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

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

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

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

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

Revenue and EPS:

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

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

Source: YCharts/Seeking Alpha

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

Source: Company IR/Seeking Alpha

Margins:

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

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

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

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

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

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

Cash Flow:

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

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

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

Key Metrics:

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

Source: Earnings Call Transcripts

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

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

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

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

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

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

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

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

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

Update on Net Energy Metering (NEM) 3.0:

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

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

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

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

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

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

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

Per SolarBuilderMag, Enphase has previously stated the following:

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

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

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

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

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

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

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

Third-Generation and Fourth-Generation Battery:

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

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

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

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

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

Inflation Reduction Act (IRA):

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

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

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

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

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

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

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

IQ9 and IQ10 Microinverters:

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

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

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

Channel Inventory:

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

Julien Dumoulin-Smith

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

Badri Kothandaraman

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

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

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

Valuation:

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

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

Conclusion:

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

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

If you own ENPH or are looking to own ENPH, please join us on our weekly webinar where the Portfolio Manager goes into great detail about our positions and buy plans for each stock. On the Advanced premium plan, we offer real-time trade alerts for every buy/sell or add/trim. Learn more about Advanced Market Signals here.Learn more about Advanced Market Signals here.

Recommended Reading:

• CrowdStrike: Steady Growth, Strong Bottom Line
• Lam Research: Wafer Fab Equipment Leader & HBM/DRAM Memory
• AEHR: Strong Top Line & Strong Bottom Line – Fiscal Q4 2023 Earnings
• Enphase – Post Q123 takeaways
• Enphase – what to look for in Q1
• Enphase Q4 Earnings: A Perfect 10
• First Solar Q1 Earnings: IRATC Timing, Strong Backlog, Higher ASP Per Watt

In our First Solar deep dive and Q123 earnings preview, we pointed out that post Q1 may provide a better entry point mainly due to the timing of the IRATC recognition. In Q4, management had guided that the IRATC will only begin to make a meaningful impact after Q1.

Despite First Solar’s timing guidance, consensus expectations were elevated going into the first quarter and was disappointed by the amount of the Q1 IRATC recognition. Taking the high end of $710 million in IRATC 2023 guidance, First Solar recognized $70m or about 10%.  They expect to recognize 25% in 1H and the rest in the 2nd half of the year. This equates to $108m in Q2 and $532m in Q3/Q4, respectively.  

Importantly, First Solar did not change their 2023 guidance. However, it does indicate that earnings will be heavily weighed toward the 2nd half.

Key earnings highlights

• Q123 sales were $583 million, up 49% y/y and down 45% sequentially. Sales missed consensus expectations of $713
• Q123 eps was $0.47, vs a loss of $0.41 in 2022. EPS missed consensus expectations of $0.86  

The lower than expected sales was mainly due to the timing of module sales and higher logistics costs that were partly offset by higher ASPs. Gross margins were 20% vs 25% in Q1 2022.

Reviewing the key points we were looking for going into Q1.

1.     Any revisions to the treatment, timing or total amount of the 2023 IRATC?

First Solar reiterated full year sales of $3.5b and IRATC amount of $660-710 and $0.17 IRATC per watt. For the first time, they shared the IRATC timing recognition – 25% in the first half and 75% in the second half.

From a timing perspective, First Solar is still mainly selling inventory that was made in 2022 and not eligible for the full IRATC in 1H23. As the year progresses, they will start to sell more inventory made in 2023 and the amount of the IRATC recognized will increase accordingly.

From a legislative perspective, there is still a tug-of-war to finalize the details of the IRA bill between the Treasury and Congress. It comes down to Assembled vs Made in the USA. The former relates to companies that apply for waivers to procure certain components overseas, assemble the final product domestically and then attempt to qualify for the IRATC.

This is how First Solar characterized it:

“I would like to take a moment to discuss the policy environment in our key markets. In the United States, with respect to the Inflation Reduction Act, we continue to await guidance related to the domestic content bonus provision.

We believe it is imperative that the United States Treasury Department issued guidance consistent with the Congressional intent of the IRA, which is to nurture true domestic solar manufacturing, ensuring a robust domestic supply chain for American made solar modules. It is critical to guidance recognized that to qualify for the bonus. At a minimum, the manufacturing of solar cells must occur in the United States. This is not only consistent with clear objective of the IRA, but is also supported by the legal framework under the Buy America Act Regulations expressly referenced by Congress in the enactment.

While the intent of the IRA and regulations governed and are clear, it is unfortunate that sections of the industry are advocating that treasury grant some form of waiver that would allow bonus credits for solar panels assembled using 4 subcomponents, such as solar cells. We believe that any such waiver runs contrary to the letter of the law and Congressional intent. The purpose of the bonus credit is to incentivize domestic manufacturing and the creation of a domestic solar supply chain and not to create an entitlement simply to support foreign manufacturers.”

An outcome closer to the Congressional intent rather than the Treasury will enhance First Solar’s competitive position due to its vertically integrated US operations.

2.     On track to meet production targets and update on contracted backlog?

First Solar’s contract backlog grew from 61.4GW in Q4 to 71.6 GW in Q1. The current backlog is about 6x 2023 production capacity. They’re sold out through 2026, ex-India. Volume sold targets remained unchanged at about 12 GW. US capacity expansion plans in Ohio and Alabama are on track.

3.     Update on capex plans and related financing

First Solar finished Q1 with cash and equivalents of $2.3 billion vs $320m in debt. First Solar expects the year to end at about 1.35 billion after capex. Q123 capex was $371m and fcf was negative $336m.

Typically, First Solar requires 20% of the contract upfront to secure it. Given their sold out orderbook through 2026, First solar is requesting that a greater portion of 20% deposit in in cash, which is reflected as deferred revenue on the balance sheet. Currently, this stands at $1.2 billion. This provides a significant portion of the financing required for expansion.   

First solar confirmed it does not rely on super regional banks for banking services nor financing. They did not indicate that any of their clients, mainly large utilities, are experiencing difficulties either.

4.     ASP per watt?

Since the beginning of 2023, pricing dynamics are trending higher. First Solar ended 2022 with a contracted backlog of 61.4GW at an average ASP of $0.288 per watt.

In Q1, it ended with a contracted backlog of 69.4 GW, at an avg ASP of $0.295 per watt. New bookings since the Q4 earnings call, totaled 4.4GW at an average price of $0.318 per watt. Management was constructive on overall ASP in the future. One driver is that large utility clients are looking to secure multiple year agreements and it appears First Solar has greater pricing power in those situations. 

“And generally, we see much higher volumes and larger agree purchasing power and a multiple-year agreement. You may see ASPs more aggressively into that situation. So I wouldn't attribute the increase to any one lever. But what I would say is that we're still very happy with the market and the opportunity and the ASP that we're receiving”

Meanwhile, adjusters are a potential source of earnings upside starting in Q2.

“So we are currently processing additional amendments associated with providing U.S. manufactured product, which will be reflected in our Q2 contracted revenue backlog when reported. As we previously addressed, a substantial portion of our overall backlog includes the opportunity to increase the base ASP through our application of adjusters, we're able to realize achievements within our technology road map as of the required timing for delivery of the product.”

5.     Any improvement in logistics costs that was a significant drag on 2022 earnings?

Logistics continue to be a drag on gross margins. Management stated the following:

“Although logistics costs decreased during the quarter, they continue to remain elevated relative to pre-pandemic levels. During the first quarter, they reduced gross margin by 15 percentage points. As we look to the second half of the year, we expect to see a reduction in logistics costs.”

First Solar’s Q1 gross margins ended at 20%, which demonstrates how much logistic costs detracted from profitability. To provide a recent historical context, logistics costs reduced gross margins by 19 percentage points in 2022, 11 percentage points in 2021 and 6 percentage points in 2020. So they are off the peak but still have not returned to pre-pandemic levels. A return of somewhere between 2020 and 2021 levels will be a source of positive upside to gross margins.

6.     2023 earnings expectations

It’s helpful to take a step back and examine reported 1Q23 eps vs management guidance and consensus expectations. At the end of q422, First Solar guided for a 2023 eps of between $7-8. They provided no 1Q23 guidance except that the IRATC benefit will be seen after Q1. Consensus forecasted  $0.86 Q1 eps or 11% of the midpoint of First Solar’s 2023 eps guidance.

First Solar reported an actual Q1 eps of $0.41, less than consensus, and 5% of their 2023 guidance. First Solar maintained their FY 2023 guidance of $7-8. Put another way, whether they met or missed, Q1 was not expected to be significant quarter in 2023 by management nor consensus.  

