Coauthor: Royston Roche
We’d like to discuss a few stocks that are showing strong price action in the solar industry. Perhaps the most obvious front runner in clean energy right now is Enphase. The most recent quarter was exceptional as the company reported improving top line growth and an improving bottom line. The company also provided a strong guide for accelerating revenue (again).
Please reference our free analysis on The Inflation Reduction Act of 2022 and Europe's Energy Crisis here.
An important standout accomplishment from Enphase has been management’s ability to reliably meet its revenue guidance for fifteen quarters since its last miss in September of 2018.
The same is true on the bottom line with fourteen consecutive beats since Dec of 2018.
To have met guidance for 4 years is no small feat considering we’ve been through a pandemic and had ongoing supply disruptions that has directly impacted the solar industry. Given the many variables we’ve seen in the last four years, this is the only company that I recollect accomplishing this. Certainly, it instills confidence that management will meet/beat moving forward compared to its lumpy solar industry peers.
Enphase reported Q2 growth of 68% for revenue of $530 million. This is up from revenue growth of 46% last quarter. Guidance is for revenue growth of 75% for Q3 to $613 million and analysts are expecting 60% growth in Q4 to $664 million.
The company also provided the following on the call: “We shipped approximately 1,213 megawatt DC of microinverters and 132.4 million megawatt hours of IQ Batteries in a quarter” with the company guiding for 130 to 145 megawatt of IQ batteries in Q3. This is up from 120 megawatt hours in Q1.
Microinverters shipped were up 39.7% which marks an acceleration from the 15.7% year-over-year change in Q1. This is down from the peak of 117.2% in Q2 2021 but it’s also a boon that Enphase delivered this growth on top of the hard comp.
In the United States, the revenue increased 15% sequentially and 66% year-over-year. Europe revenue grew 89% year-over-year and 69% sequentially.
Right now, fiscal year revenue is slightly decelerating from 78% growth in FY2021 to 63% expected growth for FY2022.
Management stated they’ve grown IQ battery shipments by 28% per quarter over the last two years in North America and are now introducing these batteries into Europe.
Gross margin is a tick higher than it’s been in the most recent quarters at 41% compared to 40% in FY2021. Gross margin guide was for a range between 38% to 41%. The gross margin is expected to improve when IQ8 reaches scale.
Operating margin expanded to 17% in Q2, up from 14% in the previous quarter and up from 15% in FY2021. Net margin is improving, as well, at 14.5% up from 12% last quarter and 10.5% in FY2021.
Enphase saw a sizable increase in operating cash flow to $201 million, up from $102 million in the previous quarter.
The margin of 38% is nearly double what it’s been in previous quarters. Free cash flow also doubled to $192 million, up from $90 million in Q1. This is 2/3 of the cash flow from all of FY2021, which was at $300 million for the year. This increase was due to higher revenue and an improved cash conversion cycle in Q2.
GAAP EPS is at $0.54 compared to $0.28 in the year ago quarter. Adjusted EPS is at $1.07 compared to $0.53 adjusted EPS in the year ago quarter.
With that said, Enphase has a debt to cash ratio of 1:1. This reflects cash and marketable securities of $1.25 billion and debt of $1.29 billion. Given the current cash profile of the company, this should improve but does need to be monitored.
Note on Valuation
Enphase is not the easiest entry when it comes to valuation. The stock had a blowoff top moment in November of 2021. This aside, the stock is not reliable where it’s currently trading with little success of trading above this top line valuation. In a perfect world, we would find an entry around 10-12 forward P/S or 15 current P/S. That may seem like wishful thinking yet we want to be prudent as solar can be volatile.
Given the strength of the earnings report, we are trading at the stock’s highest valuation on a forward PE ratio in 2022 of 70. Previously, a forward P/E of 50-55 was the top for this stock in 2022. In other words, we will need another blowoff November top to see gains from here, if history is any indication. OR, Enphase will need to start a new valuation trajectory which is risky to predict without more data to support this conclusion.
Product Overview: IQ8 Inverters
Enphase has six models of microinverters in the IQ8 line, which are popular for their performance during a grid outage. Due to IQ System Controllers and IQ Load controllers, the system can sustain off grid. What is unique about the IQ8 is that the system will continue to perform off-grid even without a battery although the battery option is also popular.
