now can.

In the face of what I would call a “no bad news is good news” earnings report, it was really the valuation that caused us to enter the stock. If the stock was trading at a more median valuation using 2022 comps, it would have been a harder decision (perhaps we would wait for the Q1 report).

But, with Elon Musk buying Twitter and selling a lot of Tesla stock, the valuation is very low. Even with the current run-up we’ve seen, it remains very low.

In the tough macro of 2022, Tesla’s forward P/S was between 8 and 11.5. It’s currently at 5.5.

The forward PE Ratio is trading at a 45 forward and traded between 55 forward and 75 forward last year in the tough macro:

Finally, if we look at FCF, it’s trading at a steeper discount as it was at 125 prior to October and is now at a 55 EV/Revenue:

Conclusion:

Over the past few years, Tesla has demonstrated excellent operating leverage. The company has halved its average sales price (ASP) between 2017 and 2022, yet improved the GAAP operating margin from (14%) to 17%. This helps illustrate why a lower ASP may not necessarily weigh on the operating margin. The bull case for Tesla is that the higher volume of sales, optimized supply chains/vehicle design, and deflationary pressure on COGS will improve (and/or sustain) the margins over time. 

The bear case is that Elon Musk is misrepresenting January orders, that they’re lowering prices due to competition, and the softer gross margin and low FCF this quarter is forewarning of more margin contraction up ahead. 

Investors should be aware it was mentioned in the call that “there will be an impact on operating margin in the near term” from the lower prices. What could offset this is a beat on production and deliveries, which as you know, comes out monthly.

Enphase: Stellar 2022 … Will It Continue? Plus Q3 Earnings

Posted on by io-fund

Enphase was one of the top performing stocks in the Nasdaq last year and for good reason – the company reported accelerating revenue in 2022 across two quarters and has expanding margins. This is a killer combo in any environment but most certainly the current one where many companies are reporting the opposite, such as decelerating revenue and/or contracting margins.

Notably, because Enphase was aptly rewarded last year by awarding investors with 47% gains in 2022 compared to the Nasdaq’s (33%), the entry has proven a bit tough. As of now, our entry is flat (more or less) and it’s likely I/O Fund stops out given there could be a broader market pullback on the horizon. If so, we will try again in the future. There are details at the end of this analysis on the stop we plan to follow for Enphase.

This analysis is meant to keep close tabs on a company with an exceptional product, which is the IQ8 Microinverters, and a strong management team. You can read our most recent Enphase analysis here, and then dating back further, we covered the company in 2021 and also in 2020.

Enphase is seeking new ways to manufacture domestically to take advantage of the Inflation Reduction Act. The IRA provides a credit of approximately $43 per microinverter manufactured in the United States directly to Enphase. Analysts on the call were excited to hear about the prospect of Enphase improving it’s already-good bottom line with IRA credits.

The new policies of NEM 3.0 in California passed in December could provide a boon in Q1 for Enphase due to Enphase being a leading provider of solar plus storage. However, management has gone on record to say that it could subsequently cause a slowdown after Q1 in California because ultimately the new policies reduce the rate at which a resident can sell back power to the grid by up to 75%. 

On the product side, the next iteration of microinverters will introduce gallium nitride (GaN), which increases power while maintaining the same footprint. The IQ9 series and IQ10 series will incorporate GaN and will increase MW and also greatly increase AC frequency from 100 kilohertz to up to 1 megahertz.  The company is also expanding with a third supplier on batteries to achieve 250 MW hours per quarter on storage or more. Right now, Enphase ships 130 MW hours of batteries per quarter. 

We discuss this and more below.

Q3 Earnings Overview:

  • Revenue accelerated again for the second quarter
  • Margins expanded, some 2X or greater from the year ago quarter
  • Regarding a question on the recession and potential slowdown in growth, management stated this year will have “very healthy double digit, high double digit growth percentage”
  • Updates on IRA and NEM 3.0 in State of CA: IRA is a serious boon for the next 10 years whereas NEM 3.0 may cause an eventual slowdown in CA revenue.

Enphase reported revenue of $634 million for growth of 80.57% compared to $613 million expected. This represents Enphase’s second acceleration in revenue this year, up from 67% last quarter and up from 46% in Q1. This level of revenue acceleration is rare in the current environment.

Guidance for Q4 revenue of $680 million to $720 million represents growth of 69.8%. Overall, analyst estimates are moving upward.

  • Q4 was originally estimated at $664 million and is now a consensus of $701 million. 
  • The same for Q1, which originally had analyst estimates of $640 million compared to current consensus of $680 million. 

This is important to keep an eye on as it helps Enphase defend its current valuation if revenue estimates continue to go up.

In Q3, Enphase reported GAAP EPS of $0.80 and adjusted EPS of $1.25, which beat estimates of $1.08. Enphase beat EPS estimates and analysts are raising consensus estimates for the next two quarters. Should the consensus numbers continue to go up, this also helps Enphase’s bottom line valuation.

On top of accelerating revenue, Enphase has been expanding its operating margin. In Q3, the company reported a GAAP OM of 21.4% — which is nearly double the GAAP OM in Q3 of last year at 10.6%. This is also the highest GAAP OM in 2022 with 17.8% in Q2 and 14% in Q1.

The adjusted operating margin of 30.5% is six points higher than last year’s 24.4% adjusted OM. This was also the highest adjusted OM in 2022. For next quarter, the company is guiding for 28.8% adjusted OM.

GAAP net margin of 18% is nearly three times higher than the GAAP net margin of 6% in Q3 of last year, and has also been expanding each quarter in 2022. This led to net income of $115 million in Q3.

The company reported free cash flow of $179 million in Q3 for a FCF margin of 28% and operating cash flow of $188 million. The FCF margin has fluctuated between 20% and 36% over the past few quarters. There is $1.4 billion in cash on the balance sheet and $1.29 billion in debt.

The company paid stock based compensation of $52.3 million, or 8.2% of revenue.

Key Metrics:

Enphase reports its microinverter sales by Megawatt shipments, or the total capacity of all microinverters shipped in a single quarter. Last quarter, Enphase shipped 1,709 MW DC of microinverters, or 40% QoQ, up from 1,213 MW in Q2. 

Batteries were flat QoQ at 133.6 MW of hours compared to 132.4 MW of hours last quarter. However, this is up over 100% YoY from 65 MW of storage shipped in Q3 2021.

Enphase’s international mix is growing rapidly with Europe up 70% QoQ and 136% YoY. Latin America was up 100% QoQ and 129% YoY.

Fewer EV chargers were shipped this quarter at 6,370 compared to 8,250 chargers shipped last quarter. 

Of the microinverters shipped, 47% were IQ8 up from 37% last quarter. There was a question about the slowing rate of growth in IQ8 inverters and the answer below discusses why the percentage is not the right thing to focus on. There was a large sequential jump in MW DC of microinverters shipped from the 1709 to 1213 MW, and therefore, IQ8 shipments nearly doubled. It was also good to hear in the answer below that IQ8 is expected to take up 90% of microinverter shipments by Q2 of 2023.

Mark Strouse

Yes, good afternoon. Thank you very much for taking our questions. I’ve got two questions. Maybe I’ll just kind of roll them into one. The IQ8, I believe you mentioned that was 47% of shipments this quarter. I believe in 2Q that number was 37%. Just kind of what drove that, that seems like a relative kind of slowing in what I would’ve expected kind of the progression over the coming quarters to be. And then the second part of that is kind of despite that relatively slowness in IQ8, gross margins are still coming kind of ahead of expectations. So just a bit more color on those two metrics please.

Badri Kothandaraman

Yes. If you see, you got to look at it a little bit carefully. It’s 37% of 3.3 million microinverters that we shipped in Q2, that’s approximately one point something in Q2, while now it is 47% of 4.3 million microinverters. So therefore, I would say, the IQ8 microinverter volume is doubled from Q2 to Q3. What we have seen historically is the transition, is complex. It can take over four to six quarters. That’s what – I mean, around four to six quarters. This is what we told you before. We started Q1 was at 20% I think or 19%, Q2 37%, Q3 47%. We expected to further climb in Q4. Our target is to get to 90% conversion in Q2. That’s what our target is. You asked a question on gross margin. On gross margin, our product mix of IQ8 was higher, like what I told you, 47%. 

Net Energy Metering (NEM) 3.0 in California:

Last month, 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.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 use 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.’”

During the earnings call in October, Enphase had said the following about NEM 3.0:

“Next, I’d like to comment on NEM 3.0 in California. As of now, there is still no decision from the California Public Utilities Commission, CPUC. We hope the CPUC eliminates the grid participation charge while providing a glide path for the solar only market, as well as incentivizing the solar-plus-storage market.”

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.

Notably, Enphase plans to have an additional cell pack supplier from China early next year with a lead time of 10 to 12 weeks. This may help in satisfying any demand from customers who want to beat the April 13th deadline for NEM 3.0. 

California is a large solar market with 12 GW of distributed solar generation installed, or about 25% of the state’s peak demand. There are over 80,000 customer-hosted batteries connected to the grid.  

Update on the Inflation Reduction Act:

We covered the Inflation Reduction Act here in a free article in September. The IRA allocated $369 billion allocation for energy security and climate change over the next 10 years. The investment tax credit is 30% for residential solar and standalone storage, and Enphase is one of many companies that will reap the rewards.

As discussed on the earnings call, the IRA allows for $0.11 per AC watt production for the domestic manufacturing of microinverters. In response, Enphase plans to “open four to six manufacturing lines in the U.S. by the second half of 2023.” 

The CFO stated the following: “We are planning to add a total of four to six lines in the U.S. At this time, we are planning that by the end of Q4 2023, so four lines, per line would be 750,000 units a quarter. Four lines would be 3 million units a quarter in the U.S., six lines would be 4.5 million units a quarter in the U.S.” According to the transcript below, Enphase will see $43 per 384W microinverter shipped. This will help expand the company’s margins of up to $193 million per quarter in additional income/IRA credits. 

Note: the company is doing about 4.5 million microinverters per quarter right now so demand needs to double and/or Enphase will need to lean away from global manufacturing for the microinverters. In his answer, the CEO is clearly saying this will take time. I believe he’s also implying if all things are equal (or perhaps better with automation) this would be adding the credit to the current profile of the company in terms of costs/bill of materials considering Enphase is shipping exactly 4.5M microinverters per quarter now. Per the CEO’s answer, the variable that remains is value-added manufacturing activities, such as cutting, drilling and assembling the parts. Presumably, this would be higher global costs.

Steve Fleishman

Yes. Hi, good afternoon. Thanks. Badri, just in thinking about U.S. manufacturing, could you give us any color on what the cost difference might be in the U.S. and how much of the $0.11 that could offset in terms of just manufacturing costs here?

Badri Kothandaraman

Yes, I mean it’s too early to talk about it, Steve. But again the $0.11 per watt is the big number, if you do the economics, you see, let’s say I ship a inverter with 384 watts of AC, $0.11 a watt $43, right? And the manufacturing cost that, of course, we have the total manufacturing cost, which is bill of materials plus value added manufacturing. The bill of materials will roughly stay the same regardless of the, there may be some small changes, but if domestic content is not required, the bill of materials will likely stay the same. So therefore the variable here is value added manufacturing and how efficient the contract manufacturers can set up the factories? What level of automation they can have? How can we help in them achieving great levels of automation. That’s the question

Later on, an analyst followed up by asking a similar question. Due to the importance of the statement, I’m copying the entire transcript here:

Julien Dumoulin-Smith

Excellent. Hey, good afternoon Badri and team. Thank you and congratulations again. So just on the cost side of this equation, right, I mean I just want to make sure I heard you right on the U.S. manufacturing, I mean, how much of an incremental cost and/or incremental need from U.S. content is it required? I’m just trying to understand the relative cost under the ledger versus the $0.11 a watt that we’re talking about. I guess that you guys hold onto the $0.11. I’m just trying to understand what the offsets would be, especially considering the fact that you still have a pretty good line of set on U.S. growth and therefore being able to just serve U.S. demand from U.S. manufacturing, and avoiding logistics at the same time. So the net, net, net of the two of those, as best you understand it today, obviously considering I guess [ph] still pending, 

Badri Kothandaraman

Right. So like what I said, maybe you did not hear what I said. Is the production based tax credit is $0.11 per AC watt. If we take a 384 watt micro inverter, that is $43 of credit. Now when we look at our microinverter, you have bill of materials and then you have value-added manufacturing cost, and then you have overhead, which is warranty expenses and all of those. So if you see all of those constitute the cost of the product. Now the bill of materials, assuming there are no restrictions on domestic content, expect the bill of materials to be roughly staying the same.