Rather Q1 was more of a transition quarter in a post-IRATC world. Consensus likely overestimated the impact of the IRATC and underestimated logistic costs still being a drag on gross margins.

Conclusion

In the Q1 call, management stated the following:

“I would like to reiterate that from an earnings payment perspective, as previously noted on our February earnings guidance call, we anticipate our earnings profile will be higher in the second half of the year due to contractual delivery schedules, timing of first sales of our Series 7 products and the timing of recognition of Section 45X benefits, driven by both the timing of volumes sold as well as the inventory lag where our product sold in the early part of 2023 may have been manufactured in 2022.

We are maintaining our 2023 guidance in full, including full year earnings diluted share of $7 to $8.”

Objectively speaking, First Solar was straightforward in the q4 call on its 2023 earnings cadence  and how short-term inventory timing and continued normalization of logistic costs through 2023 meant earnings would be 2nd half weighted.

Meanwhile, First Solar’s 2023 IRATC and EPS guidance before Q1 also painted a compelling earnings picture in 2024 and 2025 which led to positive earnings revisions. However, the market’s expectations got a bit ahead of itself in Q123. It is why we felt post Q1 could offer a better entry point.

The fundamental story in terms of order book growth, contracted backlog, and increasing ASPs supported by important legislation are still in place. The team believes that First Solar is one of the “national champions” of the IRA bill, so for now we are willing to look through Q1 and give credibility to their 2023 guidance. 

However, First Solar will have to show in Q2 that Q1 was in fact just a transition period into a post IRATC world. If they do, this will give more support to their 2nd half forecasts which indicate significant earnings power not just in 2023 but possibly through 2025.

Post Q1, consensus is forecasting $1.17, $2.49 and $3.18 for Q2, Q3, and Q4 respectively. Which would equate to $1.64 in H1 and $5.67 in H2 for a total of $7.31.

Based on consensus eps 2024 $13.44 and 2025 $20.14 estimates, the valuation is not demanding.

Recommended Reading:

First Solar – What to look for in Q1
Enphase – Post Q123 takeaways
Inflation Reduction Act – How and which companies will benefit? First Solar Deep Dive
Enphase Q4 Earnings: A Perfect 10
Solar Stocks: Enphase, Stem and First Solar
Solar Stocks Lead The Market This Year As Energy Crisis Heats Up

Enphase reported Q123 earnings on 4/25/23 after the market close. Enphase reported better than expected sales, gross margins and normalized eps.

·       Q1 sales came in at $726m, above consensus of $720m and flat sequentially

·       Non-gaap gross margins improved to 45.7%, compared to 43.8% in Q4

·       Non-gaap eps was $1.37 vs $1.22 consensus

·       Generated $224m in fcf and ended Q1 with $1.78b in cash and cash equivalents

For Q223, Enphase guided to the following

·       Sales of between $700-750 million vs consensus of $760 million; taking the midpoint this is flat sequentially and lower than consensus

·       Non-gaap gross margin 43.5%, down sequentially

The lower sequential guide, driven mainly by weaker conditions in states outside of California, has been the main driver in the price reaction. However, the price seems to have overextended to the downside.

We will review the key points we outlined in our preview.

1.     Outlook for the European business

Europe continues to experience healthy growth in their core markets of Netherlands, France, Germany, Belgium, Spain, Portugal and the UK.  Europe was up 21% sequentially. Non-gaap gross margins are greater than 45%. Their sell through at the end of Q1 was at an all-time high. Enphase expects Q2 to be better than Q1 and their business is growing much faster than expected. Channel inventories are also healthy. The plan to expand into new counties is on track. Their non-US business currently comprises 30% of revenue and has helped offset weakness in the US.

2.     Orders US residential installer level

As we outlined in our preview, this is an important driver of the stock price for 2023. The market was looking for signs of stabilization in the US. California accounts for 20% of total revenues. Although down 9% sequentially, CA was in-line with seasonal trends supported by NEM 2.0 and installers are building 3 to 4 months backlog.

It was in the states outside of California, down 25% sequentially, that was weaker than expected. This is how Enphase described it.

“As I said earlier on this call, our sell-through of microinverters in the US was 21% lesser in Q1 compared to Q4. Our sell-through in California was only 9% lesser than Q4. There was some impact due to the weather in early Q1, but the NEM 2.0 rush in Q1 more than compensated for it. 

California installers took advantage of the NEM 2.0 rush and have built up a solar backlog for the next three to four months. We believe when the stockholders aren't expanding their crews to accelerate installation, they're laser focused on their cash flow due to the high interest rate environment and are looking clarity — for clarity on the NEM 3.0 demand.

Sell-through of our batteries in California was 23% lesser in Q1 compared to Q4, as installers focused mainly on solar. We expect this trend to continue for the next three to four months. After that, we see NEM 3.0 as a net positive for California and expect strong demand to resume for solar plus storage.

Let's cover the rest of the US. The sell-through of microinverters in non-California states was 25% lesser in Q1 compared to Q4. We observed that the sell-through was even lower in states with low utility rates such as Texas, Florida and Arizona. In these states, the economics of loan financing has worsened due to rising interest rates.”

This is how Enphase described the environment installers are facing.

“Our installers, in general, are navigating three key challenges: first, the rapid increase in interest rates over last year; second is switch from selling low APR with high dealer fees, the selling market rate loans with low dealer fees; and third, the delayed payment from the loan originators or as the industry calls it, reduction of M1 payments.

Let's discuss about the second and third challenges. We see the move to high APR and low dealer fee loans as a positive for the industry. The demand for market rate loans remained strong. New capital providers who were not able to buy below market rate loans are now offering solar financing. Installers are adjusting their sales practices for a higher interest rate environment.

We are also seeing new lease providers entering the market with focus on servicing the long tail. We think capital will be available for both long-tail — for long-tail installers regardless of the mix of loan and lease.

On the reduced M1 payments, loan originators are providing less cash to installers at the time of contract signing and a greater percentage after installation. This creates a working capital challenge for the installers and is forcing them to become more efficient.

As the installers adjust to this new reality, we expect the sell-through of microinverters and batteries to incrementally improve in Q2 compared to Q1. Q2 is seasonally stronger and should help the situation even more.”

Enphase expects these conditions to improve in Q2.

“So I think it's going to be interesting to watch the situation in the next few quarters. But I think this is a resilient industry. And I believe things are only going to get better from here. Q1, as I indicated, is usually the worst quarter of the year due to seasonality. And so that — Q2 is usually a good quarter in terms of seasonality and with the adjustments installers are making in running their business, we expect things to be incrementally better.”

In terms of revenue California is the biggest at 20%. But what these comments highlight is that in aggregate other states are just as important and have their own different macro drivers both at the installer and consumer level.

On the positive side, Enphase expects pricing to remain firm.

“Question: First one's on pricing as a follow-up to a prior question. Our check suggest pricing through the US resi ecosystem is coming down rapidly. So US resi solar module pricing is down 15% to 30-plus percent. Powerwall pricing is down. Meaningfully some of your inverter peers have lowered inverter pricing. We've heard that you guys have — you may have lowered pricing as well for specific larger customers on a one-off basis. I think, Badri, you just mentioned that you don't see any drop in pricing, but can you talk — can you give us some more color on how you expect to maintain price, especially in this more difficult environment? And can you talk about price specifically in Q3 and Q4, if you expect it to hold, how does it hold? And if there is some risk, maybe talk about that risk? Thanks.

Answer: We don't see any drop in pricing. In fact, we see our gross margin sequentially up a couple of percent from Q4 to Q1. And also, I broke out the gross margins in Europe because some of you had been asking me. The gross margins in Europe are incredibly healthy. They're over 45%. The gross margin in the US is incredibly healthy.

Pricing is stable for us. Gross margin means both price as well as cost. And so we do value-based pricing, which is basically price products based upon the value they bring compared to the next best alternative like alkaline batteries, it may be increased power, increased safety. In microinverters, it may be increased quality, increased service. So that's on the pricing side.”

3.     Status of US based manufacturing operations

Enphase is on track to partner with 3 different manufacturers to add inverter capacity in the US. Upon completion, the US will be almost 50% of total global capacity.