The IQ8 Microinverter offers a microgrid with split-phase power conversion that converts DC power to AC power. Because solar panels only produce DC power, inverters are necessary to convert this to alternating current (AC), which is the current that houses use for energy needs. The DC to AC conversion and solar output is performed through the IQ8 and is done off-grid.
The System Controller or “smart switch” connects the home to the grid power, batteries and the solar photovoltaics, and transitions the system from grid power to backup power. The Load Controller sheds non-essential loads to offer longer off-grid power. The IQ battery offers up to 10kWh of energy capacity, so rather than feeding power back to the grid, the system stores the back-up power for future use.
Notably, the system is modular so a home owner can start small and build a bigger system over time. The system also does not require a battery for off-grid power, and thus, the IQ8 can be more cost effective for entry-level systems. The IQ8 is not compatible to existing systems, however, so it’s only available for new installs.
The secret sauce for the IQ8 Inverters is a customized, proprietary ASIC chip that can quickly change loads and grid events, which ultimately reduces the required battery sizing and battery power. The system adjusts according to the amount of electricity it has access to and this brain or intelligence is helpful when a system is off grid either temporarily or permanently. It also helps to store more energy by knowing when a house has excess power.
Another key feature is the microinverters come with a 25-year warranty and the battery has a 10-year warranty. My understanding is this is an industry-leading warranty, which is key for this level of home or commercial investment.
The IQ8 was first tested in Australia in 2017 due to “anti-islanding” which refers to grid-connected inverters that must shut down when there is a loss of electricity supply from the grid. The reason for shutting down the inverters is to protect the power line workers who are restoring the system. The solution that Enphase designed were the IQ8 models which are “always on” by combining the inverters, batteries, system controllers and load controllers listed above for a mini grid that can produce power from the sun and efficiently store this power at night.
Although California comes to mind for a region that shuts down its grid frequently due to wind storms to prevent fires, or perhaps Texas during the ice storm, this is also in demand globally where there are weak grids (Latin America) or no grid (Africa and parts of India). The company has cited in the past that there are 1.2 billion people who can benefit from the IQ8 due to persistent and permanent grid issues. The company’s current revenue mix is 80% United States and 20% international.
To understand how impactful the IQ8 has been for Enphase, consider that right now it comprises 37% of the company’s shipments and Enphase management expects this to reach 90% by Q2 2023. That is a lot of growth for one product in four quarters’ time.
IQ8 Inverter and IQ8 Batteries Discussions on the Earnings Calls
When asked on the call why the IQ8 system is performing well compared to competitors, the CEO responded:
“Yes, I mean we IQ8 provides a lot of value. Three things is sunlight, backup. Basically, when the grid is out, IQ8 continues to work and provides power, one; number two, it removes any limit on solar to storage ratio, which is the limit of today. In other words, you can have a lot of solar with very tiny storage, and the extreme end being zero storage, that's number two.
Number three is sunlight jumpstart, which means that in other batteries when you completely drain the battery, because you use it overnight, and you accidentally drained it, you accidentally drained it in the morning, IQ8 can come and independently jumpstart the batteries. Because it can provide — it can generate its own microgrid and kickstart the battery.”
Here was another lucid moment on the call when management described why they’re pulling ahead:
“We are trying — we have with the home energy management solution that we have, we are providing a very comprehensive solution. This is not just about the solar part, not just about the battery part or just about the EV part or managing the heat pump, etcetera. Our goal is to provide a one stop shop, a completely comprehensive solution. And everything is managed from software with a home energy management system. This is true in Europe. And actually, it's true here as well.
So for us, our value-add when we think about relative to competition is not look at any one single piece. Although we have to be better than them in every individual component that we are building. But it is about looking at the overall solution. So the homeowner has a great experience where they have one app, and they see they get unprecedented visibility into the performance of their entire system.”
IQ8 battery shipments grew 28% per quarter over the past two years. The company is releasing a third generation in early 2023. According to the earnings call, this battery will “deliver double the power enabling homeowners to start heavy loads.” The release is slightly delayed due to increasing the AC Power of the microinverter following feedback.
The company stated they currently have manufacturing capabilities of 5 million microinverters and will soon have a 6 million capacity after expanding manufacturing to Romania. Enphase is expanding rapidly into Europe including the IQ batteries after launching the IQ batteries two years ago in North America.
The energy crisis in Europe a catalyst as this drives more demand for self-consumption due to high utility rates and feed tariffs. However, Europe has a more stable grid than the United States and other regions, and thus, the sunlight backup is not as desirable as other regions.