The value-added manufacturing cost is the one that’s the variable cost depending on the country. And then the warranty expands in logistics, freight, et cetera, largely the same because now it is local and while the cost to ship raw materials to the U.S. may increase, but the cost to ship to customers will decrease. So that is a wash. So really if you consider those three components, we need to look at one portion of that, which is value-added manufacturing.

Now our contract, it needs to be economical for our contract manufacturers as well. They also need to make, they need – they also need to be profitable. It’s not going to happen if they do not make any money. So therefore, we are working on finalizing the agreements we do have letters of intent, which we think are reasonable constructs and bottom line is with the constructs we have in mind, provided this AR [ph] implementation is approved. I think, the money to be made or the credit that we can get would be significant and it’ll create a lot of jobs, which is really what we want

 

Product Updates:

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. 

Here is what was said on the call:

“We are planning to utilize 1 megahertz for IQ 10, but on IQ9, we will probably be around 200 to 300 kilohertz. And then what happens is the transformer scales basically to these – to one over the square root of the increase. So that means that the transformer can come down, the size of the transformer can come down […] So that footprint can come down, the volume can come down, the FX can still be the same. 

And soon there will be an opportunity, although we are not planning to do in the DC stage yet, implement again in the DC stage, there is opportunity for us to implement again in the DC stage as well. So lots of optimization possible. Name of the game is to keep the footprint the same, not bloated. Size is important for us and I think we can get the cost structure as well under control. And if we are able to pack in 480 watts AC punch into similar number of components, similar cost structure, then we directly get the cost benefit there in terms of cost per watt.”

 

Comments on Recession:

Due to Enphase performing so well last year on stock price, naturally there will be questions on whether Enphase can sustain this growth and overcome recessionary pressures. Although we are quoting a lot from the transcript, this particular call was 1:15 minutes and so there’s a lot cover. This part is especially important as I/O Fund is tracking some weakness in Enphase’s technicals yet we don’t want to be complacent on re-entering if Enphase has a repeat year.

Phil Shen

Great. That’s great color. Thanks, Badri. As it relates to 2023 again, but just for the general micro business I know there’s not official guidance, but was wondering if you could talk through, how does a potential recession maybe some potential for demand slowing in 2023 for resi solar in the U.S.? How could that – how are you thinking about that? Are you seeing any of initial signs of that at all? And I think you saw the 70% year-over-year growth in Europe this quarter, what kind of sequential growth could we see in Europe as we get through next year for the micro inverter business? Thanks.

Badri Kothandaraman

Yes, I mean the, you asked us, do we see any slowdown? We don’t. Our demand is very strong as we see it. It’s of course too early to talk about Q1, but even Q1 bookings are right now quite healthy. So that’s what we see today. The – there are a few factors that are in favor for us. The utility rates are continuing to climb, so that accelerates our business. The IRA, Inflation Reduction Act and the ITC extensions for both for ITC 30% ITC for solar and storage are fantastic. So those also provide a nice launch. And then for us this is not true in the U.S. but Europe, the energy crisis in Europe is accelerating renewables big time. So these are the three things where we are seeing a lot of tailwinds from these three things and our demand is strong.

And here was a second question on whether Enphase can continue its high growth rate:

Gus Richard

Yes, thanks for taking the question. Just wondering, you guys have been growing at 70%. Can you sustain that level of growth? And I’m not asking for a forecast and if not, where do you see the limits of growth coming in? Is it your installer network? Is it availability components? Could you just discuss that a little bit it’d be helpful?

Badri Kothandaraman

Right. When you start from a small base, of course the growth is going to be high. And then when you build it to some respectable numbers after that, the question is are we going to be able to sustain the growth? We think there are great drivers for sustaining the growth, which is the utility rates even in Europe, for example, in Germany are quite high. The energy crisis is accelerating in our renewables in Europe. So all of those are external drivers. They’re tailwinds that are in our favor. So we think we can sustain good double-digit growth percentages in general. But we do need to maintain a focus on quality and customer experience. And many of the installers love the quality on microinverters. And our market share gain that we have is based upon our quality plus the customer service that we provide them on microinverters.

I talked about the – some stumbling blocks on storage and we are working on them and we expect storage will be also providing a similar customer experience enabling us to unleash that opportunity as well in Europe. So we are incredibly optimistic like what I said, we doubled from 2020 to 2021. We doubled a gain from 2021 or we will double the gain from 2021 to 2022. And 2022 to 2023 it may not be possible for us to double, but we will have very healthy double digit, high double digit growth percentage.

 

My notes:

The levelized cost of energy has dropped exponentially over the past 10 years, which I first covered here. In the chart below, solar is to the left in orange and it’s gas comparison is in gray to the right.

Source: Lazard Levelized Cost Of Energy, Levelized Cost Of Storage, and Levelized Cost Of HydrogenLevelized Cost Of Energy, Levelized Cost Of Storage, and Levelized Cost Of Hydrogen

 Here is a look at how the LCOE has dropped dramatically over the past 10 years from the same report:

 

The lower LCOE helps to illustrate why Enphase may do well during a recession as a solar plus storage system can drive down energy costs.

 

Conclusion:

 

The question as to whether Enphase will continue its winning streak to sustain high revenue growth in 2023 is that it’s highly probable. In addition to developing GaN microinverters, the IRA tax credit for domestic manufacturing could boost the company’s bottom line. These are catalysts to the already strong earnings performance. Management stating IQ8 will be 90% of microinverter sales by Q2 is helpful and the company is expanding its suppliers with a mix of global and domestic.

There is one caveat which is valuation. Depending on how you look at it, Enphase is testing the upper range of its 2022 valuation if we compare it to Jan-July. If you assume the price activity between July-December will repeat, then this is a good entry point. However, if we see a broader market pullback, Enphase could easily revert to its Jan-July trading history on valuation.

As with 2022, this year will require navigating the broad market for entries as much as (if not more so) than individual stock charts.

Enphase Technicals 

By Knox Ridley

Enphase appears to be in the final move of a large uptrend that started in January of 2022. The current drop has gone further than anticipated. This has reduced the probability that we should see a final push towards the high $300s before putting in a major top. 

This now opens the door to us being in the first move down in a large degree drawdown. The line in the sand will be the $245-$237 support zone. If this breaks, we will stop out of our position and wait for this large degree drawdown to complete. 

However, it is much more likely that we see a bounce back towards the $282-$304 region before a major breakdown, if this is the scenario in play. What will be the major clue is the structure of this bounce. If it is a clear 5-wave move, then we will favor blue, and hang-on as we push to new highs. If it is a 3-wave bounce, we will look to unload our position for a modest gain in the yellow box above and re-enter at a future date.

 

Solar Stocks: Enphase, Stem and First Solar

Posted on by io-fund

Coauthor: Royston Roche

We’d like to discuss a few stocks that are showing strong price action in the solar industry. Perhaps the most obvious front runner in clean energy right now is Enphase. The most recent quarter was exceptional as the company reported improving top line growth and an improving bottom line. The company also provided a strong guide for accelerating revenue (again).

Please reference our free analysis on The Inflation Reduction Act of 2022 and Europe's Energy Crisis here.

An important standout accomplishment from Enphase has been management’s ability to reliably meet its revenue guidance for fifteen quarters since its last miss in September of 2018.

The same is true on the bottom line with fourteen consecutive beats since Dec of 2018.

To have met guidance for 4 years is no small feat considering we’ve been through a pandemic and had ongoing supply disruptions that has directly impacted the solar industry. Given the many variables we’ve seen in the last four years, this is the only company that I recollect accomplishing this. Certainly, it instills confidence that management will meet/beat moving forward compared to its lumpy solar industry peers.

Enphase reported Q2 growth of 68% for revenue of $530 million. This is up from revenue growth of 46% last quarter. Guidance is for revenue growth of 75% for Q3 to $613 million and analysts are expecting 60% growth in Q4 to $664 million. 

The company also provided the following on the call: “We shipped approximately 1,213 megawatt DC of microinverters and 132.4 million megawatt hours of IQ Batteries in a quarter” with the company guiding for 130 to 145 megawatt of IQ batteries in Q3. This is up from 120 megawatt hours in Q1. 

Microinverters shipped were up 39.7% which marks an acceleration from the 15.7% year-over-year change in Q1. This is down from the peak of 117.2% in Q2 2021 but it’s also a boon that Enphase delivered this growth on top of the hard comp. 

In the United States, the revenue increased 15% sequentially and 66% year-over-year. Europe revenue grew 89% year-over-year and 69% sequentially. 

Right now, fiscal year revenue is slightly decelerating from 78% growth in FY2021 to 63% expected growth for FY2022. 

Management stated they’ve grown IQ battery shipments by 28% per quarter over the last two years in North America and are now introducing these batteries into Europe.

Gross margin is a tick higher than it’s been in the most recent quarters at 41% compared to 40% in FY2021. Gross margin guide was for a range between 38% to 41%. The gross margin is expected to improve when IQ8 reaches scale.

Operating margin expanded to 17% in Q2, up from 14% in the previous quarter and up from 15% in FY2021. Net margin is improving, as well, at 14.5% up from 12% last quarter and 10.5% in FY2021.

Enphase saw a sizable increase in operating cash flow to $201 million, up from $102 million in the previous quarter. 

The margin of 38% is nearly double what it’s been in previous quarters. Free cash flow also doubled to $192 million, up from $90 million in Q1. This is 2/3 of the cash flow from all of FY2021, which was at $300 million for the year. This increase was due to higher revenue and an improved cash conversion cycle in Q2.

GAAP EPS is at $0.54 compared to $0.28 in the year ago quarter. Adjusted EPS is at $1.07 compared to $0.53 adjusted EPS in the year ago quarter. 

With that said, Enphase has a debt to cash ratio of 1:1.  This reflects cash and marketable securities of $1.25 billion and debt of $1.29 billion. Given the current cash profile of the company, this should improve but does need to be monitored. 

Note on Valuation

Enphase is not the easiest entry when it comes to valuation. The stock had a blowoff top moment in November of 2021. This aside, the stock is not reliable where it’s currently trading with little success of trading above this top line valuation. In a perfect world, we would find an entry around 10-12 forward P/S or 15 current P/S. That may seem like wishful thinking yet we want to be prudent as solar can be volatile.

Given the strength of the earnings report, we are trading at the stock’s highest valuation on a forward PE ratio in 2022 of 70. Previously, a forward P/E of 50-55 was the top for this stock in 2022. In other words, we will need another blowoff November top to see gains from here, if history is any indication. OR, Enphase will need to start a new valuation trajectory which is risky to predict without more data to support this conclusion. 

Product Overview: IQ8 Inverters

Enphase has six models of microinverters in the IQ8 line, which are popular for their performance during a grid outage. Due to IQ System Controllers and IQ Load controllers, the system can sustain off grid. What is unique about the IQ8 is that the system will continue to perform off-grid even without a battery although the battery option is also popular.

The IQ8 Microinverter offers a microgrid with split-phase power conversion that converts DC power to AC power. Because solar panels only produce DC power, inverters are necessary to convert this to alternating current (AC), which is the current that houses use for energy needs. The DC to AC conversion and solar output is performed through the IQ8 and is done off-grid. 

The System Controller or “smart switch” connects the home to the grid power, batteries and the solar photovoltaics, and transitions the system from grid power to backup power. The Load Controller sheds non-essential loads to offer longer off-grid power. The IQ battery offers up to 10kWh of energy capacity, so rather than feeding power back to the grid, the system stores the back-up power for future use. 

Notably, the system is modular so a home owner can start small and build a bigger system over time. The system also does not require a battery for off-grid power, and thus, the IQ8 can be more cost effective for entry-level systems. The IQ8 is not compatible to existing systems, however, so it’s only available for new installs.

The secret sauce for the IQ8 Inverters is a customized, proprietary ASIC chip that can quickly change loads and grid events, which ultimately reduces the required battery sizing and battery power. The system adjusts according to the amount of electricity it has access to and this brain or intelligence is helpful when a system is off grid either temporarily or permanently. It also helps to store more energy by knowing when a house has excess power. 

Another key feature is the microinverters come with a 25-year warranty and the battery has a 10-year warranty. My understanding is this is an industry-leading warranty, which is key for this level of home or commercial investment. 

The IQ8 was first tested in Australia in 2017 due to “anti-islanding” which refers to grid-connected inverters that must shut down when there is a loss of electricity supply from the grid. The reason for shutting down the inverters is to protect the power line workers who are restoring the system. The solution that Enphase designed were the IQ8 models which are “always on” by combining the inverters, batteries, system controllers and load controllers listed above for a mini grid that can produce power from the sun and efficiently store this power at night. 