“Let's come to US manufacturing. As we discussed last quarter, the IRA, Inflation Reduction Act, will help bring back high-tech manufacturing to the US and stimulate economy through creation of new jobs. We are opening manufacturing lines with three different manufacturing partners, adding a capacity of 4.5 million microinverters per quarter, bringing our overall global capacity to 10 million microinverters per quarter as we exit 2023. We expect to begin US manufacturing with one partner in Q2 and with the remaining two in Q3.”

4.     Potential earnings benefit from Inflation Reduction Act corporate tax credits

Enphase confirmed they will also deduct the IRATC from costs of sales.

“Now I'd like to discuss how the advanced manufacturing production credits from the IRA will be reported in our earnings while waiting on the implementation guidelines from the US Treasury. Based on the current guidelines, the production credit can be claimed as direct pay or in the form of tax credit. Under direct pay, the production credit will be accounted for as a reduction in cost of goods sold. And in tax credit, you will be reported in the tax expense line.”

“Incrementally we will provide us the same dollar impact to our earnings per share as the production credit is nontaxable. We expect the production credit net of any incremental costs for domestic manufacturing to be in the range of $20 to $30 per microinverter sold to customers. We expect to ship 50,000 net in USA microinverters to customers this quarter. We plan to have our US contract manufacturing facilities to be fully operational by the end of 2023. We estimate shipments to reach our US capacity of 4.5 million microinverters per quarter by the end of 2024, assuming robust demand.”

We outlined in our preview the base case for potential gross margin improvement from the IRATC. Given the timing on manufacturing capacity, we likely won’t see a gross margin uplift until the end of 2023 into 2024.   

Conclusion

For Enphase, Q1 was a tale of two regions. The core markets in Europe are strong and entry into new markets is on track. On the other hand, the US is starting to feel the impact of higher interest rates as installers adjust to the changing financing economics.

Until there are signs that the US has bottomed out and is improving, this will be a headwind. Meanwhile, any hoped for uplift from the IRATC won’t be seen until the medium-term.

Recommended Reading:

https://io-fund.com/premium/enphase—what-to-look-for-in-q1
https://io-fund.com/premium/enphase-q4-earnings-a-perfect-10
https://io-fund.com/premium/first-solar-what-to-look-for-in-q1
https://io-fund.com/premium/inflation-reduction-act-how-and-which-companies-will-benefit-first-solar-deep-dive

We recently did a deep dive into the Inflation Reduction Act (IRA) and its key provisions here. We identified First Solar (FSLR) as a key beneficiary of the bill and analyzed how it would impact its profitability. First Solar has been one of the few companies that have provided clear guidance on how Section 45x of the Inflation Reduction Act and the related Corporate Tax Credits (IRATC) would impact its 2023 earnings.   

First Solar is due to report their q123 earnings on 4/27/23 (amc). This is an important quarter because it is the first where the market will be able to assess the impact of the IRATC. There are several key factors that investors will be looking for.

1.     Any revisions to the treatment, timing or total amount of the 2023 IRATC?

2.     On track to meet production targets and update on contracted backlog?

3.     Update on capex plans and related financing

4.     Outlook on ASP per watt?

5.     Any improvement in logistics costs that was a significant drag on 2022 earnings?

6.     2023 earnings expectations

We will cover each point in more detail below.

1.     Update on IRATC

In its Q422 earnings call, First Solar stated that it had consulted with various regulatory bodies and was advised to treat the IRATC as a reduction in the cost of sales. This accounting treatment has a direct impact by increasing gross margins.  

“Following consultation review with outside advisers, our auditors and the SEC, we expect to recognize these credits as a reduction to cost of sales in the period such modules and the integrated eligible components are sold to customers”

“I’ll now cover the full year 2023 guidance ranges. Our net sales guidance is between $3.4 billion and $3.6 billion; gross margin is expected to be between $1.2 billion and $1.3 billion, which includes $660 million to $710 million of advanced manufacturing production tax credits under Section 45X of the IRA This results in a full year 2023 earnings per diluted share guidance range of $7 to $8.”

Taking the mid-point of the 2023 IRATC and sales guidance, this would result in gross margins of 36% compared to 16% without the IRATC.

We will look to see if management provides any updates to the guidance above. Management indicated that the IRATC will begin to make a more meaningful contribution after Q1. Indicating that the gross margin uplift will be more visible after Q1.

“Section 45X credits, recognized, will increase after Q1, driven by both the timing of volumes sold as well as the inventory lag, whereby products sold in the early part of 2023 may have been manufactured in 2022.” 

2.     On track to meet production targets and update on contracted backlog?

First Solar ended 2022 by manufacturing 9.1 GW of capacity. For 2023, they have guided for 11.5 to 12.2 GW. Meanwhile, their contracted backlog stands at 61.4 GW. This is about 5x their estimated 2023 production capacity.

First Solar is currently expanding its capacity in Ohio and Alabama. By 2024, they estimate that about 50% of their total production capacity will be US based.

We will look for updates on these targets for any meaningful changes. For example, if their US capacity is ahead of plan, how this may impact the amount and timing of the IRATC.

3.     Update on capex plans and related financing

In the Q4 call, First Solar indicated they did not require external financing.

“Operationally, in 2023, we’re expecting to produce 11.5 to 12.2 gigawatts of modules, and after taking into account reductions in inventory, fell 11.8 to 12.3 gigawatts. From a capital structure perspective, our strong balance sheet has been and remains a strategic differentiator, enabling us both to weather periods of volatility as well as providing flexibility to pursue growth opportunities including self-funding our Series 6 and Series 7 transitions.”

We ended 2022 in a strong liquidity position. And coupled with strong forecasted operating cash flows, modular advance payments and our existing India credit facility, we expect to be able to finance our current capital programs without acquiring external financing. We are evaluating putting in place our revolving credit facility to support jurisdictional cash management as well as to provide short-term optionality and expect to address more details on our capital structure and liquidity outlook at our Analyst Day.”

4.     Outlook on ASP per watt?

In Q4, First Solar stated:  

“We had a total contracted backlog of 61.4 gigawatts with expected future revenue of $17.7 billion for a portfolio average base ASP of $0.288 per watt, before the application of potential adjusters”

The potential adjusters apply to their domestic production and are impacted by the IRATC. These adjusters are an important source of potential upside to domestic ASP and earnings.

First Solar has also guided to an IRATC of $0.17 per watt, which is effectively an addition to the   ASP per watt ($0.288 + $0.17). Any indication that either or both will increase is a positive.

We will look for updates on these pricing dynamics for 2023.  

5.     Any improvement in logistics costs that was a significant drag on 2022 earnings?

2022 was a difficult year for First Solar. Gross margins were 2.2% vs 25% in 2021. A main factor was higher than average logistic related costs due to the pandemic that other solar companies faced. Demurrage costs – financial penalties incurred for leaving goods on the port beyond the agreed time – were particularly a heavy burden.

Management indicated that they expect a return to normalized levels over the course of 2023. Other solar companies that reported Q4 after First Solar had begun to see significant improvement in logistics related costs. This could be an additional source of margin improvement for First Solar sooner than expected.

It’s important to point out that between the 2023 IRATC and the one-time nature of the 2022 demurrage costs, a year over year comparison of earnings between 2022 and 2023 is not necessarily an apple to apples comparison.

The IRATC has fundamentally changed the earnings profile of First Solar starting in 2023.   

6.     2023 earnings expectations

Given the new post-IRATC investing world, consensus expects Q1 sales to be $720m, an increase of 96% y/y.  And earnings to improve from a loss of $0.41 to a gain of $0.94. FY 2023 earnings are 2nd half weighted.  

Given the accounting treatment of the IRATC, the primary focus should be on earnings per share.

Quarterly

Yearly

Yearly

How to position ahead of Q123?

Year to date First Solar is up about 45%, reflecting the optimism post their 2023 IRATC guidance in their Q4 call. Consensus revisions have also been increasing as a result, mainly 2nd half weighted.

Suffice to say, positive expectations have been building up going into the report. Given First Solar’s prior comments that “Section 45X credits, recognized, will increase after Q1”, this timing effect may provide a better entry point.

First Solar has guided for 2023 EPS of between $7-8 and total 2023 IRATC of between $660-710m. Any upward revisions to this guidance will be viewed positively. Additionally, if they provide any insight into beyond 2023, that will also be positive although it’s probably too early to expect that.

Fundamentally, we believe that the IRA is a significant piece of legislation and First Solar has positioned themselves as a National Champion in its implementation.