Management stated the following on the call regarding the size of the German market: “The last I heard is it's roughly two gigawatts residential time adopting solar. And I'm hearing 80% attach, so two gigawatts times 80% is 1.6 gigawatt hours of batteries, that's the market.”
To put that in perspective, Enphase shipped 130 to 145 megawatts of batteries or 580 megawatts per year. At 1.6 gigawatt, or 1600 megawatts, the German market alone is 2X the annual output of Enphase. The company also serves Belgium, the Netherlands, France, Australia, South America and Latin America, to name a few.
Enphase is expanding into EV charger market following the acquisition of ClipperCreek. Enphase-branded chargers for residential homes are expected to go to production this quarter. The company stated the smart EV charger will be introduced to customers in the United States and Europe in early 2023.
In the opening remarks, management stated they have a “healthy” level of inventory in Q2 although storage channel inventory “was a little elevated due to longer installed times.” As stated in the introduction, the company has instilled confidence in analysts and investors for how management has navigated supply chain issues with a beat on every earnings report during the supply crisis. Notably, the supply chain issues are affecting Enphase less so than the company’s competitors and Enphase has actually been able to pull ahead in regions such as Europe for this reason.
Praneeth Satish
Got it. And then just staying on Europe. I mean, it sounds like you're gaining share, partly because competitors don't have supply. So I guess what happens when competitors there rebuild supply? Do you think that'll impact your growth? Or do you think once an installer tries an Enphase product, they don't go back to competitors? Like it's just how durable is the growth? Thanks.
Badri Kothandaraman
Well, we cannot be arrogant. We need to create meaning. We need to provide value to the installers, which is high quality, which we think we are quite good there when compared to competition. So we are good there in terms of customer experience. We pride ourselves on net promoter score and answering the calls. We need to continue to do that. That's a big differentiator for Enphase.
Stem
Stem is a high-risk moonshot stock. The reason that Stem is a moonshot is because it’s a small cap in a volatile industry and the stock has negative operating cash flow plus negative GAAP bottom line margins. In addition to this, one customer makes up 50% of revenue.
Due to the change in market environment, which is primarily caused by the Fed raising rates, companies that operate at a loss are more volatile than they were previously.
The negative operating cash flow has certainly improved — most especially in the recent quarter with a margin of (10%). This is an improvement from (62%) to (69%) in the previous three quarters albeit still negative in a cash sensitive macro environment. The GAAP operating margin has been lumpy and is currently at (45%) which is an improvement from (85%) in the previous quarter.
In Q3 of 2021, there was a revaluation of SPAC warrants which caused a non-cash adjustment in the net income, hence we are not looking at the year ago comps.
The gross margin is causing the weaker bottom line with a 12% GAAP Gross Margin and a 17% adjusted GM in the most recent quarter. This is an improvement from 9% GAAP Gross Margin in the previous quarter and up from 0% GM in the year ago quarter. Notably, in Q4 of 2021, Stem had a negative (3%) gross margin which further highlights the thin GM this company operates from.
As outlined below in regard to forward key metrics, the hope/expectation is that software sales will drive a higher GM than the company is currently seeing: “And so I think that over time you're going to see more and more software revenue rolling into the P&L and so we would expect that software, really services line item to grow quite significantly over the coming years.”
In the investor’s presentation, it’s noted that Stem has a GM of 80% for software and a GM of 10% for front of the meter hardware to 20% to 40% for back of the meter software. FTM makes up the majority of Stem’s business today (more below).
The company has cash and short-term investments of $335 million at the end of Q2 2022 compared to $352 million at the end of the Q1 2022. The company has a debt of $449 million at the end of Q2 2022.
The revenue growth for Stem is exceptional, however, and clearly the company is doing something important on a product level as it’s been posting triple digit revenue growth for many quarters and this doesn’t appear to be slowing down anytime soon. Here’s a snapshot of Stem’s recent revenue growth and two quarters of forward estimates.
There are some positive key metrics such as bookings of $226 million, for 402% growth. The company raised guidance to $775 million to $900 million, which is up from $650 million to $750 million.
The company reports on contracted annual recurring revenue or CARR. CARR was at $58 million and guidance was raised by $5 million to $65 million to $85 million. This represents the software portion contribution from the Athena product.