Although California comes to mind for a region that shuts down its grid frequently due to wind storms to prevent fires, or perhaps Texas during the ice storm, this is also in demand globally where there are weak grids (Latin America) or no grid (Africa and parts of India). The company has cited in the past that there are 1.2 billion people who can benefit from the IQ8 due to persistent and permanent grid issues. The company’s current revenue mix is 80% United States and 20% international. 

To understand how impactful the IQ8 has been for Enphase, consider that right now it comprises 37% of the company’s shipments and Enphase management expects this to reach 90% by Q2 2023. That is a lot of growth for one product in four quarters’ time.

IQ8 Inverter and IQ8 Batteries Discussions on the Earnings Calls

When asked on the call why the IQ8 system is performing well compared to competitors, the CEO responded: 

“Yes, I mean we IQ8 provides a lot of value. Three things is sunlight, backup. Basically, when the grid is out, IQ8 continues to work and provides power, one; number two, it removes any limit on solar to storage ratio, which is the limit of today. In other words, you can have a lot of solar with very tiny storage, and the extreme end being zero storage, that's number two.

Number three is sunlight jumpstart, which means that in other batteries when you completely drain the battery, because you use it overnight, and you accidentally drained it, you accidentally drained it in the morning, IQ8 can come and independently jumpstart the batteries. Because it can provide — it can generate its own microgrid and kickstart the battery.” 

Here was another lucid moment on the call when management described why they’re pulling ahead:

“We are trying — we have with the home energy management solution that we have, we are providing a very comprehensive solution. This is not just about the solar part, not just about the battery part or just about the EV part or managing the heat pump, etcetera. Our goal is to provide a one stop shop, a completely comprehensive solution. And everything is managed from software with a home energy management system. This is true in Europe. And actually, it's true here as well.

So for us, our value-add when we think about relative to competition is not look at any one single piece. Although we have to be better than them in every individual component that we are building. But it is about looking at the overall solution. So the homeowner has a great experience where they have one app, and they see they get unprecedented visibility into the performance of their entire system.”

IQ8 battery shipments grew 28% per quarter over the past two years. The company is releasing a third generation in early 2023. According to the earnings call, this battery will “deliver double the power enabling homeowners to start heavy loads.” The release is slightly delayed due to increasing the AC Power of the microinverter following feedback.

The company stated they currently have manufacturing capabilities of 5 million microinverters and will soon have a 6 million capacity after expanding manufacturing to Romania. Enphase is expanding rapidly into Europe including the IQ batteries after launching the IQ batteries two years ago in North America. 

The energy crisis in Europe a catalyst as this drives more demand for self-consumption due to high utility rates and feed tariffs. However, Europe has a more stable grid than the United States and other regions, and thus, the sunlight backup is not as desirable as other regions. 

Management stated the following on the call regarding the size of the German market: “The last I heard is it's roughly two gigawatts residential time adopting solar. And I'm hearing 80% attach, so two gigawatts times 80% is 1.6 gigawatt hours of batteries, that's the market.”

To put that in perspective, Enphase shipped 130 to 145 megawatts of batteries or 580 megawatts per year. At 1.6 gigawatt, or 1600 megawatts, the German market alone is 2X the annual output of Enphase. The company also serves Belgium, the Netherlands, France, Australia, South America and Latin America, to name a few.

Enphase is expanding into EV charger market following the acquisition of ClipperCreek. Enphase-branded chargers for residential homes are expected to go to production this quarter. The company stated the smart EV charger will be introduced to customers in the United States and Europe in early 2023.

In the opening remarks, management stated they have a “healthy” level of inventory in Q2 although storage channel inventory “was a little elevated due to longer installed times.” As stated in the introduction, the company has instilled confidence in analysts and investors for how management has navigated supply chain issues with a beat on every earnings report during the supply crisis. Notably, the supply chain issues are affecting Enphase less so than the company’s competitors and Enphase has actually been able to pull ahead in regions such as Europe for this reason. 

Praneeth Satish

Got it. And then just staying on Europe. I mean, it sounds like you're gaining share, partly because competitors don't have supply. So I guess what happens when competitors there rebuild supply? Do you think that'll impact your growth? Or do you think once an installer tries an Enphase product, they don't go back to competitors? Like it's just how durable is the growth? Thanks.

Badri Kothandaraman

Well, we cannot be arrogant. We need to create meaning. We need to provide value to the installers, which is high quality, which we think we are quite good there when compared to competition. So we are good there in terms of customer experience. We pride ourselves on net promoter score and answering the calls. We need to continue to do that. That's a big differentiator for Enphase.

Stem

Stem is a high-risk moonshot stock. The reason that Stem is a moonshot is because it’s a small cap in a volatile industry and the stock has negative operating cash flow plus negative GAAP bottom line margins. In addition to this, one customer makes up 50% of revenue.

Due to the change in market environment, which is primarily caused by the Fed raising rates, companies that operate at a loss are more volatile than they were previously. 

The negative operating cash flow has certainly improved — most especially in the recent quarter with a margin of (10%). This is an improvement from (62%) to (69%) in the previous three quarters albeit still negative in a cash sensitive macro environment. The GAAP operating margin has been lumpy and is currently at (45%) which is an improvement from (85%) in the previous quarter. 

In Q3 of 2021, there was a revaluation of SPAC warrants which caused a non-cash adjustment in the net income, hence we are not looking at the year ago comps.

The gross margin is causing the weaker bottom line with a 12% GAAP Gross Margin and a 17% adjusted GM in the most recent quarter. This is an improvement from 9% GAAP Gross Margin in the previous quarter and up from 0% GM in the year ago quarter. Notably, in Q4 of 2021, Stem had a negative (3%) gross margin which further highlights the thin GM this company operates from.

As outlined below in regard to forward key metrics, the hope/expectation is that software sales will drive a higher GM than the company is currently seeing: “And so I think that over time you're going to see more and more software revenue rolling into the P&L and so we would expect that software, really services line item to grow quite significantly over the coming years.”

In the investor’s presentation, it’s noted that Stem has a GM of 80% for software and a GM of 10% for front of the meter hardware to 20% to 40% for back of the meter software. FTM makes up the majority of Stem’s business today (more below).

The company has cash and short-term investments of $335 million at the end of Q2 2022 compared to $352 million at the end of the Q1 2022. The company has a debt of $449 million at the end of Q2 2022.

The revenue growth for Stem is exceptional, however, and clearly the company is doing something important on a product level as it’s been posting triple digit revenue growth for many quarters and this doesn’t appear to be slowing down anytime soon. Here’s a snapshot of Stem’s recent revenue growth and two quarters of forward estimates. 

There are some positive key metrics such as bookings of $226 million, for 402% growth. The company raised guidance to $775 million to $900 million, which is up from $650 million to $750 million. 

The company reports on contracted annual recurring revenue or CARR. CARR was at $58 million and guidance was raised by $5 million to $65 million to $85 million. This represents the software portion contribution from the Athena product. 

On the earnings call, management pointed toward the software helping to raise forward key metrics: “But, as far as the, say the philosophy of the business, I think that's where it gets super interesting is that the bookings growth really, determines what's going to happen longer term for us. And that's really, so we're kind of locking in and that's where the CAR metric comes in. And so you're starting to lock in long term long dated software contracts during that time period.”

The company also reported contracted backlog of $727 million and a pipeline of $5.6 billion, up 229%.  

When you look at forward fiscal year estimates, there is a marked slowdown to 73% in FY2023 and 45% in FY2024. Here is what two of the eight covering analysts have said recently about Stem:

Northland analyst Abhishek Sinha initiated coverage of Stem with an Outperform rating and $24 price target. The U.S.-based complete battery storage solutions provider is "well positioned" with "a very dominant position" as the global push for lower emissions, vast improvements in battery technologies and a solid support by the passage of IRA bill should drive industry participants to make extensive use of energy storage systems, Sinha tells investors. Stem "has a significant head start against competition," as evident from the fact that it has over 50% repeat customers in Q3 bookings, the analyst added.

Morgan Stanley analyst Stephen Byrd raised the firm's price target on Stem to $20 from $13 and keeps an Equal Weight rating on the shares. The analyst increased growth rates for solar, wind, energy storage, and clean hydrogen, and raised price targets on many clean tech stocks, due to the clean energy support featured in the new Inflation Reduction Act legislation. The bill recently passed by Congress and signed by President Biden will accelerate the decarbonization of the U.S. economy, lead to significant increased domestic manufacturing, and provide the necessary support to jump-start decarbonization technologies that are on the cusp of being commercially viable, Byrd tells investors in a research note.

More on Product

Stem offers in-front of the meter storage (FTM) and behind-the-meter storage (BTM). FTM relies on the grid whereas BTM is independent of the grid. Per the earnings call, 91% of Stem’s sales are coming from FTM at the moment. 

Athena is Stem’s AI software, which is designed to lower energy costs, reduce carbon emissions, stabilize the grid, solve intermittency, and create storage networks. As cumulative installs grow, Athena becomes more intelligent through continuous learning, creating more value to new and existing customers. 

Athena AI optimizes time-of-use and demand charges, resulting in 10% – 30% monthly electricity bill reductions. The product saves clients’ money and helps them meet their ESG targets without changing the way they operate. Stem’s SaaS contracts range from 10-20 years and contain recurring monthly payments that are driven by storage assets under management (AUM). The company’s customer list includes Amazon, Whole Foods, Facebook/Meta, UPS and Adobe.

In the 10-Q filing, the company discloses that in Q2, one customer “Customer D” made up 50% of their revenue.

The Athena software is leveraged at times when Stem does not supply the software. Per management: “One is the largest behind the meter portfolio down in Southern California was a replacement with Athena software on an existing platform. And we have talked about that in the past. That's not inclusive in this 10X obviously, but I would say the majority of what we're seeing are large front of the meter projects whereby the developer may be procuring their own hardware and utilizing Athena and all the attributes that we bring.”

As the analyst pointed out, this scenario is the ideal scenario as software can ramp much faster than hardware in a supply constrained environment: “Biju Perincheril: Got it. Now I was thinking, this is a sort of nice tailwind sort of adding to your hardware plus software business making that transition to the software, becoming a bigger part of the business, making that a faster transition.”

Stem recently acquired AlsoEnergy, a company that offers an application called PowerTrack. The app allows for remote troubleshooting, identification of hardware faults, access to site documentation and customized dashboards. Per the earnings call, AlsoEnergy ranks number one in its category for an app for standardizing clean energy portfolios on one interface and for lowering total cost of ownership. This was a software acquisition, which is good for Stem’s longer-term gross margin. 

Valuation

Stem is the rare small cap that is outperforming the Nasdaq and the Russell 2000. Some of this comes from the outperformance of the solar industry, yet it certainly challenges the narrative overall as Stem has weak margins.

Due to the company’s weak margins, we cannot value the stock based on the bottom line. However, renewable energy certainly has a plethora of higher risk stocks to comp the top line valuation. Plug Power has negative gross margins on average of (25%). Chargepoint has a worse operating margin than Stem at (84%) to (110%) in the most recent two quarters. Blink takes the cake with a negative operating margin of (193%) and (153%) in the most recent quarter. Prior to this, the GAAP OM was (300%). 

Despite these weak fundamentals across the board, Stem has the lowest top line valuation. 

With that said, on an individual level, Stem is trading at its highest top line valuation for the year and the stock fails frequently around the 12 current P/S mark and the 6 forward P/S mark. Therefore, Stem is not a buy for our portfolio right now until the valuation comes down OR until there is a clear, undeniable breakout where the market is signaling its ready for a higher valuation for Stem and others. It’s likely the first scenario will happen.

Catalysts and Risks

IRA legislation which we covered in detail here is a catalyst for Stem’s customers. 90% of Stem’s revenue comes from the United States, which is key for the subsidies. Management pointed specifically to the provision for retrofitting storage as less than 10% of solar AuM currently has storage attached.

Stem has stated they have fully contracted their 2022 supply and are current contracting supply for 2023 and 2024. This is what was discussed on the call regarding IRA and a potential increase in sales:

Mohit Manrai

Got you, and then probably just on the previous question here, from Brian on just for next year demand over here if we get like an IRA or not, if when we get the IRA approved, do we have enough supply for batteries to support that kind of demand here?

John Carrington

I'd say that we have to understand exactly the details around this as far as what the demand looks like. If you, as I said, if you look at some of the third party estimates, it's ranging from 20% to 300%. So we're have to — we'll have to unpack that.  

Note: Management is referring to a 20% to 300% increase in the addressable market for the storage market, per industry analysts.