Recommended Reading:

Enphase – what to look for in Q1
Inflation Reduction Act – How and which companies will benefit? First Solar Deep Dive
Enphase Q4 Earnings: A Perfect 10
Solar Stocks: Enphase, Stem and First Solar
Solar Stocks Lead The Market This Year As Energy Crisis Heats Up

In 2022, Enphase rewarded investors with a 44% return vs the Nasdaq’s decline of 33%. During this time, Enphase surpassed consensus expectations each quarter through a combination of higher sales and margin expansion.  For Q123, the market is expecting $1.22 eps, an increase of 54% from 2022.

Q422 ended on a solid note which we wrote about here. For 2023 ytd, Enphase is down about 15%. We believe this is primarily due to lack of visibility into the short-term outlook for US residential solar installations that was exacerbated by the SIVB failure which we wrote about here.   

With that in mind, Enphase is due to report Q123 earnings on 4/25/23. These are the key factors we will be monitoring in the earnings release.

1.     Continued positive momentum in the European business

2.     Order visibility at US residential installer level

3.     Status of US based manufacturing operations

4.     Potential earnings benefit from Inflation Reduction Act corporate tax credits

We will discuss each and what we’ll be looking for in the earnings call.

1.     European Business

Currently, Enphase’s revenue breakdown is 71% US and 29% International. The main international markets are Netherlands, France, Germany, Belgium, Spain, Portugal and the UK. Q4 revenue was up 21% sequentially and 130% year on year. Enphase is on track to introduce the IQ8 inverter into new countries shortly. Meanwhile, q4 ended with a record sell-through and low inverter inventories at the channel level, reflecting continued healthy demand.  

Enphase ended 2022 with a quarterly production capacity of 5 million units. They are due to begin manufacturing in Romania which will manufacture an additional 1 million units.

We will look for continued positive momentum in Europe and entry into new countries.  

2.     Installer activity

Despite a strong q422 report and solid q123 guidance Enphase has underperformed this year. We believe it is due to these Q4 comments.

“Let’s now cover the U.S. We expect our U.S. business to be slightly down in Q1 compared to Q4, primarily driven by seasonality and the macroeconomic environment. We are seeing that our distributor and installer partners are a little more cautious in booking orders. We normally have a 6-month order visibility and that has been somewhat reduced as our partners watch their spending closely. On the sell-through of our microinverters, while December was quite strong for us we saw a more pronounced seasonality in January than normal.”

This “more pronounced seasonality in January than normal” took some air out of an otherwise solid earnings report. In addition, negative sentiment has also played a role. For example, there were concerns over the impact that technology sector layoffs may have on demand. Meanwhile, the rainy winter in CA – where Enphase derives 20% of revenues – was another factor that raised concerns that installations may be delayed.

SIVB’s subsequent collapse presented another potential headwind. The market is waiting to see if there’s any SIVB fallout at the installer level and consumer level. Module/Inverter manufacturers typically sell to the installers who then sell to the consumer. Installers typically provide financing to the consumer. So there is a concern how the SIVB fallout may impact the installers' ability to finance. This has been the biggest driver in the divergence in solar stock prices. After SIVB’s collapse the market punished those companies that relied more on US banks. Generally speaking, those that didn't rely on US banks for financing were viewed as being better positioned to weather the storm.  

For example, CSIQ has held up better because it relies on Chinese banks. On the other hand. RUN had received loans from SIVB in the past and had an active relationship. NOVA disclosed that it was in talks with the DOE to indirectly guarantee $3b in loans it is seeking from a US bank. So far, Enphase has not given any indications that financing is a problem. Starting last week, banks have begun to announce Q1 earnings and so far indications are that the SIVB impact has been limited.  

We will look for comments from Enphase on activity levels at the installer lever and order visibility.  

3.     Status of US based manufacturing capacity

The commencement of Enphase’s US based manufacturing is a key catalyst from an operational  and earnings perspective. We will discuss the operational importance here.

Currently, Enphase outsources all of its manufacturing to electronic contract manufacturers (ECM) mainly based in Asia. Currently, these ECM’s have the capacity to manufacture 5 million units a quarter. Enphase has plans to use a US based ECM to manufacture inverters in the US. Once that is finalized, Enphase will manufacture an additional 5 million units per quarter in the US that will commence in the 2nd half of 2023. They are targeting to produce a total of 10 million units by the end of 2023.

We will look for an update on the status of the US based ECM manufacturing. The timing of which will be a critical driver from an earnings perspective which we will cover next.

4.     Potential earnings benefit from Inflation Reduction Act corporate tax credits

We have recently written about the key provisions in the Inflation Reduction Act.

Briefly, those companies that can claim the corporate tax credit (IRATC) are able to deduct the amount from the cost of goods sold which has a direct impact on gross margins and earnings per share.

The amount that can be claimed depends on several factors and will vary for each company. For example, how much is actually manufactured in the US and when needed how much content is procured from countries which the US has free trade agreements with.

Given Enphase’s reliance on ECMs in the manufacturing process, Enphase will not be able to claim the full IRATC. Once Enphase starts using an ECM with US based manufacturing, it will have to “give away” a portion of the IRATC to the ECM.

However, Enphase can still potentially benefit from the IRATC portion that they keep. In the q4 call, they indicated a net $20 to 30 IRATC benefit to them once their US based ECM begins to manufacture units. Enphase has targeted 5m units by the end of 2023. The timing of which is important. The sooner it is online, the sooner they can realize the IRATC in their earnings.  

Using the same IRATC earnings framework in our previous IRA piece. We’ve put together a scenario analysis with three assumptions:

·       Scenario 1 – 100% of the planned US production is eligible for the IRATC and the impact on gross margins if they receive, $20, 25 or 30 per inverter

·       Scenario 2 – 50% of the planned US production is eligible for the IRATC and the impact on gross margins if they receive, $20, 25 or 30 per inverter

·       Scenario 3 – 25% of the planned US production is eligible for the IRATC and the impact on gross margins if they receive, $20, 25 or 30 per inverter

We’ve used scenario 2 as our base case. As can be seen in the blue highlight, at $25 per inverter, the impact on gross margins is potentially 47% compared to 42% ending in 2022.

This is currently not yet reflected in consensus expectations.

After the earnings release, we will look for further details on the timing and impact of the IRATC.   

Analysts’ comments going into Q123 

Despite the negative sentiment impacting the sector, analysts expect Enphase to report solid Q123 earnings.  

• Enphase Energy named short-term buy idea at Deutsche Bank. Analyst Corinne Blanchard placed a "Catalyst Call: Buy" on shares of Enphase Energy as a short-term investment idea. Enphase has been a material underperformer year-to-date, with the stock down 24% versus a 20% gain for its direct peer group, driven by a cautious tone from management in early January on U.S. residential demand and origination trends in the California market, the analyst tells investors in a research note. This has opened the opportunity for an attractive valuation level, says the firm. It believes the stock is well positioned in the short term and expects a "strong" Q1 earnings beat.
• Piper Sandler analyst Kashy Harrison upgraded Enphase Energy to Overweight from Neutral with an unchanged price target of $255. The analyst says Q1 U.S residential solar originations and sales were more favorable than feared, suggesting the U.S. is more likely to decelerate than decline during 2023. Decelerating U.S. coupled with significantly more international momentum than anticipated earlier this year may drive 40% sales growth for Enphase in 2023, the analyst tells investors in a research note. The firm views the company's Q1 earnings as a "critical update capable of validating" its view that Enphase can deliver attractive earnings growth within the current environment.
•  KeyBanc lowered the firm's price target on Enphase Energy (ENPH) to $311 from $363 and keeps an Overweight rating on the shares. The firm expects residential solar levered names to have a light Q1, as poor weather in key markets such as CA impacts deployments negatively. Nonetheless, KeyBanc also believes that Enphase is likely to deliver a solid quarter toward the top end of its Q1 guidance and produce above-consensus guidance for Q2. The firm is seeing indications of the company taking some market share from SolarEdge (SEDG).

Consensus is forecasting solid year over year EPS and Revenue growth.

Stock attributes

These are Enphase’s stock attributes that we continue to like.

• FCF generation, FCF yield currently 2%

• Valuation at lower end of historical range

Recommended Reading:

Inflation Reduction Act – How and which companies will benefit? First Solar Deep Dive
Enphase Q4 Earnings: A Perfect 10
Solar Stocks Lead The Market This Year As Energy Crisis Heats Up
Solar Stocks: Enphase, Stem and First Solar

China’s 2001 entry into the WTO marked the beginning of the golden age of globalization. This was the catalyst that led to the global outsourcing of domestic manufacturing capacity to lower costs regions in the world. As a result, world economies became more interlinked. In 2016, President Trump began his administration by imposing tariffs on China, one of the United States’ largest trading partners. This signaled globalization’s peak and the beginning of a shift downward. This shift has continued with the Biden administration and the passing of the Bipartisan Infrastructure Law (BIL) ($550B) and the CHIPS and Science Act ($53B). The legislative goal is to improve US economic competitive, innovation, and industrial productivity.

