As the solar industry starts to rebound from the downturn in demand caused by the pandemic, shares of solar innovator Enphase Energy (ENPH 0.62%) have soared by almost 50% since its second-quarter 2020 earnings call. However, with a price-to-earnings (P/E) ratio around 80 -- over twice that of the average S&P 500 company -- some investors see Enphase as an "expensive" stock. But that P/E difference just means that investors are expecting Enphase's future earnings to grow faster than those of the average S&P component. What is fueling investors' expectations? A look at the company's third-quarter 2020 earnings call reveals a few clues.
Enphase Energy's new Encharge system. Image credit: Enphase Energy, Inc.
Enphase Energy scorecard for Q3 2020
During its Q2 2020 earnings call, Enphase set several key expectations for Q3 2020 and the second half of the year. Chief among them:
| Metric | Target | Time Frame | Q3 2020 Result |
|---|---|---|---|
| Revenue | $160 million to $175 million | Q3 2020 | $178.5 million |
| Gross margin | 37% to 40% | Q3 2020 | 41% |
| Operating expenses | $28 million to $30 million | Q3 2020 | $29,571 million |
Data source: Q2 2020 earnings call and company filings. All financial metrics are on a non-GAAP basis.
In addition, the company set an expectation of achieving an "8% to 10%" "attach rate" for its storage products by Q4 2020 and for "strong sequential growth" in its European business. These two metrics are important as Enphase has historically gotten over 80% of its revenue from its U.S. microinverter business. Strong growth from a new geography and from a new product category are key to the validating the thesis of strong growth in future earnings -- and I'll discuss these separately below. Here are five key takeaways from the recent earnings report.
1. Revenue
The company's Q3 2020 revenue came in 2% ahead of expectations. That's great, but this figure includes storage, and international revenue. The company's U.S., microinverter-only revenue was actually down 20% from the same quarter a year ago. This is slightly ahead of the 25% drop in demand for rooftop solar that some forecasters had been predicting due to COVID-19. While it is difficult to get all forecasters to agree on a prediction for the U.S. rooftop solar market in 2020, the expectations going into Q3 were definitely conservative, and Enphase's better-than-expected drop in US microinverter-only performance prompts optimism.
2. Gross margin
The company beat its gross margin goal for the quarter by 1 percentage point and its stated goal for the year by 6 percentage points. This is one of the most important takeaways from the company's Q3 2020 earnings call. Not only was the company able to beat its revenue goal, but it did so while maintaining pricing power -- or its ability to control the prices of its products -- in an environment of limited demand. What this usually means is that the company is making a product that is different in ways that the market is willing to value.
On the storage side, the company shipped meaningful volumes of its brand-new product, Encharge. This product is priced at a significant premium over those of better-known incumbents. For example, on a $/kWh basis, Enphase's storage system is over 50% more expensive than Tesla's (TSLA 4.96%) Powerwall -- the current industry leader. A surge in demand for storage products on the West Coast of the U.S. may explain in part the company's ability to command such a hefty premium.
However, management's track record of consistently beating its margins goals over the last three years is quite impressive -- especially when compared to direct competitor SolarEdge (SEDG -2.16%)
Enphase versus SolarEdge gross margin over the last three years. Data by YCharts.
3. Operating expenses
The company was able to keep its operating expenses, or OPEX, at under $30 million, or within the range of the expectations it set during its Q2 2020 earnings call. This is important for two reasons: It means the company did not beat its revenue goal by simply spending beyond its plans on things like staffing, travel, or marketing; and it means that the company was able to continue to outperform its baseline financial model of "35-15-20", -- 35% gross margins, 15% OPEX, and 20% operating income as percentages of revenue.
4. Storage attach rate
Batteries are a new product for the company, and one that could help deliver the additional revenue growth that investors are pricing into the company's valuation. During its Q2 2020 earnings call, the company stated it expected to achieve a "storage attach rate," or the percentage of rooftop solar systems that also include the Encharge battery system, of "8% to 10%" by fourth quarter 2020. Using the company's Q2 price assumptions and doing a little more math, an 8% attach rate should boost the company's microinverter-only revenue by about 27%. As stated above, in Q3 2020, the first full quarter of Encharge shipments, storage contributed 10% to the overall revenue, or $17.85 million. This represents a 14.7% boost to its U.S.-only microinverter revenue -- the only region where Encharge currently ships. 14.7% is a little over halfway to 27% -- so the company appears well on its way to meet the goal of "8% to 10% attach rate" by Q4 2020.
5. European and international growth
The company's European revenue grew by 67% from the previous quarter, which qualifies as strong sequential growth by any definition, and gets the company closer to its goal of doubling its European revenue by year's end. Interestingly, overall international revenue growth was very healthy -- about 56% from the previous quarter and 36% from Q2 2019.
The bottom line
During Q3 2020, Enphase delivered a beat on its two most important financial metrics -- revenue and gross margin -- while keeping OPEX in check, and showing it is on track to meet or beat its revenue goals for its new storage product and accelerated growth of its international footprint. The successful introduction of this new product alone creates a brand-new revenue stream that should add almost 30% to the top line of a company already growing at a healthy clip. Additional new products discussed during the call should produce further top-line growth in 2021.
If the company can continue to meet or beat its commitment to 35% gross margins and its overall financial model, it should be able to exceed investors' expectations of outsized earnings growth reflected in its high P/E ratio. Investors considering investing in Enphase Energy would do well to monitor how storage and international revenue continue to grow and whether the company continues to beat its gross margin goals.