In December of 2021, the Uyghur Forced Labor Prevention Act was signed to prevent goods from being imported if those goods are developed through forced Uyghur labor. The effective date was June 2022. Stem noted that some of its customers could be impacted from this new law. “On the solar side, the AD/CVD and UFLPA issues could impact near-term panel deliveries for customers. And as I stated before, we have seen an impact on utility scale solar projects. The UFLPA process is presenting some uncertainty for developers, specifically more paperwork and compliance requirements are slowing logistics and delivery times.”

Brief Note on First Solar:

By Royston Roche

First Solar is a leading provider of photovoltaic (PV) energy solutions. It is one of the major beneficiaries of the Inflation Reduction Act of 2022 in the form of solar manufacturing tax credits. 

The company also recently announced its plan to invest $1.2 billion to expand its solar module manufacturing in the U.S. It includes a $1 billion investment for a new manufacturing facility in the Southeast U.S. and $185 million for the upgradation of the existing Ohio facility. 

The company’s revenue in the Q2 2022 fell by 1.3% YoY to $620.96 million. It beat the analysts' revenue estimates by 2.4%. Analysts expect revenue to grow 27% YoY to $738.51 million in Q3 and to decline 3.9% YoY to $872.21 million in Q4. For the full-year, analysts expect revenue to decline 11% YoY to $2.61 billion. Management guidance for the full year revenue is $2.68 billion at the mid-point of the guidance, representing a YoY decline of 8.5%.

The operating income in Q2 2022 was $144.83 million with an operating margin of 23% compared to an operating income of $110.38 million with an operating margin of 18% in Q2 2021 and an operating margin of -16% in Q1 2022. 

The operating income primarily benefitted from increased module sales, gain from the sale of the Japan project development platform of $245 million, and partially offset from the impairment of legacy systems business asset in Chile of $58 million.

The company has a record backlog of 44.3 gigawatts. Mark Widmar, CEO of the company, said in the recent earnings call, “The 10.4 gigawatts of new bookings since our prior earnings call in April are mostly for deliveries in 2024 to 2026 time frame and have a base ASP, excluding adjustors of $0.301. These new deals bring our total year-to-date bookings to 27.1 gigawatts. From an ASP perspective, we are encouraged by the pricing trajectory of our bookings as we continue to transact for deliveries as far out as 2026.”

Goldman Sachs is among the notable recent stock upgrades. Analyst Brian Lee upgraded First Solar to Buy from Sell with a price target of $172, up from $60, as part of a broader research note on Solar names. The analyst states that the company is best-levered in his coverage to the tailwinds of the Inflation Reduction Act as the most immediate beneficiary of manufacturing credits as well as benefits from demand tailwinds given its above-80% exposure to the U.S. Lee also states that he has a more constructive outlook on First Solar's module gross margin recovery.

The company benefits from the Inflation Reduction Act and also from the strong demand for alternative energy. However, we will not be buying the stock since the company’s revenue growth lacks consistency. This could change with the IRA and we will monitor this as we go along.

Solar Stocks Lead The Market This Year As Energy Crisis Heats Up

Posted on by io-fund

This article was originally published on Forbes on Sep 9, 2022,02:02pm EDTForbes on Sep 9, 2022,02:02pm EDT

Solar energy stocks have outperformed the S&P 500 Index YTD with the most noticeable divergence June-August. The S&P 500 index is down 17% YTD and Nasdaq-100 index is down 26%, yet solar stocks are leading the tech industry as Enphase Energy is up 72%, Maxeon Solar Technologies is up 62%, and First Solar is up 56% YTD.

Chart shows that Solar Energy stocks have outperformed the S&P500

Source: YCHARTS

Similarly, we can see in the below chart that Invesco Solar ETF (TAN) is up 13% YTD and iShares Global Clean Energy ETF (ICLN) is up 7% YTD, and have outperformed other popular ETFs by a wide margin, particularly the Innovator IBD 50 ETF (FFTY) is down (39%), and Cloud Computing ETF (CLOU) is down (36%) YTD.

Chart showing Solar and Cloud stocks ETFs price % change

Source: YCHARTS

Solar Stocks Have Two Important Catalysts

There are two additional catalysts that may help to support the performance of solar stocks this year. The first is the Inflation Reduction Act which is expected to allocate $369 billion to energy security and climate change. Jon Hale, Global Head of Sustainability Research at Morningstar, said that the clean energy sector ETFs had a net outflow of $223 million two weeks before the July 27th announcement and the two-week subsequent, it had net inflows of $434 million.

The second catalyst is the energy crisis in Europe. The price of natural gas is rising, which will become a tailwind for alternative forms of energy. In some cases, the cost for base load energy prices in France, Spain, Italy and Germany are quadrupling or worse year-over-year with one expert saying it’s “like paying $500 for a barrel of oil.” We look at this in detail below.

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The Inflation Reduction Act of 2022

The Inflation Reduction Act of 2022 aims to reduce the budget deficit, invest in domestic energy production and manufacturing, lower healthcare costs, and reduce carbon emissions. Our primary aim is to keep an eye on the clean energy industry as IRA unfolds.

According to the estimates, the Act is expected to raise $737 billion from increased corporate taxes, prescription drug reform and through IRS tax enforcement. This will be primarily allocated to energy security and climate change ($369 billion), affordable care act ($64 billion) for a total deficit reduction of $300 billion. The bill which was passed in both the Senate and the House of Representatives, was finally signed by President Joe Biden on August 16th.

The revenue will be raised primarily from $265 billion by allowing Medicare and others to negotiate drug prices with drug companies, $222 billion from the new 15% corporate minimum tax for companies that earn more than $1 billion a year in profits, $124 billion from the stricter IRS tax enforcement, and $74 billion from the 1% stock buyback fee.

The highlight of the bill is investments of $369 billion in energy security and climate change with the goal of reducing carbon emissions by 40% by 2030. It also aims to expand tax credits for the purchase of Electric Vehicles. According to Morningstar analyst Brett Castelli, investors need to focus on three key takeaways:

“First, the act contains a 10-year extension of solar and wind tax credits. These credits had been scheduled to phase out over the next few years and the 10-year provision provides a significant amount of time for clean energy firms to build and benefit from new capacity.10-year extension of solar and wind tax credits. These credits had been scheduled to phase out over the next few years and the 10-year provision provides a significant amount of time for clean energy firms to build and benefit from new capacity.

Second, incentives have been included to support new technology that had not previously been eligible for tax credits. The two areas that we think will see the biggest benefits are hydrogen and energy storage.hydrogen and energy storage.

Third, the act provides incentives for the domestic manufacturing of solar panels and equipment which had largely been imported previously. The provisions in this law significantly increase the incentive to manufacture solar panels and inverters domestically.”domestic manufacturing of solar panels and equipment which had largely been imported previously. The provisions in this law significantly increase the incentive to manufacture solar panels and inverters domestically.”

As stated, electric vehicles are a beneficiary. The previous federal tax credits which were available to Electric Car buyers is going to change with The Inflation Reduction Act of 2022. Companies like Tesla, and General Motors which lost the $7,500 consumer income tax credit when they sold more than 200,000 electric cars, will once again be eligible since the cap of 200,000 EV sales is now removed.

Notably, there is a maximum retail price cap of $55,000 for cars and $80,000 for vans & trucks. There are also other income conditions for the buyers and critical mineral & battery component requirements. President Joe Biden said, “It also gives consumers a tax credit to buy any electric vehicle or fuel cell vehicle, new or used and a tax credit for up to $7,500, if those vehicles were made in America.”

The solar industry will benefit since Inflation Reduction Act includes the extension of Production Tax Credits (PTCs) and Investment Tax Credits (ITCs) for the construction of wind and solar projects beginning before January 1, 2025. It means a three-year extension for PTCs and a one-year extension for ITCs.

It also extends the 30% federal tax credits for installing solar panels on rooftops by another 10 years, from 2022 to 2032. Solar installations are eligible for 26% tax credit for installations in 2020 and 2021. It now extends till 2032 for 30% tax credits, and in 2033 the tax credit will be reduced to 26% and 22% in 2034. There will be no tax credit after this period unless Congress renews it. Home battery systems that store energy generated by solar systems for later use will also be eligible for a 30% tax credit.

The Inflation Reduction Act also has created a new Production Tax Credit for the domestic production and sale of solar and wind components. The tax credit is expected to phase out at a rate of 25% for components sold after 31 December 2029, and no credits will be available after the end of 2032.

European Energy Crisis

The below chart looks at the futures market for the cost for base load energy prices in France one year out. Base load refers to the minimum energy needs to support a grid, and does not include peak energy.

Chart looks at the futures market for the cost for base load energy price in France one year out

Source: I/O FUND

On August 26th, 2022 the price was $1130/MWh. Twenty Four days earlier the cost was €507/MWh. And one year ago, the same forward price was €78/MWh. Keep in mind, this is the expected cost to power the base load of the French energy grid one year out from now.

This is not just a French problem. The same contract looking at the 1-year percentage increase in the expected cost to power a country’s base load is as follows: Italy +660%, Spain +400%, German/Austria +1200%. Alex Munton, an expert on global gas markets at Rapidan Energy Group, said, “European natural gas is so expensive it’s like paying $500 for a barrel of oil.”

To make matters worse, the French government just bailed out Electricité de France S.A. (EDF), which is the largest supplier nuclear energy to Europe, as well as large supplier of natural gas in France, Belgium, Italy and the UK through its subsidiaries. The €10 billion bailout has made the company 100% nationalized, as the French government scrambles to address the EU energy crisis.

EDF is one of a string of EU energy companies applying for emergency loans as the soaring price of natural gas affects EU supply. Uniper SE, one of Germany’s largest utility companies, was just given a new bailout that allows the German government to take a 30% stake in the company. The on-going losses are unsustainable as rapidly rising energy costs drain needed liquidity to fund daily operations.

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Uniper was Europe’s largest supplier of Russian gas. They claimed the volume it has received from Russian gas this year has fallen by 80% since June, which forced them to find alternative sources of energy at elevated prices in order to meet demand.

France’s solution to the crisis was to instill price caps on energy prices to its citizens. A politically popular policy with the consequence we are seeing with EDF. The energy suppliers are being forced to buy high and sell low due to these price caps. As a result, France has had to hand over roughly €40 Billion in 2022 to keep EDF afloat this year. Ever since, energy prices have doubled as future prices are expected to increase by about 5 times into 2023. If France maintains price caps, they will be looking at an additional €200 billion to keep EDF afloat through the winter with the current price caps.

Regardless, with energy prices increasing with no end in sight, EU officials are calling for major price caps across the board. The EU is forced to choose between on-going bailouts/nationalization of energy suppliers or face the realization that many citizens will be unable to afford energy needs for basic cooking and heating as we enter the Fall/Winter months.

How can a European utility, which has been historically safe, run into insolvency when energy demand has far exceeded supply? It goes back to standoff between Russia and the EU. Russia supplied 40% of Europe’s natural gas in 2020. In 2022, the EU has taken a stance against Russian imports due to the invasion of Ukraine.

As of July 2022, EU has seen a 60% drop in Russia natural gas deliveries, as we move into Fall/Winter. Furthermore, the Nord Stream 1 pipeline, which accounts for 1/3 of all EU’s natural gas imports from Russia, has seen around 1/5 of normal inflows this year. As a result, basic energy price throughout the EU are approaching prices that most citizens simply cannot pay.

Much like the US saw a contagion in banking in 2008, which forced a quasi-nationalization of the industry, it appears that the EU is heading in the same direction with its energy companies. With the multi-year move to shift towards a green energy grid, coupled with the sudden loss of Russian energy supply, the EU appears to have no viable option to avoid blackouts into the coming fall/winter months.

Conclusion:

The NDX is down (26%) YTD and this is one of four years in the last two decades the broader tech index has seen double digit losses. However, there are pockets of growth even in this market and solar is the leader in this regard.

On top of this sector’s excellent performance over the past few months, we foresee its leadership position continuing due to these two catalysts which will create a new trajectory in global demand for renewable sources of energy. We publish premium deep dive reports on individual stocks for our premium members with a focus on Solar this upcoming week.

Knox Ridley, Portfolio Manager at I/O Fund, and Royston Roche, Equity Analyst at I/O Fund contributed to this article.

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

Sunrun 2021 Analysis

Posted on by io-fund

Sunrun: an innovative business model

Sunrun is an innovative solar company that pioneered the Solar-as-a-service model, where it finances the initial investment of installing solar panels for residential homeowners, and then leases the solar back to the homeowner. Homeowners benefit by getting a cheaper electric bill with no upfront investment. Sunrun benefits by securing long-term (20-25 year) recurring cashflows and tax credits that it can sell to institutional investors.