On August 16, 2022, Biden signed the Inflation Reduction Act (IRA). It directs new federal spending toward reducing carbon emissions, lowering healthcare costs, funding the IRS and improving taxpayer compliance. The IRA’s primary objective is to spur investments in US domestic manufacturing capacity. This most recent legislative action is another step toward the “Made in America” goal and increasing manufacturing national security. We have written about it and its key provisions here and here.

Here in Part One, we’ll go into more detail on the key characteristics of the IRA and the earnings impact by examining one company – First Solar (FSLR). Next week, in Part Two, we’ll discuss other companies that may benefit.

What is the IRA?

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

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

Who benefits from it the most?

The majority of the $394B in energy and climate funding will be in the form of tax credits. Corporations with US manufacturing capacity are the biggest beneficiaries with an estimated $216 billion worth of tax credits available. The tax credits are meant to provide an incentive for private domestic investment in clean energy, transport and manufacturing. Many of the tax incentives are direct pay, meaning they can claim their credit in that tax year and be paid the following year.

In addition to higher energy prices, the IRA’s corporate tax incentive has contributed to the Solar sector’s outperformance. 

How does this impact earnings?

The IRA has created a tailwind for the clean energy sector. Companies are now just beginning to discuss the potential earnings impact in their most recent Q4 commentary. Some have provided more details than others.

From an investment perspective, the key is to identify companies with US based manufacturing capacity that can collect these tax credits and whose earnings will benefit in a meaningful way.

We’ve identified First Solar (FSLR) as one of the biggest beneficiaries of the IRA. Due in no part to the fact that they have provided the most visibility as to how the IRA will impact their earnings. In doing so, they have provided a useful investment framework to assess how other companies may benefit. We will discuss this next week and cover Enphase and Tesla, just to name a few.

We also want to emphasize that tech will see very few tailwinds this year, so it makes sense to take our time and to drill deep into one tailwind we have identified.

How does the IRA Tax Credit (IRATC) work?

This is how First Solar described how the IRATC will work. 

“And finally, a few words on the Inflation Reduction Act. The IRA offers, amongst other incentives, production tax credits for solar modules and solar module components manufactured in the U.S. and sold to third parties. Although we continue to await guidance from the IRS and Treasury regarding these credits under Section 45X of the statute, based on our view of both the intention of the credit and the language of the legislation, we intend to begin recording a corresponding benefit in our financial statements in Q1 of 2023. Following consultation review with outside advisers, our auditors and the SEC, we expect to recognize these credits as a reduction to cost of sales in the period such modules and the integrated eligible components are sold to customers.”

In their 2023 guidance, they went on to say

“I’ll now cover the full year 2023 guidance ranges. Our net sales guidance is between $3.4 billion and $3.6 billion; gross margin is expected to be between $1.2 billion and $1.3 billion, which includes $660 million to $710 million of advanced manufacturing production tax credits under Section 45X of the IRA; and $110 million to $130 million of ramp and underutilization costs.

This results in a full year 2023 earnings per diluted share guidance range of $7 to $8”

FSLR’s guidance provides insight on the impact of the IRATC. To simplify the analysis, we’ve taken the mid-point and excluded the ramp-up related costs.

In the case of First Solar, the IRATC has a significant impact on profitability – gross margins double. Another way to look at it is that in addition to the estimated 2023 average sales price of $0.29 per watt, First Solar will receive $0.17 per watt in the form of the IRATC.  This is how FSLR breaks down the IRATC:

“Given our fully integrated thin film manufacturing process, we expect that this guidance will entitle us to integrated tax credits for wafers, cells and module assembly, which we estimate will equal approximately $0.17 per watt for modules produced in the United States and sold to a third-party.”

First Solar has been advised to treat the IRCTC as a reduction in costs of sales. As a result, it’s important to focus on their growth in earnings per share. Assuming other companies adopt the same reporting standard, the same investment parameters will apply.

Consensus earnings are expected to increase 80% from 2023 to 2024. Comparing it to 2022 is not an apples-to-apples comparison as there was no IRCTC benefit in 2022 while gross margins were impacted by higher-than-expected logistic related costs. There were mainly penalty costs related to exceeding dock waiting times due to Covid supply-chain issues. FSLR has indicated that these and other costs will trend back down toward pre-pandemic levels over the course of the year.

Not every company will capture a similar level of profitability uplift. Generally speaking, those with higher domestic content can claim more of the IRATC. Companies will seek to capture as much of the IRATC as possible. And from an investment perspective, companies that have existing domestic capacity and can claim the IRATC in 2023 will be the stocks that benefit the most in the short-term.

FSLR provided insights on domestic capacity expansion as it relates to collecting the IRATC.

“… we believe that the intent of IRA is to create enduring long-term supply chains, which would therefore motivate and align the incentives to true manufacturing in the U.S., more than just final module assembly with all the build material being sourced from international locations.

And if everything lines up along those lines, then that sort of helps inform our view there as it relates to the inherent value of more domestic manufacturing, plus we want to make sure that, while we believe we're fully entitled to the vertically integrated manufacturing tax credit, to the extent that we can get confirmation through guidance from IRS and Treasury, that would be very beneficial as we think about factory expansion.”

The key word is “vertically integrated”. The more that a company’s US based manufacturing is vertically integrated, the more of the IRATC it can claim 

Making of a National Champion

We’ll now take a closer look at FSLR and examine how they will benefit. But first let’s see how FLSR spoke about IRA after it was signed into legislation. This is what FSLR said in their Q322 call.

“I would like to discuss the U.S. policy environment, which has evolved significantly over the past quarter. As you may recall, the joint announcement from Senators Manchin and Schumer regarding the Inflation Reduction Act preceded in our last earnings call by just 1 day. Since then, we have seen the Act signed into law and First Solar had the privilege to be part of the White House event in September, celebrating the groundbreaking piece of legislation.

In our view, by passing and enacting the Inflation Reduction Act of 2022, Congress and the Biden-Harris administration has entrusted our industry with responsibility of enabling and securing America's clean energy future, and we recognize the need to meet the moment in a manner that is both timely and sustainable. Thanks to our strong foundation, including a repeatable, vertically integrated manufacturing template, proven technology platform and solid balance sheet, we were able to respond rapidly to enact — to act by accelerating the decision to expand our U.S. manufacturing base.”

“Broadly speaking, 2022 placed us on the cusp of significant growth in domestic solar manufacturing within our core markets.”

It goes without saying that IRA is an important piece of legislature. First Solar is positioning themselves as one of the National Champions to help IRA’s implementation. As we’ve seen internationally, National Champions typically get to provide input into and receive beneficial treatment from the government and other regulatory bodies. We believe the amount of IRATC visibility that FSLR has provided, in contrast to others thus far, is a reflection of that.

What does FLSR do?

FSLR manufactures solar modules based on thin film Cadmium Telluride (CadTel) photovoltaic (PV) technology demonstrated to have lower cost, superior scalability, and a higher theoretical efficiency limit over conventional technologies, like crystalline silicon (c-Si). Solar module sales represented 93% of total sales and the majority of sales were to developers and operators of systems in the United States. A few of its largest customers include Intersect Power, Lightsource BP, and NextEra Energy. FSLR will benefit as their clients have an incentive to build out their own capacity to capture the IRATC. This is how FSLR described the IRATC opportunity for its customers.

“The opportunity for everyone, whether you're the developer or whether you're the module manufacturer or whether you're the IPP or the utility who's going to own the generating asset over time, there's opportunity for everybody.”

“And so the question is, do you want to sort of secure your business plan and take risk off the table? And if you're willing to do that and do that at a fair price, then First Solar is a great option to do that. If you're trying to take some risk and you're wanting to find opportunities to avail yourself to potentially alternative supplies that maybe will still allow you to benefit to the maximum potential under IRA, then that's a risk that some may want to take and wait. But what we see right now is that we've got more than enough opportunity to engage. Yes, it's an item that is in some of our customers' thought process. But for the most part, most people aren't paying a lot of attention to it in that regard.”

Where does FSLR manufacture?

