Shareholders of renewable energy hardware supplier SolarEdge Technologies (NASDAQ:SEDG) might need to see their doctors for whiplash. A little over one month ago, shares of the solar inverter and technology specialist were up nearly 90% since the beginning of the year. But after a 21% slide in the last month alone, those year-to-date returns now look a bit more pedestrian.
Well, pedestrian for this high-growth renewable energy stock, anyway. SolarEdge reported year-over-year revenue growth of 82% in the first quarter of 2018, expanded its gross margin to 37.9% during the period, and converted 17% of sales into net income. It expects much of the same in the second quarter of this year.
Given the eye-popping growth and expectations for it to continue, investors may be wondering why the stock is ending the first half of 2018 with a whimper. Turns out, a healthy amount of bad news in the solar industry is weighing on the stock. Should investors brush that off and consider SolarEdge Technologies stock a buy?
When it rains, it pours
The solar industry just can't catch a break lately. Earlier this year, the Trump Administration issued tariffs on solar panels and solar cell imports. That quickly injected uncertainty into domestic projects, some of which have been delayed indefinitely or cancelled, as well as into the international market at large. It even tipped SunPower to acquire its bitter rival, SolarWorld Americas, to greatly expand its production footprint in the United States -- and to score political points.
The fallout from tariffs wasn't even the worst of it. In early June, China's government abruptly slowed incentives for installing new solar. That was a shocker given that China has been the solar industry's best friend, installing over 50 gigawatts of new capacity in 2017 -- more than the United States has total. Worse, Chinese solar panel manufacturing capacity has surged in recent years, and now it appears the market will be flooded with cheap panels.
While the world will continue to grow solar capacity over time, the rate at which that expansion will occur is now much less certain than before. That's bad news for everyone, including downstream suppliers such as SolarEdge. Can the business continue to grow despite the global chaos?
Diversifying, but is it enough?
A business doesn't achieve year-over-year growth of 82% by mistake. Put in the simplest of terms, SolarEdge is not done growing. It's a global leader in photovoltaic inverters, power optimizers, and monitoring services -- all critical in wringing out the most from a solar installation -- and management has executed well on growing the company's market share and expanding operations over time.
The most recent example is the acquisition of Gamatronics, which develops uninterruptible power supply (UPS) systems for non-solar applications, such as data centers and communications equipment. SolarEdge will use the company as the foundation for a new business unit, which could prove important for diversifying revenue in the long run.
That's not the only effort to grow away from solar markets. SolarEdge recently unveiled an electric vehicle (EV) charger, which follows the launch of its EV charging single-phase inverter. This portfolio of products would allow the company to tap into what's expected to be a high-growth EV market in the coming years. Plus, customers of these products would be able to utilize SolarEdge's software monitoring platform, creating ways to leverage existing parts of the business to grow new ones.
The question is whether or not these diversification efforts can scale quickly enough to offset risks from the global solar industry -- and it remains unanswered. Considering the business is on pace to exit 2018 with an annual revenue run rate of $1 billion, all from solar applications, investors should expect the renewable energy market to remain the biggest driver of the stock and business for the foreseeable future. It's also where the biggest risks reside.
For instance, SolarEdge maintained a 42.5% market share of the solar inverter market at the end of 2017. That is almost certain to fall as the market expands and welcomes new entrants. Investors aren't necessarily worried about market share so much as what increased competition will mean for the company's margins.
In the first quarter of 2018, the business reported gross margin of 37.9%, compared to 33.6% in the year-ago period. Those juicy profit margins are what will draw competition to begin with. But margins could slip before competition creeps in. While SolarEdge didn't rely on China for a significant amount of its sales in 2017, a global market flooded with cheap solar panels could bring down hardware prices across the board, including for the company's products.
This solar stock looks more attractive, but...
While SolarEdge stock looks much more attractive to long-term investors right now than it did one month ago, there might be too much uncertainty on the horizon regarding the core business for investors to jump into a new position right now. It's encouraging to see management investing in diversification efforts, but new business segments in UPS systems and EV chargers will take years to grow to meaningful levels. Therefore, right now, I think investors might be better off waiting to see how the dust settles. But if the stock keeps falling, I might have to revisit that opinion.