Since Sunrun is financing the initial cost of installing the solar, the cost of its capital (debt + equity financing) is very important to the sustainability of its business model. Recently, Sunrun has been able to drastically reduce its cost of capital, which will likely lead to strong growth going forward. I discuss the reasons for this in greater detail next.

Reduction in cost of capital leads to faster growth

Since Sunrun needs cash to finance the equipment and labor to install solar for its customers, cheaper capital means that Sunrun can grow faster and more efficiently. During the Q2 Earnings Call, Executive Chairman and Co-founder Ed Fenster disclosed that the company’s cost of capital has declined at an accelerated rate in 2021:

“While our capital costs have been steadily falling since inception, in the last year we've seen an acceleration in these improvements, which have been most pronounced in our non-recourse subordinated debt costs. Today, this market is pricing 175 to 350 basis points below where we've placed comparable loans over the last several years.”

Sunrun is a capital-intensive business with substantial amounts of debt and upfront costs. The recent decline in Sunrun’s cost of capital will lower one of Sunrun’s largest expenses: interest. With less cash going to interest, more cash can be invested in growth. This also allows the company to offer better pricing to customers, further accelerating growth.

The way Sunrun has been able to lower its cost of capital is by selling its long-term recurring cashflow streams to income investors, such as pension funds and other institutional investors. Due to the high collection rates and multiple years of data that span two recessions (2008 and 2020), the market has started to warm up to Sunrun’s financial products (its long-term solar leases) and is paying a premium for these cashflows.

What is significant is that Sunrun now receives more cash from the sale of the long-term leases than it costs to install the leases. This means that Sunrun can finance solar installations for homeowners, and then turn around and sell the contracts for more than the “creation costs”, or the total costs to capture the customer and install the solar systems. This allows Sunrun to quickly realize returns in its solar investments, and to recycle the capital into new growth. This dynamic helps support an acceleration in growth going forward.

Sunrun illustrated this trend in the graphic below: the “Upfront Cash” bar, which is what Sunrun receives for selling its solar leases, is higher than the “Creation Cost” bar. This highlights how Sunrun can generate the necessary cash to fund its growth going forward by selling its solar leases at a higher cash value than its initial cash investment. Co-founder Fenster explained during the Q2 Earnings Call that this dynamic means that Sunrun no longer needs to issue equity financing, which will protect investors from dilution. I also believe that this helps support a premium multiple, as Sunrun should be able to self-sufficiently fund its growth going forward by selling its solar leases.

Source: Sunrun Q2 2021 Presentation

There are some caveats to this model. For example, leases that are “aged” for 5+ years generally receive a higher “Upfront Cash” value, so Sunrun needs to hold onto the leases for a few years before securitizing them. The financing deals are also complex and include tax equity financing, which is based on tax credits for solar installations. These tax credits are scheduled to be reduced in 2024, which I discuss in more detail further below in the risks section.

Sunrun’s financials are better than they seem

As mentioned above, Sunrun is a capital-intensive business, as it frontloads expenses but is paid for these services over multiple years. A quick glance at Sunrun’s income statement and cashflow statement shows a company deeply in the red, hemorrhaging cash. However, GAAP accounting does not properly showcase Sunrun’s business model, in my opinion. For example, the company must expense the majority of installation and marketing expenses upfront, but receives the cashflows over 20-25 years. This mismatch is expense and revenue recognition makes Sunrun’s earlier years appear unprofitable, but will make later years appear highly profitable.

The company can also quickly monetize its solar leases by securitizing them (discussed above), but this is considered a financing activity and is not included in operating cashflows. This is a technicality of GAAP, and the argument can be made that the sale of the leases is similar to selling the solar equipment, which if that were the case, would drastically improve the presentation of Sunrun’s cash flows. As shown in the two charts below, Sunrun’s as-presented FCF is deeply negative as the firm finances the upfront costs of solar installations. In the second chart, if we account for the sale of the long-term solar leases (which are sold as mostly non-recourse debt) as sales of equipment, then Sunrun’s FCF looks more favorable. I believe that classifying the sale of the leases as “sale of equipment” more clearly demonstrates the sustainability of Sunrun’s business model, which is illustrated in Sunrun’s Adjusted Quarterly FCF chart below.

(Note: Q4 2020 Adj. Qtrly FCF was impacted by an acquisition completed during the year. If we include acquired cash of $537 million, then Q4 adj. Qtrly FCF would be an inflow of $309 million during the quarter)

Co-founder Ed Fenster stated during the Q2 Earnings Call that “under this financing strategy, over several quarters and especially next year, the cash flow generation of the business should be substantial.” The company has over $4.5 billion of net earning assets on its balance sheet, which represent the cash value Sunrun would receive today if it sold all of its leases. With $4.5 billion in available capital on its balance sheet, and lower costs of capital, Sunrun is becoming a more efficient company. We can see this in recent results, which have started to accelerate.

Recent results start to accelerate while funding costs continue to decline

Sunrun reports Q3 results on November 4th, so the following numbers are based on Q2 results. Notably, Q2 results accelerated from the prior quarter. For example, Q2 sales grew 20% QoQ, up from the 4% sequential growth in Q1. While Q2 sales typically accelerate relative to Q1 due to seasonal trends, this represented the fastest Q2 sequential growth rate in the last four years. Moreover, Q2 orders increased 25% QoQ, which outpaced the 10% QoQ increase in installations, signaling that demand has outpaced installations. The outsized growth in orders also supports a continued acceleration in sales going forward. Pro-forma customer count also accelerated, and grew 19% YoY in Q2 to 600,000 customers, an acceleration from the 18% YoY growth in Q1. The acceleration in Sunrun’s business led management to increase their 2021 sales outlook to 30% YoY growth (up from 25%-30%).

Sunrun reported that capital costs have come down even more since the close of Q2 which is a harbinger that growth will likely continue to accelerate. For instance, on 10/11/21, Sunrun announced its non-recourse lending facility increased by $1 billion (to $1.8 billion) while interest costs also fell by 50 bps. The non-recourse lending facility is used as a bridge to finance solar installations and are paid off once the solar leases are aged and can be securitized. The large increase in the lending facility coupled with the lower interest rates highlights how the bond market believes that Sunrun’s business model is sustainable. The increase in cheap capital should also drive strong growth going forward.

Sunrun also announced that its most recent securitization deal was at the lowest cost of capital and highest advance rates in the company’s history. What this means is that Sunrun’s growth is becoming cheaper and more efficient. Sunrun’s Co-founder Ed Fenster added that “these financings highlight that Sunrun can not only fund growth but also generate cash, despite incurring billions in capital expenditures and operating cost.” Looking forward, Sunrun’s cheap capital and unique financing model positions the company well to grow rapidly with the solar market.

Trends driving the adoption of solar

Climate change, the adoption of EVs and cheaper electric bills are all tailwinds that will drive the adoption of solar going forward. Recent surveys have shown that owners of electric vehicles are often adopters of solar. With the expected ramp in EVs going forward, solar adoption will likely follow. Sunrun’s CEO Lynn Jurich explained during the Q2 Earnings Call that around 40% of EV owners have adopted or are installing solar now. Deloitte forecasts that EVs will gain significant market share in the future, which will likely be a tailwind to solar adoption going forward

There are also tax incentives for adopting solar. For instance, the federal government currently offers an investment tax credit (ITC) for the installation of solar power facilities. Since Sunrun is the owner of the solar systems it installs, the company can claim these ITC benefits and receive a cash grant for them from the U.S. Treasury, or they can sell the ITCs to investors. The federal government also offers a personal income tax credit for solar installed by residential taxpayers who purchase the solar system outright as opposed to leasing them. These tax credits have supported demand for solar, and were recently extended by two years.

Another key benefit driving the adoption of solar is net metering, which allows solar powered homes to sell their excess power back to the grid, which lowers their electric bill.  Sunrun states that upon solar installation, homeowners often realize a 10% reduction in their electric bills, which can be realized with no upfront costs. However, utilities are fighting to remove net metering, which I discuss in more detail next.

Risks and valuation

Sunrun’s main competitors are utility companies and utilities are fighting to change net metering policies. Sunrun disclosed in its 10K that it relies on net metering policies to offer competitive pricing, and changes to these policies may reduce demand for its solar offerings. Net metering is available in 39 states, but changes are on the horizon. Louisiana recently gutted its net metering policies, which is expected to lower the amount of savings homeowners will realize from adopting solar. California is also expected to change its net metering program in 2022, which is significant as 40% of all of Sunrun’s solar installations have been in California. While these risks are outside the control of management, there are some offsets that should dampen the impact from changes in net metering policies.

For instance, management disclosed that battery installations have dramatically increased in regions with unfavorable net metering policies. CEO Jurich explained on the Q2 call that battery adoption in the Bay area is almost 100%, and “some of the changes in California, around rates and [net metering] will be even more encouragement for batteries”. Sunrun reported that battery installations increased over 100% in Q2 to a record high. CEO Jurich added that Sunrun can “network these batteries together to form virtual power plants, providing incremental recurring revenue and offering an enhanced customer value proposition. This further differentiates Sunrun from companies that lack the scale, network density and technical capabilities to serve this market.”

Furthermore, California passed a bill that went into effect in 2020 that requires all new residential builds (three stories or less) to have solar installed. There is also a bill that is expected to be implemented in California that would require commercial buildings to install solar. These new mandates may help offset any demand loss from potential changes in net metering policies in 2022

Another key risk to Sunrun’s business model is changes to tax incentives. The US government currently offers favorable tax benefits, which were recently extended for another two years. The expected phase out of tax benefits may reduce demand for solar, which would be a headwind to growth for Sunrun. However, there are stipulations in the tax codes that allow the tax benefits to be accrued throughout 2026, which should provide enough time for Sunrun to continue to scale its business. Furthermore, efficiencies are driving down the costs of solar and batteries, which should help offset the need for government incentives in the future. While it is impossible to predict if incentives will be extended further, the global drive to reduce greenhouse gas emissions should motivate governments to incentivize solar going forward.

Lastly, supply chain issues present a risk in the near term to Sunrun’s ability to accelerate sales. Data gathered from S&P Global found that US solar panel imports fell in Q3 2021, possibly due to supply chain bottlenecks. This issue could lead to an increase in prices in the near term, which may cause a near term headwind to demand.

While there are many risks, Sunrun should be able to overcome them going forward. Looking at its valuation, Sunrun trades at an 8x P/S multiple, which is above its three and five -year median of 3x and 2x, respectively. The higher multiple relative to historical valuations is likely a reflection of the company’s improving financials, as the firm is now able to generate excess cash by securitizing its solar leases. Looking forward, Sunrun trades at a 6x fwd P/S multiple, which is slightly below the peer median of 7x. Sunrun appears reasonably valued relative to other solar-related peers.

Another way to value Sunrun is to look at the company’s net earnings assets, which represent the present-value of future cashflows of its leases (less cost and debt) and is similar to book value. Since Sunrun is in the business of originating long-term loans and securitizing them, this is similar to wholesale mortgage lenders, which are commonly valued at Price to Book value multiples. Below are Price to BV multiples for some mortgage originators along with Sunrun, a solar lease originator. Mortgage originators have Fannie Mae backstopping their loans with implicit guarantees, which likely awards them higher multiples. Nonetheless, the business models of these companies are somewhat similar to Sunrun’s, however Sunrun trades at a substantial discount.

In conclusion, Sunrun pioneered a unique business model that allows residential homeowners to capture the benefits of solar without the large upfront investment. Sunrun has been able to securitize the long-term leases it signs with homeowners and is now in a position where it is receiving more upfront cash from the sale of these leases then it costs to capture the customer and install the equipment, making Sunrun self-efficient and no longer reliant on dilutive equity financing.

The company’s cost of capital, the main barrier to growth, has rapidly improved in 2021, and the improvement has continued into Q4. This improvement makes Sunrun more efficient and allows the company to accelerate growth going forward. While we have seen an acceleration in growth in Q2, the decrease in the company’s cost of capital and tailwinds from the adoption of solar should support strong growth going forward. While there are risks, such as changes to net metering policies and tax codes, there are offsets to these risks that should benefit the company going forward. The company also appears reasonably valued relative to peers.

Disclosure: Bradley Cipriano and the I/O Fund may own shares in Sunrun and may change their respective positions within the next 72 hours. You can access the I/O Fund’s positions herehere. The above article expresses the opinions of the author, and the author did not receive compensation from any of the discussed companies 

Enphase Earnings (Q3 2021 Recap) – IQ8, Accelerating Growth and More!

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In the short video discussion below, I discuss Enphase's strong Q3 results which beat sales estimates and guidance also came in above consensus. The company released a new chip, the IQ8, which should drive strong demand for Enphase's products going forward. Furthermore, Enphase has also ramped up purchasing of raw materials, which supports management's statements that they anticipate elevated demand going forward. The raw material purchases signal that the company will soon ramp production of its new products, leading to higher sales going forward.