Currently, the US is 36% of their 9.8 GW manufacturing capacity. By 2024, this will expand to 50%. Total manufacturing capacity is estimated to reach 21.4 GW by 2026. FLSR will also benefit from India’s Incentive Production Scheme to encourage domestic based solar manufacturing. 

Is there demand to this utilize this increase in capacity?

Below is the amount of GW has booked through 2/28/23. FSLR has booked 67.7 GW of future deliveries. Clients typically put up to 20% down payment to secure that order – the contracted backlog is 61.4 GW.

Q422 Investor Presentation

Regarding the contracted backlog, FSLR stated the following

“We had a total contracted backlog of 61.4 gigawatts with expected future revenue of $17.7 billion for a portfolio average base ASP of $0.288 per watt, before the application of potential adjusters”

Put another way, their contracted backlog is 6x their current manufacturing capacity. This is a product of FSLR’s customers preparing to build their capacity to capture the IRATC. This type of secular demand provides FSLR great visibility on future sales and pricing power. FSLR is sold out through 2025 (excluding India). FSLR’s focus is negotiating solely for 2026 volume and working with customers who are looking to secure multiyear contracts over the remainder of the decade. This is how FLSR described the current demand environment:

“We also began the year with a record contracted backlog, a significant pipeline of bookings opportunity and a robust demand in our core markets. This momentum is driven by our points of differentiation, including a unique CadTel technology, vertically integrated manufacturing process, domestic production, strong balance sheet and commitment to responsible solar, placing us in a position to respond to emerging opportunities, particularly those enabled by the rapidly evolving policy environment. 

“After accounting for shipments of approximately 2.3 gigawatts during the fourth quarter, our future expected shipments, which now extend into 2029, are 67.7 gigawatts. Excluding India, and including our year-to-date bookings, we are sold out through 2025. We have, in recent months, pivoted from negotiating solely for 2026 volume to work with customers who are looking to secure multiyear contracts over the remainder of the decade.

From a commercial perspective, in 2022, we saw a precipitous shift towards long-term, multiyear module procurement. This record volume of multi-gigawatt deals spanning multiple years was driven by a combination of competitive pricing, competitive technology, agile contracting, shared values and trust in our ability to deliver the certainty that our customers are looking for. As a result, we had an excellent year from a bookings perspective, securing a record 48.3 gigawatts of net bookings in 2022. This was an increase of 30.8 gigawatts from our prior annual record of 17.5 gigawatts set in 2021. Our total backlog of future deliveries as of today's earnings call now stands at a record 67.7 gigawatts.”

“As it relates to converting the pipeline into future bookings, our record bookings in 2022 were driven by the favorable balance of near to mid-term available supply, aligned with customer demand for large volume multi-year procurement.”

“Our commercial strategy remains largely focused on supporting long-term multi-year customers who prioritize price and product availability certainty as well as ethical and transparent supply chains.”

This is how FSLR described the positive impact on profitability as they expand capacity to meet demand.

“I’d like to reiterate our approach to growth and gross margin expansion … this strategy includes our approach of contracting out our capacity several years in advance of production. The anticipated reduction of our cost per watt produced, the expected benefits from capacity expansion through scaling a largely fixed overhead structure in order to generate incremental contribution margin and our agile contracting approach would both provides the potential realization of incremental revenue and is expected to mitigate freight and certain commodity risks.”

Assuming, a return to pre-pandemic costs inputs levels (raw materials + logistics), the key drivers of earnings will be FSLR meeting GW expansion targets, ASP per watt and the IRATC combined with positive operating leverage. US pricing in particular may benefit from positive price adjusters that they can charge their customers based on the IRATC.

Can FSLR fund this?

One of FSLR’s competitive advantages is their financial position. Clients know that they are a financially stable partner. FSLR will not require external financing. 

“Operationally, in 2023, we’re expecting to produce 11.5 to 12.2 gigawatts of modules, and after taking into account reductions in inventory, fell 11.8 to 12.3 gigawatts. From a capital structure perspective, our strong balance sheet has been and remains a strategic differentiator, enabling us both to weather periods of volatility as well as providing flexibility to pursue growth opportunities including self-funding our Series 6 and Series 7 transitions.”

“We ended 2022 in a strong liquidity position. And coupled with strong forecasted operating cash flows, modular advance payments and our existing India credit facility, we expect to be able to finance our current capital programs without acquiring external financing. We are evaluating putting in place our revolving credit facility to support jurisdictional cash management as well as to provide short-term optionality and expect to address more details on our capital structure and liquidity outlook at our Analyst Day.”

Sales vs EPS

Given the accounting treatment of the IRATC, it is important to identify companies whose earnings will benefit from the IRATC. Sales will still be important, but it won’t capture the IRATC benefits. Here’s a consensus snapshot of FSLR’s EPS and Sales. 

Sales are still growing at a healthy rate due to capacity expansion while earnings are forecasted to grow at more than 2x that rate because of the IRATC. Recall that 2022 had no IRATC benefits and gross margins were severely impacted by logistic costs.

“Note from an earnings cadence perspective, we anticipate our earnings profile will be higher in the second half of the year, both due to contractual delivery schedules as well as the timing of first sales of our Series 7 products, which are forecast to begin shipping in Q3 of this year. This is forecasted to result in an increase in inventory at our distribution centers in the first half of 2023, which is expected to reverse in the second half of the year. Additionally, Section 45X credits, recognized, will increase after Q1, driven by both the timing of volumes sold as well as the inventory lag, whereby products sold in the early part of 2023 may have been manufactured in 2022.”

Given the recent rally after Q4, this timing effect may provide an opportunity to enter at lower levels.

How does valuation look?

Even after the recent rally, FSLR’s valuation is not demanding based on 2024 eps. Using 2024 EPS, price and multiple sensitivity indicates the valuation potential is between $275-325. We won’t start using 2025 EPS just yet. 

How do the technicals look?

We aren’t the first to appreciate the FSLR investment case. However, as long-term investors we believe this case will play out over several years and the market will provide us better entry points.

Per Knox:

FSLR is completing a symmetrical 3 wave uptrend. Note how the length of the second push higher (C wave) is nearly identical the in percentage gains from the first push higher (A wave).

The $235 region will be the exact symmetrical target for this move, and it is pushing towards this important resistance zone on weaker momentum. We will be looking for some kind of pullback from this region.

For those looking for a riskier buy, I’d look for the $175-$145 region, if we get there. The safest place to buy is if/when it can breakout above the $235 region. 

Conclusion

The Inflation Reduction Act is an important piece of legislature. Winners will emerge as a result. We’ve identified FSLR as a winner over the next few years.

In Part 2, we will apply the same IRATC investment framework to assess how other companies are positioned. As a sneak peak, Enphase has indicated they will capture a portion of the IRATC benefits but more likely toward the end of 2023 into 2024. Look for a follow up next week or so.

I/O Fund analyst team contributed to this article

Please note: the Product Road Map and Earnings Call information was updated on Wednesday, Feb 8th with the transcript.

I recently wrote there would be very few perfect earnings reports this quarter when we covered Tesla. Fast forward two weeks, and Enphase gave us a perfect earnings report this evening. The company beat on the top line, the bottom line, and expanded its margins.

When analysts tried to poke holes into a potentially weaker Q2, management said they were “cautiously optimistic” about Q2 with quite a bit of time dedicated to reasons California NEM 3.0 may not weigh on the results as much as anticipated. The reasons 2023 may be stronger than anticipated include United States manufacturing that results in IRA credits, Europe and Latin America growth, and California’s NEM 3.0 pushing residential toward batteries, which is a strength for Enphase.

Financials

The earnings report provided by Enphase is rare in this macro environment. The company beat and raised with expanding margins. Not only was it a beat and raise, but revenue growth is accelerating on a YoY basis (at least for now).

Revenue came in at $724.6 million for growth of 75.5% compared to 70% growth expected. For next quarter, the company is guiding to $700 to $740 million, above the $680 million analysts were expecting. At the midpoint, this will be 63.1% growth, which is nearly 10% higher growth than consensus of 54% for Q1.

On a year-over-year basis, this marks an acceleration from 2021 Q4’s growth rate of 55.8% and 2022 Q1’s growth rate of 46%. It’s quite a feat in the current market to accomplish this while growing the bottom line.

Notably, FY2022 revenue growth came in at 68.8% compared to revenue growth of 35.3% expected for FY2023. I’m sure we will see the FY2023 consensus updated soon to reflect the Q1 raise.

EPS beat with $1.51 reported compared to $1.26 expected. Margins were strong this quarter and are looking strong next quarter, per management guidance.