On the earnings call, management pointed toward the software helping to raise forward key metrics: “But, as far as the, say the philosophy of the business, I think that's where it gets super interesting is that the bookings growth really, determines what's going to happen longer term for us. And that's really, so we're kind of locking in and that's where the CAR metric comes in. And so you're starting to lock in long term long dated software contracts during that time period.”
The company also reported contracted backlog of $727 million and a pipeline of $5.6 billion, up 229%.
When you look at forward fiscal year estimates, there is a marked slowdown to 73% in FY2023 and 45% in FY2024. Here is what two of the eight covering analysts have said recently about Stem:
Northland analyst Abhishek Sinha initiated coverage of Stem with an Outperform rating and $24 price target. The U.S.-based complete battery storage solutions provider is "well positioned" with "a very dominant position" as the global push for lower emissions, vast improvements in battery technologies and a solid support by the passage of IRA bill should drive industry participants to make extensive use of energy storage systems, Sinha tells investors. Stem "has a significant head start against competition," as evident from the fact that it has over 50% repeat customers in Q3 bookings, the analyst added.
Morgan Stanley analyst Stephen Byrd raised the firm's price target on Stem to $20 from $13 and keeps an Equal Weight rating on the shares. The analyst increased growth rates for solar, wind, energy storage, and clean hydrogen, and raised price targets on many clean tech stocks, due to the clean energy support featured in the new Inflation Reduction Act legislation. The bill recently passed by Congress and signed by President Biden will accelerate the decarbonization of the U.S. economy, lead to significant increased domestic manufacturing, and provide the necessary support to jump-start decarbonization technologies that are on the cusp of being commercially viable, Byrd tells investors in a research note.
More on Product
Stem offers in-front of the meter storage (FTM) and behind-the-meter storage (BTM). FTM relies on the grid whereas BTM is independent of the grid. Per the earnings call, 91% of Stem’s sales are coming from FTM at the moment.
Athena is Stem’s AI software, which is designed to lower energy costs, reduce carbon emissions, stabilize the grid, solve intermittency, and create storage networks. As cumulative installs grow, Athena becomes more intelligent through continuous learning, creating more value to new and existing customers.
Athena AI optimizes time-of-use and demand charges, resulting in 10% – 30% monthly electricity bill reductions. The product saves clients’ money and helps them meet their ESG targets without changing the way they operate. Stem’s SaaS contracts range from 10-20 years and contain recurring monthly payments that are driven by storage assets under management (AUM). The company’s customer list includes Amazon, Whole Foods, Facebook/Meta, UPS and Adobe.
In the 10-Q filing, the company discloses that in Q2, one customer “Customer D” made up 50% of their revenue.
The Athena software is leveraged at times when Stem does not supply the software. Per management: “One is the largest behind the meter portfolio down in Southern California was a replacement with Athena software on an existing platform. And we have talked about that in the past. That's not inclusive in this 10X obviously, but I would say the majority of what we're seeing are large front of the meter projects whereby the developer may be procuring their own hardware and utilizing Athena and all the attributes that we bring.”
As the analyst pointed out, this scenario is the ideal scenario as software can ramp much faster than hardware in a supply constrained environment: “Biju Perincheril: Got it. Now I was thinking, this is a sort of nice tailwind sort of adding to your hardware plus software business making that transition to the software, becoming a bigger part of the business, making that a faster transition.”
Stem recently acquired AlsoEnergy, a company that offers an application called PowerTrack. The app allows for remote troubleshooting, identification of hardware faults, access to site documentation and customized dashboards. Per the earnings call, AlsoEnergy ranks number one in its category for an app for standardizing clean energy portfolios on one interface and for lowering total cost of ownership. This was a software acquisition, which is good for Stem’s longer-term gross margin.
Valuation
Stem is the rare small cap that is outperforming the Nasdaq and the Russell 2000. Some of this comes from the outperformance of the solar industry, yet it certainly challenges the narrative overall as Stem has weak margins.
Due to the company’s weak margins, we cannot value the stock based on the bottom line. However, renewable energy certainly has a plethora of higher risk stocks to comp the top line valuation. Plug Power has negative gross margins on average of (25%). Chargepoint has a worse operating margin than Stem at (84%) to (110%) in the most recent two quarters. Blink takes the cake with a negative operating margin of (193%) and (153%) in the most recent quarter. Prior to this, the GAAP OM was (300%).