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Looking forward, Enphase has amble room for growth as its new technology will drive demand for the next few quarters. Management expects the IQ8 ramp to take about four to six quarters, which provides support for sales growth well into 2023. On top of the strong growth going forward, Enphase is also highly profitable and cash flows are positive and growing fast. Enphase's strong growth, profits and cashflows position the company well to continue to take share in the growing solar industry. Watch the short video below to find out more!

Tesla Earnings (Q3 2021 Recap) – Path to 20M Annual Vehicle Production and More!

Posted on by io-fund

In the video discussion below, I provide a quick recap on Tesla's Q3 results. The company reported record profits, record vehicle production, and a war chest of cash on its balance sheet. Specifically, Tesla reported $1.6 billion in Q3 GAAP net income, a company record. Tesla is also closing in on a 1 million annual car production run rate, with plans to expand capacity by 50% per year going forward. Luckily, Tesla has a massive $16 billion war chest of cash on its balance sheet, which will help it rapidly expand its operations.

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However, the company is still early in its growth projections and has a path to nearly 20M annual production capacity in the next decade. Tesla also announced its entrance into the auto insurance space, which I think will help the company reach its ambitious capacity expansion goals. Looking forward, Tesla still has plenty of growth ahead of it, which should help support its share price. Watch the video below to find out more!

Disclaimer: This is not financial advice. Please consult with your financial advisor in regards to any stocks you buy.

Plug Power: Hypergrowth in the Renewables Sector

Posted on by io-fund

37330e62-3520-4c6d-8d52-913f5c8d0e43_Plug+Power+Hypergrowth+in+the+Renewables+Sector.pdf

“Hypergrowth” and “renewables” are two words that rarely go together. The infrastructure that is required tends to prevent the rapid growth that we see in cloud or advertising stocks. Most renewables either show the signs of a cyclical industry or they show signs of “growth at any cost.” Plug Power is a growth at any cost company. This has worked many times in tech – to do whatever it takes keep growing – so we won’t want to discount the company based on this tactic. What Plug Power and other renewables require is a different mindset than cloud, ad-tech, consumer tech or crypto investing.

We’ve discussed before that the cost for clean energy is finally competitive with the cost for fossil fuels. This has helped drive the investments in building more infrastructure. However, this isn’t the case for clean hydrogen which complicates Plug’s story. We discuss this more below and why we are interested in Plug despite hydrogen being far behind solar and wind in terms of cost reduction.

Please note: at this time, the I/O Fund has chosen Stem and Plug Power as our two choices for exposure to renewables. This was discussed in the July 2021 Renewables Overview.July 2021 Renewables Overview.

Overview of Hydrogen:

The Paris Agreement of 2016 is widely considered to be the point when global initiatives in renewable energy were kickstarted. The proclamation was signed by 196 countries that promised to limit global warming to “below 2-degree Celsius above pre-industrial levels.” This translates to a goal of cutting carbon emissions by 25% by 2030 and to be net zero by 2070.

When we’ve covered renewables in the past, the main takeaway is that the cost to produce energy is dropping to where it’s competitive with fossil fuels. This lower cost to produce solar PV and wind has resulted in more interest in electrolytic hydrogen. The ultimate goal is to use clean energy to produce hydrogen rather than natural gas or coal. This will be accomplished by building electrolyzers near solar fields and wind farms to supply the hydrogen and then transport it where it’s needed. Hydrogen is transported either by pipeline or by liquid form on ships. From there, it’s used to fuel a wide variety of vehicles and buildings. 

Source: IEA

Most importantly, hydrogen is designed for energy storage whereas wind and solar are designed for energy generation, therefore, a hybrid of the two is ideal. Hydrogen allows energy to be stored for weeks — and even up to months — after solar or wind has generated energy. This is important because wind and solar fields are often located too far away from cities to be effective without a storage option

Of all the technologies in existence today, hydrogen has the greatest potential for seasonal energy storage, according to the National Renewable Energy Laboratory (NREL). The major components to hydrogen power is fuel cells, refueling equipment and electrolyzers. Fuel cells use the fuel from hydrogen with the oxidizing effects of oxygen to create electricity. They are made up of an anode, electrolyte of ions and cathode.

Source: Fuel Economy

Today, the grid is mainly used to produce hydrogen. Currently, natural gas is the primary source of hydrogen production and accounts for 75% of the hydrogen production in the world today, or about 70 million tons. This equates to 6% of the global natural gas use. After natural gas, the second most popular supply source for hydrogen is coal. Grid-based hydrogen is used in oil refining, ammonia production, methanol production and steel production. This is distinct from clean hydrogen.

Here are the various ways to produce hydrogen:

  • Renewables: using solar and wind, hydrogen can be produced with water (electrolysis) – considered clean hydrogen (or green hydrogen)
  • Nuclear: same as renewables, nuclear energy can be used for electrolysis
  • Steam methane with CCS: proven method with carbon capture, utilization and storage with natural gas, needs to scale – considered blue hydrogen
  • Steam methane: uses natural gas without carbon capture, utilization and storage, thereby producing carbon emissions. This is the current way hydrogen is produced and produces many emissions as it’s not clean hydrogen production rather it’s gas and coal powered hydrogen – considered gray or brown hydrogen

Fuel costs account for 45% to 75% of production costs. This makes hydrogen fuel cells sensitive to gas prices (for the natural gas production) and this is why it costs more to produce hydrogen in regions like Japan, China and Korea, where natural gas is an import.

To put in perspective how far behind hydrogen development is (and, consequently profitability), consider that in terms of megawatts, hydrogen in 2017 was comparable to solar in 1996 and wind in 1992.

Source: Green Tech Media

Bull Case for Hydrogen:

The bull case is that hydrogen can be useful in many industries where is has little to no presence, such as transport, manufacturing, buildings and for power generation. This will be catalyzed by the need for energy storage as it will be impossible to power the world’s energy needs with renewable energy sources on their own. Essentially, the argument here is that world cannot meet its renewable energy goals without energy storage and hydrogen is the best candidate for this.

The decarbonization goals set forth by the Paris Agreement and the decarbonization that commercial industries are seeking on their own (Amazon, Wal-mart, etc) will require a versatile energy carrier. Therefore, a primary bull case is that the decarbonization goals will require hydrogen for energy storage as they simply can’t be met with renewable energy sources alone. The expectation is that governments will be forced to drive down the cost of hydrogen to meet these goals. The driving down of costs for solar and wind with subsidies is cited as an example of how this has been successfully accomplished. For instance, New York has committed $13 million in state tax credits to Plug Power for building its Gigafactory in the Rochester area.

On a similar note, costs to produce hydrogen have halved in the last five years and are at 3% of their 2005 level currently. Another point for the bull case is that hydrogen can use the existing natural gas pipelines and network. Transporting hydrogen through existing pipelines is a lower cost option for delivering larger volumes.

The hybrid method of using hydrogen as an energy converter alongside renewables energy production can save hundreds of billions in Euros, according to a study done on the European Union. In the EU, the goal is to have 32% of the energy demand and 50% of the electricity demand come from renewables by 2070.

Bear Case for Hydrogen:

The bear case is that hydrogen production is cost prohibitive as there is an efficiency loss of up to 70% when converting energy to another form, such as from electricity to hydrogen that is then shipped, stored, and then converted back to a fuel cell. In this scenario, the 70% efficiency loss means hydrogen is more expensive than the electricity or gas used to produce it.

According to the Wall Street Journal and BloombergNEF, hydrogen supplies less than 5% of the world’s energy and could reach nearly a quarter of global energy consumption by 2050 for a total of $2.5 trillion in direct revenue annually.

Admittedly, 2050 seems a ways off with current CAGR at 4.32% through 2027. The global generation market was at $117 billion in 2019 and is estimated to reach $165 billion by 2027. Another source puts the near-term projection at 5.7% CAGR from 2021 to 2028. Steam methane will continue to have the largest share through the forecast period.

This low CAGR and far-off projections add to the bear case around the efficiency loss for hydrogen, which is why we placed the CAGR growth under the cons. Typically, this low CAGR would mean the market is not investable (at least not for growth investors like ourselves).

However, as the bulls point out, this can change quickly if there is enough pressure from legislation and corporate interest.

Plug Power:

Plug Power manufactures fuel cell systems for the industrial sector and manufacturing sector. The company’s line of products include GenKey, GenDrive, GenFuel, GenCare and ProGen. GenKey helps material handling vehicles reduce dependency on lead-acid or lithium-ion batteries. GenDrive offers a proton exchange membrane fuel cell to power material handling vehicles, such as forklifts and hand operated trucks. GenFuel provides a hydrogen fueling system for GenDrive vehicles. ReliOn provides backup power for telecommunications and the utility sector. ProGen offers fuel cell engines for the electric vehicle market to replace batteries. Here’s a good article about ProGen and the partnership with Renault.

By the end of 2022, Plug Power will have two of three plants operational in Georgia, Pennsylvania and New York. The plants will be green hydrogen plants using electrolyzers for hydrogen produced by wind, solar and hydropower. These plants will help Plug achieve the company’s goals of producing 500 tons per day of green hydrogen by 2025 and 1,000 tons by 2028.

  • New York’s Gigafactory will be where the largest green hydrogen product facility plant will be built in North America. The initial production will be 45 metric tons of green liquid hydrogen to service the NE regions with 120 megawatts of eletrolyzers producing hydrogen.
  • In Southern Central Pennyslvania, Plug will be leveraging Brookfield Renewables hydroelectric facility to potentially produce 15 tons per day.
  • Last month, Plug announced plans to build a plant in Georgia with plans to produce 15 tons per day. This plant will be near Home Depot and Southern Company’s headquarters.

This quarter, the company discussed expanding its product line from material handling to expanding more into mobility. This includes various vehicles, such as commercial fleets, airport ground equipment and tuggers for factories. General Motors (GM) was named as the “fourth pedestal” customer for its auto manufacturing facilities. This includes factory tuggers and forklifts. These factory vehicles are loading and unloading heavy equipment everyday which typically requires battery power. The other three pedestal customers for Plug are Amazon, Walmart and Home Depot. We touch more on this below.

The company also released a new product last year called GenSure HP that provides backup power for data centers and energy storage systems with potential deployment in 2021. The backup power solutions compete with generators and backup battery power.

Plug Power acquired United Hydrogen Group and Giner ELX, a leading provider of hydrogen engines and fueling solutions. This acquisition lends itself to Plug Power producing more green hydrogen. At the time of acquisition, United Hydrogen Group was producing 6.4 tons of hydrogen with expertise in hydrogen generation, liquefaction and distribution.

Giner ELX specializes in PEM electrolysis including grid-level storage solutions and also fuel cell vehicle refueling stations. The company uses electrolyzers to turn surplus power into hydrogen. The result is injecting hydrogen into the natural gas network or fueling turbines for peak-time electricity generation. The long-term goal is to have hydrogen fueling stations that look like gas stations.

Partnerships:

Most stock analysts will point towards the partnerships that Plug Power has as either a major benefit or as a customer concentration risk. Both are probably true.

Amazon is Plug’s biggest customer for both fuel cells and electrolyzers. The partnership formed in 2017 when Amazon agreed to a $600 million deal to equip forklifts in Amazon’s warehouses. The incentive to use fuel cells over batteries is partly driven by reducing labor and freeing up physical space. In exchange, Amazon had the right to buy up to 23% of the company through warrants. The warrants vested last year and Amazon took control of 55 million shares at a price of $6. The warrants caused Plug Power to report negative revenue last year with the loss from the warrants being greater than the company’s sales.  The more headline-worthy development as of late is that Amazon sold its shares and this can appear like a lack of confidence from one of Plug’s partners. On the other hand, Amazon may have wanted to cash in on the gains as Plug has been trading around $25.

In 2010, Wal-Mart partnered with Plug for the first time, and in 2017, the partnership was expanded with a three-year contract and an opportunity for Wal-Mart to buy 17% of Plug Power. At the time, Wal-Mart made up 34 percent of Plug’s revenue. Plug supplies Wal-Mart with GenDrive fuel cell-powered vehicles in 37 distribution centers. In August of 2020, Plug Power expanded again with Wal-mart to supply their eCommerce network.

Similar to Wal-Mart and Amazon, Home Depot is a partner with Plug Power on reducing electricity and battery use by using fuel cell-powered material handling fleets. Most recently, the two companies partnered on a Dallas, Texas facility that is 1.5 million square feet with Plug powering the material handling fleets.

In the Q1 2021 recap, Plug Power also discussed its partnership with General Motors, what the company calls its “fourth pedestal customer” with GM deploying GenKey solutions at multiple plants.