What remains in question is Q2 and there were many questions about this on the earnings call, which I will detail below when the transcript comes out. I do want to say there’s plenty on the product road map to offset a potential slowdown in United States residential. Yet, it’s prudent to weigh both sides and to be prepared if Q2 is “less strong” than Enphase investors are accustomed to.

Margins:

On a year-over-year basis, the margins are expanding. In some cases, the margins nearly doubled year-over-year.

• GAAP Gross Margin of 42.9% compares to 39.5% in the year ago quarter. Adjusted gross margin also expanded by 350 basis points (bps).
• GAAP Operating Margin of 21.6% compares to 14% in the year ago quarter. The adjusted operating margin expanded by 700 bps.
• GAAP Net Margin of 21.2% compares to 12.7% in the year ago quarter. The adjusted net margin expanded by 440 bps.

Cash Flow:

Cash flow margins also increased both year-over-year and sequentially. Notably, Q4 is a stronger quarter seasonally than Q3.

• Operating cash flow of $253.7 million for a margin of 35% up from 23.5% in the year ago quarter. This is also 650 bps higher than Q3.
• Free cash flow of $237.3 million for a FCF margin of 32.7% up from 20.3% a year ago. This is also 450 bps higher than Q3.

The company has $1.61 billion in cash and $1.29 billion in debt. The company paid $77 million in stock based compensation.

Product Road Map:

·       The third-generation battery will be released in North America and Australia in the second quarter. This is the battery that management is saying will support a softer landing from NEM 3.0 when analysts about California-related concerns. The battery has 5KW modularity and 2X the power of the existing battery. Due to this, management has stated “we expect our battery business to perform well in the second half of the year”

·       EV chargers were discussed in the comments on the forum here. The IQ smart EV chargers will ship in the United States in Q2. There is also a new bidirectional charger on the product road map for early 2024. These bidirectional chargers can receive power from a residence or grid and also send power back to a residence or grid. Read more here. The battery storage also helps to keep vehicles powered in the event of an outage. The full roll-out for bi-directional is expected in January 2024.

·       The much-anticipated IQ9 will be released in 2024. This release incorporates gallium nitride (GaN) for better thermal properties (resulting in higher power) and also a higher frequency. 

·       However, the 480 watt IQ8P will be released for the United States market in H2 2023. This will be warm-up for the IQ9 with more emphasis on IQ9.

·       Manufacturing at Romania will start in Q1 2023 and will increase capacity to 6 million microinverters and then United States manufacturing will primarily increase the capacity to 10 million.  

·       Look for increased battery sales in Europe as the company is rolling this out now with limited battery availability in Europe prior to 2023 (mainly microinverters in Europe until now).

Earnings Call:

There were quite a few questions about the upcoming Q2 quarter, and any potential weakness from NEM 3.0 and also the United States residential solar market. We outlined what the initial concerns were in our last earnings write-up found here.

Also, please note, the CEO can be a bit long winded at times, and this leads to the longest earnings calls that I personally cover. I’ll try to take out the most pertinent excerpts. To read full responses, please reference the transcript here.

California is 20% of Revenue

The United States makes up 71% of Enphase's revenue. Certainly, it's important to pay attention to any U.S. slowdown. However, outside of California's potential Q2 pull forward, Enphase has been able to beat and raise in light of analyst notes predicting the slowdown would impact growth in Q1.

The information below is important if we do see a slowdown from NEM 3.0. The question that remains is if battery sales will pick up to help offset any impact, if Europe will pick up and/or carry the growth should there be any impact (this region is carrying the growth for Q1 to the point of a 10% raise on revenue), and when the market will begin to price in a better bottom line from IRA credits. NEM 3.0 seems to be the main obstacle in Enphase’s path so I want to start here.

“Ameet Thakkar

Great. Thanks for that. And then I think this time last year when we had this call, and certainly a battery kind of uptake in California will increase, and that might change things. But I think you guys said that like California was roughly 20% of total revenues post the initial NEM 3.0 proposal. I was just wondering if you could kind of give us kind of a refresh on where ‘22 ended up in terms of California as a percent of total revenues.

Badri Kothandaraman

Those numbers are right. Yes. California, the revenue is approximately 20% of our total revenue. That’s correct.

Ameet Thakkar

And it’s still 20% in ‘22?” 

Cautiously Optimistic About Q2 and Discussions on Why NEM 3.0 Will Encourage More Batteries:

This is what the CEO said about Q2 in the opening remarks:

“There are a couple of interesting observations I thought I will share with you. Even with the pronounced seasonality and sell-through in January, we would like to point out that our activations are holding up. The second point to also note is that in conversations with our installers and distributor partners, they have started to see originations pickup in January when compared to December. Although the data we have is limited, these two points make us cautiously optimistic about Q2. We have also seen some analyst reports about a possible shift from loans to PPA due to the high prevailing interest rates. We work with thousands of installers every quarter […]. Any shift from one type of financing to another only has a minor impact to our business, almost negligible.”

Here was one of the questions:

Brian Lee:

“Hey, guys. Good afternoon. Thanks for taking the questions. Kudos on the solid execution. First question I had was just around NEM 3.0. I think there is different implications of that policy uncertainty near term and medium term from what we’re hearing. So maybe just wanted to get your thoughts near-term, some views out there that maybe there is a pull forward on demand in California would be curious what you’re seeing with respect to that? And then kind of in the medium term, we’re hearing the industry is still maybe trying to figure out how to navigate this. 

So curious how you specifically are thinking about the second half of 2023 in the U.S. you kind of base case in California to be down significantly? And then how do you see yourself navigating that, if that’s the case? Are you driving more product to other states, focusing more in Europe? Just curious just how you’d be thinking about planning into that period of higher policy uncertainty in the back half? And then I had a follow-up.”

Badri Kothandaraman

Yes. On NEM 3.0, we aren’t really seeing any pull forward right now. But in talks with few installers in California, both big and small, like what I said, the originations are up strongly. They are all quite optimistic. And maybe we will see something soon that’s why I talked about an optimistic Q2. But so far, we haven’t seen any pull forward demand yet. 

Now on talking about NEM 3.0 in general. NEM 3.0 is going to be incredibly positive for us […] With NEM 3.0, it matters when you export these electrons. So you have 24 hours a day, 365 days a year. So basically, 8,760 data points, and there is an export rate for each of those data points. Each of those hours, there is an export rate. And – but what it works out to be is if you are interested in a pure solar system, your payback dropped understandably from, let’s say, 5 years, it increases actually to something like 7 or 7.5 years with the pure solar system. But the moment you add batteries, you can add batteries in steps of 5-kilowatt hour, 10-kilowatt hour, 15-kilowatt hour, the moment you add batteries, that payback comes right back in to that 5 to 6-year time, to that 5 to 6-year period. That is the stock difference with NEM 2.0. With NEM 2.0, the grid was the battery. Batteries didn’t have an ROI because batteries were primarily for resilience only. With NEM 3.0, batteries are going to be financially attractive. […] We got the right batteries for it with the third-generation battery. We got the modularity, which I think will start becoming popular. Grid tied may become popular, but we will be ready to do either grid tied or off grid, on grid with backup.”

The Comment About the United States Slowdown:

Here was the comment about the United States slowdown:

“Normally, we have 6-month order visibility and that has been – that is now somewhat reduced as they watch their spending. And then I also talked about the fact that our sell-through, which is what the distributors sell to the installers. Our sell-through was quite strong in December, while we saw a little bit more seasonality than normal in the month of January.”

Here is a longer discussion, which points toward Enphase not counting on the U.S driving the growth, rather it was stated and discussed a few times, growth will come from Europe and a bit from LatAm.

“Badri Kothandaraman

Yes. I mean, look, seasonality has always existed in the solar industry from Q4 to Q1. And historically, I would say that, that seasonality is a 15% number. That means, in general, the sell-through in Q1 is usually 15% down compared to the sell-through in Q4. Now right now, and I’m giving you a lot of data from January, and that’s the data we have. Our Q4 was very strong, including December. January, we start to experience a little more than 15%. That’s why I said more pronounced seasonality. And of course, we think it is due to the macroeconomic environment, but what we saw interestingly was the activations remain the same. I mean approximately and they were a little bit down they didn’t have that much of a seasonality. So that basically was somewhat good because the customer demand at least whatever we saw was – I mean, did not get that much affected. But having said that, I think the installers are quite cautious. Therefore, they basically are only buying what they need from their distributors, which is a stark difference from 2022, where they were focused on supply. They were focused on maximizing what they had in their warehouse. Now is that they are worried about their spending, they are worried about their OpEx, they are worried about their cash flow. Therefore, they are going to make sure they do exactly what is required. So that’s why I think – and I don’t have a crystal ball. I cannot be sure. That’s why I think we are seeing some customers who used to book 6, 9 months ahead, now will not book so much ahead. They will be a little more conservative.

