Solar-inverter leader Enphase (ENPH 3.80%) has been an all-star stock over the past few years. Looking back just five years, you'll see the stock is up by an astounding 2,820%. That's nearly a 30-bagger.
What's more remarkable? The stock is down about 60% over the past year, meaning the returns were even higher if one had sold at the stock's late 2022 top.
The long-term returns suggest Enphase is a quality company riding the wave of solar deployment worldwide, which means this recent sell-off could be a terrific buying opportunity.
On the other hand, it's also possible the stock could fall further, if the recent sell-off portends longer-term industry headwinds or competitive threats.
So which is it? Let's dive in.
Enphase's strengths
First, and perhaps most importantly, in a sector marked by commoditization and competition, Enphase's high-quality microinverters appear to be differentiated from the competition. That's unique among solar companies.
A microinverter is the device that converts direct-current (DC) power from solar panels to alternating-current (AC) power that can be used to power homes. Most inverter systems are "string" inverters, which convert power from an entire array of panels. However, Enphase's high-tech microinverters operate at each panel, maximizing efficiency and performance with lower maintenance costs. Enphase also increases functionality thanks to proprietary networking and software, and inverters are powered by its proprietary ASIC, or application-specific integrated chip.
That differentiation has enabled Enphase to grow while also maintaining healthy margins. Even in the recently challenged past few quarters, Enphase's operating margin is 22.75% over the past 12 months, which is pretty high for a company that's still investing for growth and has seen some headwinds.
And while the U.S. market has been challenged over the past two quarters -- we'll get to that in a minute -- residential solar growth still seems that it has a way to go. That's especially true overseas, where Enphase continues growing like a weed. Enphase's Europe revenue more than tripled year over year last quarter, while its Australia revenue more than doubled. The company also introduced a new inverter that can handle higher-power panels popular in places with a high amount of sunshine, including parts of Latin America. Meanwhile, despite some near-term headwinds in the U.S., management was keen to point out on the recent conference call with analysts that residential solar in the U.S. is only 4% to 5% penetrated.
And Enphase is also beginning to sell more products than just inverters. The company began selling its own battery systems along with inverters in 2020, and after the acquisition of ClipperCreek in 2021, it began selling at-home electric-vehicle chargers as well. Enphase has also acquired software companies that help customers manage their systems and for installers to find quality leads. So revenue from these products is just starting to kick in.
Despite all of this, Enphase's stock has plummeted back to earth, but it also now trades at a much more reasonable valuation. Its P/E ratio is now just 31 times trailing earnings and 24 times next year's estimates -- much lower than in its recent past.
ENPH PE Ratio data by YCharts
But there are real concerns as well
Despite all these positives, there are good reasons Enphase's stock is down. For one, its U.S. revenue has now declined two quarters in a row, and the company projected a big drop in third-quarter revenue as it attempts to help dealers lower their inventory.
The primary reason given is higher interest rates. While residential solar does save customers on utility bills, solar systems are expensive, usually running into the tens of thousands of dollars. So customers usually buy them with loans or on lease. As interest rates have risen, demand has plummeted in the U.S., especially in Texas, Arizona, and Florida, which have relatively low utility rates.
That has increased costs and pushed out the payback period, making solar overall less appealing. And while many expect interest rates to eventually come down from their recent levels, it is not at all assured that that will be true.
As the market has gone into correction, Enphase's lower-priced competition may cut prices further in a bid to desperately win business. It's also possible that string-inverter competitors SolarEdge and Tesla continue to improve their offerings, making their next-best solutions "good enough" for cash-strapped buyers.
But Enphase doesn't just face competition from other inverter manufacturers. It also faces the substitution threat of utilities improving their offerings. That's specifically what we're seeing in the problem states right now. If utilities continue to innovate and figure out more ways to deliver more renewable power at reasonable costs, that could further slow residential solar adoption. In Europe, consumers and businesses are very concerned about self-sufficiency, especially given the challenges the Russia-Ukraine war are posing. However, in energy-abundant markets like in the aforementioned southern states, that may be less of a concern.
Has the U.S. residential solar market tapped out? Image source: Getty Images.
And while 4% to 5% penetration sounds low, it's not clear what penetration residential solar will achieve. Is it 50%? Or 10%? The answer is uncertain, as the U.S. market appears to have matured after early adopters have already bought their systems. And Enphase is still primarily a hardware company, without much in the way of recurring revenue that could sustain a high multiple.
In addition, it appears management was caught by surprise by this downturn. The company's conference calls were actually quite optimistic for a turnaround earlier in year, but it turns out that didn't materialize. As Enphase has greatly ramped up its partner contract production capacity in anticipation of further growth, the market has gone in the other direction.
For growth companies, an inability to predict market trends can be dangerous, since all companies have to invest in product development, manufacturing capacity, and working capital before sales occur. If sales continue to be weaker than expected, a company can get stuck within a dangerous situation. Enphase does have an excellent balance sheet, with $1.8 billion in cash against $1.3 billion in debt. So that shouldn't be a concern at this point. But it is something to monitor.
The verdict
Overall, I would still lean toward Enphase as a buy rather than a sell here, although it's going on my watch list and not in the portfolio.
While the third quarter could mark a bottom in Enphase's overall results, the past few disappointments have left me wondering about management's credibility in predicting this evolving market. There's also a transition going on in the major market of California, which makes up about 20% of Enphase's U.S. sales. The state has recently passed net metering rules that make solar panels by themselves less attractive. On the other hand, implementation of "smart" home batteries should mitigate this issue and enable Californians to maintain prior payback periods.
Enphase management insists this will actually be a positive, as the change could catalyze more Californians to buy both microinverters with the company's new batteries attached; on the other hand, that would make up-front costs higher, even though the payback period will be roughly equal with a battery. Moreover, Enphase is newer to the battery game, so it's possible installers could mix-and-match Enphase's microinverters with other battery providers.
In sum, I'd like to see how California sales react to this policy change, which should become apparent in the next couple of quarters, rather than take management's word for it.
However, with international sales now making up 41% of sales, up from previous quarters and showing eye-popping growth, that should cushion the blow from any U.S. softness. That makes me more inclined to buy if there is confirmation that California sales don't fall off a cliff and perhaps if interest rates begin to come down. But the uncertainty is enough that one can remain patient.