With the Renault partnership, Plug Power will be putting its fuel cells into light commercial trucks in Europe. Road tests will start by early 2022 with a goal of 20,000 trucks on the road by 2025. The two companies have a goal of reaching 1/3 of the market in 2030, when an anticipated 500,000 vehicles will be hydrogen powered. That would represent 7X growth between 2025 and 2030.

Financials:

As the title of this analysis states, Plug Power is a hypergrowth company in renewables. This hypergrowth is priced at a premium with Plug trading at up to a 75 forward P/S. When you adjust Plug Power for a 1-year forward to account for its forward growth compared to renewables peers, it becomes more reasonable. Pictured below, Plug narrows the gap with Enphase from a difference of 14 to a difference of 7 on the 1-year forward.

 For the first quarter of 2021, Plug Power reported $72 million in revenue, up 76% year-over-year from $40.8 million. Gross billings were up 71% year-over-year at $73.7 million, compared to $43.0 million in the year-ago quarter. The revenue was a beat as analysts were expecting $69 million in sales but the EPS missed.

The gross product margin was at 38% although the company reported gross losses of ($12 million). Operating losses were at ($48.2 million) with net losses of ($60.8 million). This works out to EPS of ($0.12) with analysts expecting ($0.08).  These gross margins are an improvement on a percentage basis from the ($9.7 million) lost in the year-ago quarter on ($40.9 million) in revenue.

The company has raised cash by selling stock for $1.6 billion and also for $1.8 billion. This resulted in $4.4 billion in cash for the company with $330 million in debt despite diluting shareholders. The company has a term loan with a 9% interest rate.

These losses are incurred due to the costs associated with fuel cell systems and related infrastructure, plus the cost to deliver fuel to customers. Growth investors need to understand there is an inherent cost to the renewables sector and get comfortable with losses before a company reaches scale. As discussed in the Hydrogen Overview above, Plug Power is exposed to commodities such as natural gas prices and also natural gas supply.

In regards to this quarter, Plug Power highlighted a few events that negatively impacted their operating margins. Fuel gross margins were negatively impacted due to the escalation of rates from one of their natural gas suppliers and from force-majeure events that caused the price of hydrogen to spike. One of those was the Texas freeze. The company is also exposed to freight costs, which caused a $2 million expense. The company stated in the Investors Letter that they plan to diversify their supply chain to mitigate this moving forward.

The company reaffirmed its targets for 2021 and also for 2024. The company’s goal for 2024 is $1.1 billion in revenue from 50% green hydrogen. The company stated the following regarding 2021 guidance: “Investors should expect $115 million to $120 million of gross billings for the quarter. This is approximately 40% of our target revenue of $475 million for the year. Usually, at this point in the second quarter, we are about 33% of our annual revenue will have been achieved. We are at a run-rate that is higher from both a revenue and growth rate level than we have experienced in the past. We also foresee a very strong third quarter.”

If Plug Power hits the revenue target for 2021 at $480 million and then the gross billings target of $1.2 billion and the revenue target of $1.1 billion in 2024, then that would be 150% growth. This is substantial for a renewables company that faces cost efficiency issues inherent to its industry.

Accounting Issues:

On March 15th, Plug Power announced the company would need to restate three years’ worth of financial statements. At the time, the company stated the restatement would not affect the company’s cash position, business operation or the return from commercial agreements.

The changes were: 2020 net revenue was $7.2 million compared to the previously stated net loss of $100 million and the net revenue of $230 million was an adjusted revenue loss of $300,000. This came after a large EPS miss in the fourth quarter of ($1.12) compared to ($0.11) expected. As previously discussed, the revenue was also negative because of Amazon exercising its warrants which led to a revenue miss in the fourth quarter of $32 million in losses compared to roughly $50 million expected.

The restatements pertained to the accounting for service contracts and classification of certain costs, such as R&D. The overall impact was minimal with a total decrease in EPS of ($0.13) or about a 6% increase in the company’s total loss. The change in reported sales amounted to a 2% decline. There was no change in cash.

Risks:

We’ve reviewed the risks in this analysis. Mainly the concentration of customers and also the cost efficiency of hydrogen as it costs more than the gas to produce it. Competitors are another risk as they range from smaller in size, such as Ballard and FuelCell Energy, to gas companies, like Shell and BP Amoco.

Conclusion:

We understand the challenges around hydrogen yet are willing to take the risk as any progress will be aptly rewarded. Perhaps it will be to our benefit the company’s stock was beaten down over a minor accounting error. We like Plug’s Power ability to post hypergrowth despite the challenges with hydrogen and especially clean hydrogen. We think incremental improvements – whether that’s subsidies, new global partnerships, or a stronger move into mobility – could cause the company to become a renewables leader.

2021 Renewables Analysis: Overview of Stocks We Are Targeting

Posted on by io-fund

Over the past fifteen years, there has been a marked shift in the world’s most valuable industry. Oil dominated the top 10 in the prior decade and technology dominates in the current decade. However, what will happen when these two dominant industries merge into renewables and combine the addressable market of fossil fuels with the disruptive nature of technology?

It’s a big question to ask as many renewables companies look like moonshots, or they’ve operated for some time and have cyclical financials. There are many highs and lows in their financials due to the level of infrastructure required for renewables and the dependency on cyclical supply chains. To put it plainly, the financials in the renewables sector are what most growth investors try to avoid. First Solar is a great example as the company rotates between 100% growth in some quarters and negative growth in others. Cyclical issues are the norm and not the exception. We discuss this more towards the end of the report as we identify a handful of companies we are keeping a close eye on.

You can reference our previous renewables report here.

The Bull Thesis:

Our first report on renewables highlighted a study from the College of UC Berkeley claiming that by 2035 the U.S. could see up to 90% of U.S. energy consumption come from renewable energy sources. This report assumes favorable subsidies and legislation that should facilitate this transition and acknowledges that government assistance is not a guarantee. Without government support, the report claims the U.S. could see up to 55% of its energy consumption come from renewable sources by 2035.

Since year-end 2020, we’ve seen even higher growth reported than previously estimated with worldwide capacity growing by 45%. This is the largest annual growth rate since 1999. The growth was driven by a 90% rise in wind power and a 23% expansion in new solar power installations. Most importantly, the IEA is predicting that large capacity gains in renewable energy becomes the “new normal” in 2021 and 2022 with gains in capacity similar to 2020.

The key point to renewables is that the levelized cost of energy (LCOE) for utility-scale solar photovoltaic (PV) has plummeted 400% in the past five years. I covered this for MarketWatch with the image below to depict how competitive solar has become compared to other energy sources. This is important because the industry has seen a change in the story and (generally speaking) is why the renewables’ financials were deep in the red over the last couple of years.

This has led to hockey stick growth. According to the report, wind is growing the fastest (50%) within the renewables category yet solar (26%) is expected to overtake wind power.

The reason for this growth is that the technology is being developed for and marketed to individual consumers whereas wind is designed primarily for a region’s electricity grid. As the efficiency and storage continue to increase, and the cost continues to go down, more people will likely migrate to having a home that is independent of the grid predominantly due to a reduction in personal expenditures, which will also align with the desire to become greener.

More importantly, the cost to produce 1 kilowatt of solar electricity is now competitive with wind, and is the cheapest form of electricity available when taking into account utility-scale systems installed in locations that receive full sun.

If we use the metric of levelized cost of energy (LCOE), solar is more expensive to build upfront, but much cheaper to maintain, compared to a natural gas power plant that is less costly to build but has significant and on-going costs to maintain. As stated, the LCOE for solar has plummeted as much as 400% in the past five years, making the economic incentive a real driver for municipalities and business to develop on a large scale.

Global Addressable Market

Renewable energy companies have global addressable markets, which makes it an attractive industry for investment. In any given region – China, the United States or Europe, energy accounts for 15-18% of the country’s GDP. According to Brookfield Renewable Partners, one of the world’s largest investors in renewable energy, $5 to $10 trillion will be invested in renewable energy worldwide by 2030.

We’ve covered why we are keen on China for electric vehicles specifically. In a similar vein to the country having a need for electric vehicles due to a lack of oil, China is also the biggest manufacturer of solar photovoltaics and the largest producer of solar-generated electricity. According to Wood Mackenzie, China will exceed the United States on solar power through 2024.

Last year, China accounted for 50% of the world’s growth in renewable energy capacity. In Q4 of 2020, China added 3X gigawatts in capacity compared to Q4 2019.

The country’s global share is at 22.9% with a 10-year annual growth rate of 33.4%. Compare that to the United States with a similar global share of 20.1% yet with a 10-year annual growth rate of 10.1%.

India is forecast to become a growth market, as well, with ambitions to reach 225 gigawatts of power by 2022 compared to 10 gigawatts of power in 2019.

India and the United Kingdom are tied for the second highest 10-year annual growth rate in the 17% range after China’s 33%.

With that said, the United States is a key market with 5% of the world’s population yet accounts for 17% of the world’s energy. The daily per capita energy consumption in the United States is 2.6 gallons of oil, 9.7 pounds of coal, and 255 cubic feet of natural gas. Residential consumption is 11.8 kilowatts (KWh) per person.

Even though the growth rate is much lower in the United States, on a per capita basis, the country is in a wide lead for both fossil fuels and renewables. In Q4 of 2020, the United States added 19 gigawatts compared to 13.7 in the year-ago quarter compared to the 3X growth China reported.

Constraints to Renewables:

Renewable energy’s capacity factor is more fixed due to the elements. Solar has a capacity factor of 25%, while wind has a capacity factor of 35%. These numbers are based on the rotation of the sun and other weather patterns. Advancements within this field must come from an acceleration of efficiency during the restricted time that it can produce energy.

The average size of natural gas power plants in the U.S. is 820 megawatts.  The average current capacity factor for natural gas in the U.S. is 58%. This means that the average natural gas power plant produces 4,166,256 MWh/year.

Compare this with one of the more advanced on-shore wind turbines, which is about 810 ft high with a blade diameter with a 518 ft diameter. One turbine has a 5 MW size, with a capacity factor of 35%. Therefore, one turbine equals 15,330 MWh/year. In order to have the equivalent energy output of the average natural gas power plant, you would need 272 of these turbines.

There are now off shore wind farms where the capacity factor is an impressive 63%. Furthermore, General Electric has developed an off shore turbine called the Haliade-X that can produce 12 MW.  So, one of these turbines produces 66,225 MWh/year. Even with such improvements, you would still need 63 of these turbines, which seems more plausible.

The scalability issue becomes even more exacerbated with solar. For example, the United States is in the process of beginning to build one of the more advanced solar farms in the world, called the Gemini Solar Project in Nevada. When completed, the generation facility will have a size of 690 MWs, and the total land mass it will take to build this array is roughly 7100 acres. For perspective, Central Park in NYC is about 840 acres. So, the size of the Gemini Solar Project is the size of about 8.5 Central Parks.

With a capacity factor of 25%, the total MWh/year comes out to 1,511,100 MWh/year. Thus, you would need nearly three Gemini Solar Projects to equal the average energy output of the average natural gas power plant.

We have seen huge improvements in renewable energy tech; however, total scalability of the U.S. energy grid is not feasible (yet).

Impact from Covid

Due to COVID-19, the energy sector as a whole saw the largest drop in investments in history. The sector as a whole experienced a roughly 20% decline in investments, which includes renewable energy projects. Many believe this is a temporary setback, and preliminary earnings reports seem to agree in some cases while other companies are still reporting negative revenue growth.

Stocks We are Watching

Renewable energy companies that generate free cash flow and have strong balance sheets have a competitive advantage over financially weaker rivals, since they have greater access to the capital needed to finance growth. That's why investors should focus their attention on financially strong clean energy companies.

Although this is not an extensive list, we spell out our thoughts on why a couple of names make our watchlist and why others don’t. We are providing this in case it’s helpful as renewables often have quarters with negative revenue growth, etcetera, so more depth into why we ignore this in some cases and not others may be helpful.

Plug Power:

Plug Power is a high growth company within renewables, and thus has attracted a very high valuation. As we covered before, management is expecting high growth over the next several years, believing that in 2024 it will earn $200 million in operating profit and record gross billings of $1.2 billion (gross billings will be $325M-$330M in FY’20). 

Per our previous coverage, HC Wainwright projected Plug's revenues in 2024 will be about $1.1 billion — more than four times the company's trailing revenues currently. Current consensus is projecting Plug to grow revenue 40% next year in FY 2021.   