And regarding your question on more – that the originations, whether they are improving or not, this is the data. We work with thousands of installers. We have a very strong sample set. We talked to a lot of distributors. Some of our distributors service hundreds of long tail installers. So we don’t see originations ourselves. We only – what I reported to you is anecdotal information. But we hear that originations and especially originations in California are back to being strong in January. That’s what we hear. And I think that is – that’s why I said that – plus the fact that we are not seeing that much of a link in activation points me to cautiously optimistic Q2 versus Q1.”

Europe is a Primary Growth Driver:

As discussed on the call, the United States is expected to decline between Q4 to Q1. 

“Let’s now cover the U.S. We expect our U.S. business to be slightly down in Q1 compared to Q4, primarily driven by seasonality and the macroeconomic environment. We are seeing that our distributor and installer partners are a little more cautious in booking orders. We normally have a 6-month order visibility and that has been somewhat reduced as our partners watch their spending closely. On the sell-through of our microinverters, while December was quite strong for us we saw a more pronounced seasonality in January than normal.”

For Europe, the company is expecting: “As for Q1, we expect healthy growth compared to Q4, consistent with the overall growth in the European market.” This will be driven by expanding to more countries for the IQ8 microinverters and increased battery sales.

Additional Quotes on the Europe’s Geo Strength:

“Well, as you said, we do not guide something annually, but European market is growing. At least our internal reports talk about served available solar market of about 13 gigawatts in 2023. The markets to really – the markets that are really driving are Netherlands, Germany, Spain, France, Italy, and even actually Austria, Poland, etcetera. They are all becoming quite significant markets. In addition, attach – battery attach is also growing. Like what I have stated in the prior question – answering the prior question, the attach rate on batteries in Germany is 80%. So, solar plus storage is growing healthily. And the geopolitical situation accelerated it last year, and that’s continuing what do – that’s what our position is […]”

Jeff Osborne

Hi. Good afternoon Badri. I have two quick ones. You touched a lot on Europe, but I was wondering if you can specifically drill down on the visibility you have there in terms of Q1 and Q2.

Badri Kothandaraman

Yes. Europe is actually the opposite. We do have good visibility. We do have these strong orders. Partners, our installer partners, distributor partners, they rely on us for supply. A few of them even come to our headquarters quite routinely, that’s something that we are starting to see. And we also visit them quite a bit. So, I think we do have decent visibility there.

Perhaps Most Importantly, Europe was hinted as the primary driver for reaching the 90% IQ8 Microinverter mix:

“Ameet Thakkar

Good afternoon Badri. Thanks for squeezing me in. Just I guess a follow-up on that last line of questioning. But I think you guys have targeted to get to 90% in terms of IQ8 mix by the end of the second quarter, I think you just said 60% is kind of what’s baked in for the first quarter. Are you guys running a little bit behind on that?

Badri Kothandaraman

We are running a little behind, I would say. I would – I am going to – or rather we are going to introduce IQ8 into several countries in Europe in the near-term. So, in Q2, we will probably be at maybe a little lower than 80%. And I think in Q3, we should probably catch up to that 90%.”

Manufacturing Capacity & IRA Credits:

In the opening remarks, this is what was stated about manufacturing in the United States:

“We plan to begin U.S. manufacturing of our microinverters in the second quarter of 2023 with a new contract manufacturing partner and in the second half of 2023 with our two existing contract manufacturing partners. We plan to open 6 manufacturing lines by the end of this year adding a quarterly capacity of 4.5 million microinverters, bringing our total quarterly capacity to more than 10 million microinverters as we exit 2023.We continue to await the details of IRA implementation from the U.S. Department of Treasury.” 

In regards to the benefit from IRA, the company is expecting the following:

“Badri Kothandaraman

Yes. I mean net-net, we expect a net benefit of between $20 and $30 a unit. I am giving you a wide range right now because we do have some puts and takes, and we will refine it as we go.”

Back of the napkin math puts this at a $500 million net benefit to Enphase once the credits roll-out. They do say it’ll take time, but that’ll help an already strong bottom line while other companies struggle to maintain profitable during a macro slowdown. 

Conclusion:

Articles like this one aren’t very meaningful considering Enphase raised Q1 guidance by 10% in light of a United States slowdown. This is being achieved through international sales, such as Europe and Latin America. 

My takeaway was that even with a “less than perfect” Q2, the manufacturing credits coming from IRA, as well as the product road map, will offset this by year end. The CEO did state “they are fully booked for Q1” and “bullish about 2023.” This leads me to believe a softer United States market is being accounted for in the Q1 guide – and I hope the same will happen come Q2 or soon after – which is that the U.S. market isn’t the thesis right now anyways except for the IRA credits. 

I believe the IRA credits shouldn’t be underestimated in terms of impact, and we are comfortable riding the wave of Q2 given the company’s ability to overcome many macro obstacles, thus far. We are looking for strong bottom lines and resiliency in a tough macro, and Enphase ticks those boxes. 

Additional Analyst Commentary: 

I’m starting with the bearish comments first, but per usual, it seems the bearish analysts were on a different earnings call than the bullish analysts as they are taking exact opposite positions on the same information. As you know, I’m in the bullish camp for three main reasons:

1.     The resiliency of this company in 2022 and going into Q1 2023 is rare, and I suspect they have what it takes to continue on this path. No major flags although there’s a question mark on 20% of revenue and how a decrease in microinverters will impact the company compared to an increase in storage. 

2.     The European segment is clearly carrying the company and seems poised to continue doing so per the sequential decline in the United States, yet raise on revenue growth (we have +10% at the midpoint, analyst below has +7% — analyst below likely referring to their estimate)

3.     Strong product road map, a few catalysts and any one of them can absorb a limited impact to 20% of revenue. Strong bottom line with clear information on this improving with or without a recession.

“Barclays analyst Christine Cho raised the firm's price target on Enphase Energy to $257 from $251 and keeps an Equal Weight rating on the shares following the "solid" quarter. While Enphase ended 2022 on a high note, microinverter shipments will slow as installers remain cautious in a tougher macro tape with inventory channels already at healthy levels, the analyst tells investors in a research note.”

“Susquehanna analyst Biju Perincheril lowered the firm's price target on Enphase Energy to $275 from $365 and keeps a Neutral rating on the shares. The analyst said they beat on the top and bottom line but demand within the US is becoming more uncertain as macroeconomic concerns are causing installers to purchase only what they need right now rather than to secure future supply.”

“Cowen analyst Jeffrey Osborne raised the firm's price target on Enphase Energy to $341 from $335 and keeps an Outperform rating on the shares. The analyst said its Q4 EPS upside was driven by gross margin strength attributed to IQ8 penetration. Q1 revenue guidance is 7% above consensus at the midpoint with the U.S. expected to decline QoQ on seasonality with management optimistic U.S. will rebound in 2Q23.”

“Oppenheimer analyst Colin Rusch raised the firm's price target on Enphase Energy to $328 from $323 and keeps an Outperform rating on the shares. With Enphase beating Q4 expectations and guiding ahead of the Street, the firm believes bearish investors will focus on slower battery sales in Q1 2023 and risk to the CA demand post NEM 3.0, but notes both set Enphase up for accelerating growth through 2023. Oppenheimer continues to see U.S. residential solar demand as more resilient than feared and believes Enphase is making sound changes to its battery and commercial rooftop products while being poised to enjoy 500-800bps-plus margin improvement from U.S. manufacturing credits.”

“Craig-Hallum analyst Eric Stine lowered the firm's price target on Enphase Energy to $315 from $323 and keeps a Buy rating on the shares. The firm notes Enphase reported a beat across the board in Q4 and guided Q1 2023 above the Street, with it fully booked and Europe a primary driver. While the Q1 guide does call for revenues down modestly quarter-over-quarter at the midpoint, Craig-Hallum thinks that Enphase's plan to more than double its capacity by the end of 2023 shows the true growth path and outlook, and with the majority of this expansion in the U.S., it also means substantial incremental EBITDA from the 45-times Advanced Manufacturing Tax Credit.”