Despite these weak fundamentals across the board, Stem has the lowest top line valuation.
With that said, on an individual level, Stem is trading at its highest top line valuation for the year and the stock fails frequently around the 12 current P/S mark and the 6 forward P/S mark. Therefore, Stem is not a buy for our portfolio right now until the valuation comes down OR until there is a clear, undeniable breakout where the market is signaling its ready for a higher valuation for Stem and others. It’s likely the first scenario will happen.
Catalysts and Risks
IRA legislation which we covered in detail here is a catalyst for Stem’s customers. 90% of Stem’s revenue comes from the United States, which is key for the subsidies. Management pointed specifically to the provision for retrofitting storage as less than 10% of solar AuM currently has storage attached.
Stem has stated they have fully contracted their 2022 supply and are current contracting supply for 2023 and 2024. This is what was discussed on the call regarding IRA and a potential increase in sales:
Mohit Manrai
Got you, and then probably just on the previous question here, from Brian on just for next year demand over here if we get like an IRA or not, if when we get the IRA approved, do we have enough supply for batteries to support that kind of demand here?
John Carrington
I'd say that we have to understand exactly the details around this as far as what the demand looks like. If you, as I said, if you look at some of the third party estimates, it's ranging from 20% to 300%. So we're have to — we'll have to unpack that.
Note: Management is referring to a 20% to 300% increase in the addressable market for the storage market, per industry analysts.
In December of 2021, the Uyghur Forced Labor Prevention Act was signed to prevent goods from being imported if those goods are developed through forced Uyghur labor. The effective date was June 2022. Stem noted that some of its customers could be impacted from this new law. “On the solar side, the AD/CVD and UFLPA issues could impact near-term panel deliveries for customers. And as I stated before, we have seen an impact on utility scale solar projects. The UFLPA process is presenting some uncertainty for developers, specifically more paperwork and compliance requirements are slowing logistics and delivery times.”
Brief Note on First Solar:
By Royston Roche
First Solar is a leading provider of photovoltaic (PV) energy solutions. It is one of the major beneficiaries of the Inflation Reduction Act of 2022 in the form of solar manufacturing tax credits.
The company also recently announced its plan to invest $1.2 billion to expand its solar module manufacturing in the U.S. It includes a $1 billion investment for a new manufacturing facility in the Southeast U.S. and $185 million for the upgradation of the existing Ohio facility.
The company’s revenue in the Q2 2022 fell by 1.3% YoY to $620.96 million. It beat the analysts' revenue estimates by 2.4%. Analysts expect revenue to grow 27% YoY to $738.51 million in Q3 and to decline 3.9% YoY to $872.21 million in Q4. For the full-year, analysts expect revenue to decline 11% YoY to $2.61 billion. Management guidance for the full year revenue is $2.68 billion at the mid-point of the guidance, representing a YoY decline of 8.5%.
The operating income in Q2 2022 was $144.83 million with an operating margin of 23% compared to an operating income of $110.38 million with an operating margin of 18% in Q2 2021 and an operating margin of -16% in Q1 2022.
The operating income primarily benefitted from increased module sales, gain from the sale of the Japan project development platform of $245 million, and partially offset from the impairment of legacy systems business asset in Chile of $58 million.
The company has a record backlog of 44.3 gigawatts. Mark Widmar, CEO of the company, said in the recent earnings call, “The 10.4 gigawatts of new bookings since our prior earnings call in April are mostly for deliveries in 2024 to 2026 time frame and have a base ASP, excluding adjustors of $0.301. These new deals bring our total year-to-date bookings to 27.1 gigawatts. From an ASP perspective, we are encouraged by the pricing trajectory of our bookings as we continue to transact for deliveries as far out as 2026.”
Goldman Sachs is among the notable recent stock upgrades. Analyst Brian Lee upgraded First Solar to Buy from Sell with a price target of $172, up from $60, as part of a broader research note on Solar names. The analyst states that the company is best-levered in his coverage to the tailwinds of the Inflation Reduction Act as the most immediate beneficiary of manufacturing credits as well as benefits from demand tailwinds given its above-80% exposure to the U.S. Lee also states that he has a more constructive outlook on First Solar's module gross margin recovery.
The company benefits from the Inflation Reduction Act and also from the strong demand for alternative energy. However, we will not be buying the stock since the company’s revenue growth lacks consistency. This could change with the IRA and we will monitor this as we go along.