In Plug’s most recent earnings report, the company “reaffirm(ed) the recently raised gross billings targets for 2021 and 2024.”  Plug Power’s accounting issues have also been cleared up with minimal impact on the overall financial outlook of the company. The company reported 76% growth in revenue year-over-year for $72 million in revenue which was less than analyst expectations at $77 million. There was also a EPS miss at ($0.12) compared to ($0.08) expected.

Why has the stock done well despite a weaker-than-expected earnings report? My guess is because Plug Power is the fastest growing company within the renewables sector and the underlying key metrics are stronger than the surface-level ER reveals. Although profitability is an issue, Plug Power’s fuel cell systems segment is growing rapidly and this is the company’s most profitable segment.

Gross billings are also very healthy. Here is what the CEO said in the last earnings call:

“Investors should expect $115 million to $120 million of gross billings for the quarter. This is approximately 40% of our target revenue of $475 million for the year. Usually, at this point in the second quarter, […] 33% of our annual revenue will have been achieved. We are at a run rate that is higher from both a revenue and growth rate level than we have experienced in the past.”

Plug Power is at the top of our list right now for renewables.

Enphase:

Enphase has done well because it’s a safer choice than many other renewables as the company has been consistently profitable for many quarters (9 out of the last 10). The company has an adjusted gross margin of 41% with adjusted EPS in the most recent quarter of $0.56.

Not only is Enphase consistently profitable yet the company has maintained industry-leading growth. The most recent quarter reported 46% growth year-over-year and 14% sequentially. In 2019, Enphase was in the 75%-100% growth range. This is important because the company is very consistent where other solar stocks are not.

During Covid, there was a brief pause in revenue growth in Q3 and Q2 of 2020. The company reported flat growth in Q3 2020 and -6% growth in Q2 2020. For this industry, that is not bad at all and is actually a sign of strength that Enphase bounced back faster than it’s peers.

The company has a cash balance of $1.48 billion. In March, the company issued convertible notes due 2024 and 2025 for net proceeds of $1.19 billion.

For the second quarter, Enphase management guided for $300 million to $320 million, or 140% growth. Again, this is due to the weaker quarters the company had last year during Covid, which were flat to negative. It’s better to look at the growth on an annual basis, which is expected to be 70% growth for FY 2021 with analysts expecting $1.32 billion this year, up from $774.4 million.

Enphase is at the top of our list for renewables.

SolarEdge:

SolarEdge competes with Enphase yet does not have the same consistency as the company has reported flat to negative growth for four quarters. The company reported revenue of $405.5 million, or (6%) year-over-year yet up 13% sequentially.

Adjusted gross margins are at 36.5%. The company has $515 million in cash.

Looking forward, SolarEdge is expecting $445 million to $465 million in revenue, or an increase of 37% for the upcoming quarter. The annual growth for FY2021 is expected to be around 29% with the year after at 25.3%.

We will keep an eye on SolarEdge for improving financials.

Blink and ChargePoint:

ChargePoint operates the largest online network of independently owned EV charging stations operating in 14 countries. The adjusted gross margins are in the 20-25% range.

We like this company for its strong cash position and steady forward growth. Revenue increased 24% year-over-year to $40.5 million with management guiding for $46 to $51 million in revenue next quarter. The company also confirmed its revenue outlook of $195 to $205 million for FY 2022 ending in January. This represents 37% growth year-over-year. The company has cash and cash equivalents of $610 million after exercising warrants worth $73.8 million.

Blink is a fast-growing company with revenue growing 72% year-over-year and charging stations growing 370% year-over-year. However, the company has very little revenue to speak of with $2.2 million in the first quarter. It’s easier to put up triple digit numbers with a low revenue base. The company also losses of $7.4 million that have gotten steeper as the company grows, up from losses of $3 million in the previous year.

We wanted to highlight these two to show why we prefer Stem as our high beta play. Not only is Stem growing faster but plans to be profitable this year. Notably, we also have exposure to EVs through Xpeng and Nio. We’ve owned Tesla and Lucid Motors in the past.

Stem:

Stem has over 900 systems operating on its Athena AI software in over 200 cities worldwide. Athena AI optimizes time-of-use and demand charges, resulting in 10% – 30% monthly electricity bill reductions.

The company is still in its infancy with $33M in net revenue for the FY 2020. Revenue is projected to grow 348% YoY in 2021 to $147M. With the way the company recognizes its sales, 88% of its forecasted 2021 revenues are from contracts that have already been executed. This means there is minimal risk that the company will fall short of its 2021 revenue target of $147M. Notably, the company has a pipeline of $1.43 billion.

The company reaffirmed its 2021 financial guidance for $147 million in the latest earnings report on May 17th. The company also outlined they expect nearly half of the annual revenue to come in Q4.

Revenue came in at $15.4 million in revenue compared to $4 million in the year, up nearly 275%. Adjusted gross margins were at 19% compared to 1% a year ago.

The company expects to reach adjusted EBITDA profitability in 2022 and turn FCF positive in 2023. Gross margins are expected to improve to 38% by 2025. The gross margin improvement will be driven by Stem’s increasing software revenue, which is the highest margin portion of their business (~80%)

Stem is a newer company that must prove itself. On that note, we are very bullish on this company for the exposure to software within the renewables sector that this particular investment provides. Notably, Stem is the one renewables stock and the only SPAC we remained with during the sell-off. Please reference our Stem position on the portfolio and our past research here.

iSun:

iSun offers solar, energy and data solutions. The company is a “deSPAC” or basically SPAC post-merger that has very low gross margins. In the most recent quarter, the company reported $7.26 million in revenue yet had only $119,000 in gross profit. This nearly $0 in gross profit is a pattern in previous quarters, as well. We see this company as too high risk for an entry at this time. The margins would need to improve substantially for consideration.

Bloom Energy:

Bloom Energy has revenue of $194 million per quarter, an increase of 23.8% year-over-year. The adjusted gross margins are at 29% with adjusted EPS of ($0.07). The company has negative operating margins of (7.4%) in the first quarter of 2021 which is an improvement from the (29.6%) operating margin in the first quarter of 2020.

The company has cash of $365.7 million and debt of $522.2 million.

Management guided for forward revenue of $950 million to $1 billion for FY 2021, or 25.7% growth. The company was flat last year and saw very low growth the year prior.

Overall, this company is not high growth enough for our portfolio.

Conclusion:

One reason why the renewables sector is at a starting point (and we are not seeing the full picture yet in terms of financials) is that Moore’s Law applies to renewable tech. For example, the cost per watt in solar has gone from $22 in the 1980s, to $3 in 2011, and is now about $2.90 per watt. In fact, MIT released a report explaining how close we are to $0.20 per watt, which will make the economic benefit of transitioning to solar a real driver for both individuals, businesses and municipalities.

Right now, we rate Plug Power slightly higher than Enphase in terms of positions we want to build. We are also reiterating our conviction on Stem compared to other high beta plays in this sector. We believe these are the top three choices – Plug Power for growth, Enphase as a market leader and Stem for its position with the Athena AI software and strong revenue growth out the gate.

Stem Energy (STPK) Update

Posted on by io-fund

We recently increased our allocation to Stem Energy (STPK) and we are revisiting the stock in the write-up below. I originally covered Stem Energy (STPK) in detail in early February here and later here.

On a fundamental basis, nothing has changed with Stem (STPK) since the last time I covered the company.  The stock has followed the way of most all SPACs during the recent Nasdaq correction.  In a risk-off trading environment, SPACs and more speculative investments with little or no revenue are typically the hardest hit.  The Defiance Next Gen SPAC ETF SPAK still sits over 23% down from its all-time-high price.

SPACs have been grouped together by many investors and sold off together with no attention paid to the underlying company beneath the shell.  The fact is SPACs typically have little or no revenue, so investors can easily rationalize selling these stocks first when the market environment turns bearish.  That is why it is important to step back and remind yourself why you invested in these companies in the first place.  In the case of STPK, we continue to have a high conviction because nothing has changed with the thesis that led to our initial investment.  The only thing that has changed is the stock price as STPK has been sold off along with hundreds of other SPACs that have been grouped together in one category.

STPK has shown solid relative strength in the face off the recent SPAC sell-off, outperforming the SPAK ETF notably YTD.  Below, we compare STPK’s performance to some of the most notable SPACs of 2020:

As time goes on, SPACs will no longer be categorized as just that.  In the future, the underlying business fundamentals of these public companies will be the biggest factor in how the stock performs.  To get to that point, these companies may need to announce real revenue and cash flows to separate themselves from the hundreds of other SPACs with lofty projections. SPACs may never recover to all time-highs as a category; however, the very best SPACs will recover and shareholders will be rewarded. The goal is always to pick the leader and this may be more crucial in a high-risk category such as SPACs. Our allocation to STPK has increased as we believe the company is fundamentally stronger than other SPACs.

As previously mentioned, investors are taking a more cautious approach to SPACs and stocks in general.  For SPACs specifically, the market is taking a skeptical view that these companies can actually deliver on their projections.  From the market’s perspective, these companies are in “Prove It” mode in regards to their projections.  As time goes on and these companies begin to announce quarterly financials, it will become crystal clear which SPACs are actually able to deliver and which are not.

We embrace the concept of letting the financials do the talking because we are comfortable with Stem Energy’s probability of delivering strong results. Stem utilizes its proprietary AI software, Athena, to smartly store and deploy energy, resulting in 10% – 30% monthly electricity bill reductions for its clients.  Athena AI reduces volatility and enables solar generation time-shifting to support local grid capacity needs.  Stem currently has over 900 systems operating on its Athena AI software in over 200 cities worldwide.  The company currently has a 75% market share in California’s BTM storage market, which is the largest in the US.  In 2019, Stem was the leading commercial energy storage installer in California with 3x the kW installed as its closest competitor. 

Source: Citron Research

Over 75 countries, including the US, have committed to net zero emissions by 2050.  An additional 35% of Fortune 500 companies have made a commitment to Carbon Neutrality.  These are two massive tailwinds for Stem, as management estimates there is a projected $1.2T in new revenue opportunities for integrated storage that are expected to be deployed by 2050. 

Electricity production is the #2 polluter responsible for 27% of greenhouse gas emissions.  Stem’s product effectively reduces its client’s electric bills 10-30% and helps them meet their corporate ESG targets without changing the way the operate. 

Stem’s full revenue projections are below:

Source: Stem Investor Presentation

Stem has two distinct business segments comprised of hardware and software.  Stem makes money from their hardware segment with upfront payments for initial purchases.  The company is targeting 10%-30% gross margins for the hardware segment of the business. 

The more profitable segment of the business is expected to be the software segment.  Stem’s software segment is a recurring SaaS model secured by 10-20 year contracts with monthly recurring cash flow.  Revenue is recognized ratably during life of the contract with additional upsell revenue opportunities from Athena applications.  Stem is targeting 80% gross margins for the software segment of their business and is expecting the software segment to be the main driver of gross profit by 2026.

Source: Stem Investor Presentation

Stem currently has over $200M of contracted backlog and over 100% of its $147M revenue projection for 2021 already locked in.  While many SPACs will likely fail to meet their estimates, we expect Stem to deliver a nice upside surprise on the $147M estimate.

After the transaction with Star Peak Energy Corporation is complete, Stem will have $525M in net cash and 0 debt to capitalize on growth opportunities.  The company plans to use the majority of this cash to fund future growth while also using about 3.6% for estimated repayment of debt.    

For a more detailed report on Stem’s business, I first covered the company in detail here and again in late February here.  Jim Cramer, who has been critical of the SPAC market in general, has recommended STPK as 1 of his top SPACs to own for the future. 

Stem has a solid management team that includes former executives at First Solar, General Electric, and Siemens. CEO John Carrington worked as General Manager and Chief Marketing officer at General Electric for over 16 years where he led global innovation, new technology efforts and product strategy.  In total, Stem has 145 employees and a management team with former leadership experience at technology, energy, and industrial companies.   

Stem has a list of clients that includes Apple, Amazon, Google, Facebook, and Walmart and a backlog of contracts that will drive future growth beyond 2021.  We believe Stem is positioned to win many more contracts in the future as renewable energy becomes a bigger part of the economy.  In my last report covering Stem, I wrote the following:

“There remains a great deal of untapped potential for energy efficiency improvement through implementation of new technologies.  Stem is ideally positioned to be an industry leader in the energy storage market as more companies follow the path that Apple and Amazon have already taken.”

This remains true despite short-term price movements in the stock.  We believe Stem is one of the best companies to go public via the SPAC method and has a very bright future ahead of it.  We remain bullish on the name and bullish on the renewable energy industry.  We look forward to the company releasing financials because we are confident it will serve as validation for our investment.     

Due to SPACs being volatile in nature, we lean heavier on technical analysis and only buy at key levels. Knox Ridley will update readers as he enters new tranches in this company.