The solar energy business has long been tumultuous, with commoditization, falling prices, and low margins more the norm than the exception.
However, one corner of that market has actually been quite profitable over the years: the inverter market, which is dominated by two companies, Enphase (ENPH 1.19%) and Solaredge (SEDG +13.47%). An inverter is a device that converts the direct current (DC) electricity that is generated by photovoltaic solar panels into the alternating current (AC) electricity that we use to power our homes and businesses.
While there are other inverter companies out there, these two have carved out a nice duopoly as industry leaders, thanks to some sophisticated technology that boosts efficiency, safety, and offers ongoing services to homeowners and installers.
But today, the residential solar market is undergoing a bust as inflation and higher interest rates are causing the U.S. market to decline and overseas markets to slow. Formerly priced for ongoing growth, shares of Enphase and SolarEdge are now down 63% and 64%, respectively, from their all-time highs.
Still, each company is profitable, and the solar energy market should continue to grow over the long term. That could make this sell-off a golden opportunity -- but which stock is the better buy?
NASDAQ: SEDG
Key Data Points
Differences between Enphase and SolarEdge
The main difference between Enphase and SolarEdge is that Enphase makes microinverters, which convert DC to AC at each panel. SolarEdge makes traditional string inverters, in which the current from all panels in a system is converted at a single point. However, SolarEdge does add intelligence to each panel by way of its power optimizers, which help each panel reach its maximum power point based on current and voltage, and allow for more flexible positioning than traditional string inverters.
All things being equal, microinverters tend to be a higher-end, more differentiated product with a longer warranty. That's important, as the inverter is the piece of equipment that tends to fail first in a solar power system. In addition, microinverters streamline the process of expanding a system because they make it easier to add more panels. Furthermore, string inverters tend to only work at the level of the lowest-current panel, meaning if one panel has a problem or has shading issues, it affects the whole system.
In a recent survey of U.S. solar installers, Enphase came out as the most preferred provider, with 74% of installers carrying the brand, while 60% of installers carried SolarEdge. But both were far ahead of anyone else.
Basically, the Enphase microinverter is like a Mercedes -- a high-end machine with all the bells and whistles -- while SolarEdge is more like a Toyota -- more affordable, but with enough bells and whistles to set it apart from more basic models. Over the long term, Enphase has generated higher gross margins than SolarEdge, which one would expect from the "luxury" product.
However, while one may be the "better" solution all else being equal, the answer to the question of which is the better value for customers or the better stock for investors depends on several factors. And there are several good reasons to think that SolarEdge stock may be the better buy right now.
ENPH Gross Profit Margin data by YCharts.
Solar is doing much better in Europe, where SolarEdge has more exposure
As mentioned, the U.S. is experiencing a slump in residential solar installations due to inflation and higher interest rates. However, in Europe, interest rates haven't risen quite as much, and electricity prices tend to be higher, especially since Russia began its 2022 invasion of Ukraine, which makes solar more attractive.
After a blockbuster 2022, growth in Europe's residential solar market is slowing, but it's still relatively strong. Meanwhile, it appears that the installation rate in the U.S. is actually declining in the near term. There are also reasons to think the weak market environment in the U.S. could worsen as a new regulatory regime in California kicks in later this year. That actually caused a surge of demand for Enphase's California business as customers there rushed to buy systems ahead of new regulations, but its U.S. business is now projected to decline.
But both companies are seeing solid growth in Europe. Last quarter, Enphase's European segment revenues more than tripled year over year. Meanwhile, SolarEdge's European revenues were up 52% quarter over quarter, and management noted sell-through in Europe was up 115% compared with last year.
So why would that give an edge to SolarEdge? Because Europe accounted for about 73% of SolarEdge's solar revenues last quarter. By contrast, Enphase's international segment only accounted for 41% of its total revenues last quarter, and even that was up a lot from the prior quarter and year. And while the bulk of that was European revenue, Europe does not make up all of that segment.
With SolarEdge more levered to the "less bad" geography right now, it didn't guide down by nearly as much as Enphase did for the third quarter. That's probably due to its larger position in Europe, whether by design or luck.
|
Company |
Q2 Revenue |
Q3 Revenue Guidance (Midpoint) |
Forecast Change |
|---|---|---|---|
|
Enphase |
$711.1 million |
$575 million |
(19.1%) |
|
SolarEdge |
$991.3 million |
$900 million |
(9.2%) |
Data source: Enphase and SolarEdge Q2 earnings releases.
SolarEdge is cheaper -- both the stock and the product
In the current macroeconomic climate of higher interest rates and cash-strapped consumers, SolarEdge may also be better positioned here for a couple of reasons.
First, even though it's a lower-margin business, SolarEdge trades at a cheaper price-to-earnings ratio than Enphase, and even more so on a forward price-to-earnings basis. Looking at the estimates below, SolarEdge appears primed for better earnings growth one year out, but it's still the cheaper stock.
ENPH PE Ratio data by YCharts.
If interest rates stay high, investors are likely to gravitate toward value stocks over growth stocks, as higher rates will discount future earnings by a greater amount, putting the onus more on near-term profits.
And in this environment, squeezed consumers might gravitate more toward SolarEdge's cheaper string inverters over Enphase's pricier microinverters, all else being equal. This again perhaps sets SolarEdge up for better near-term performance.
California's new regime may favor SolarEdge
Finally, SolarEdge may have a leg up in California under the state's new regulatory regime. In the prior net metering regime, NEM 2.0, California's residential solar customers could consistently feed their excess electricity to the grid at market rates. However, that led to utilities being overloaded with excess electricity at certain times, and having to pay solar power system owners a hefty rate for it. The new NEM 3.0 regime uses a "net billing" metric under which compensation for sending electricity back to the grid is calculated on an "avoided cost" basis, and will vary widely according to the hour of day and time of year, depending on what utilities need.
Therefore, NEM 3.0, which went into effect on April 15, will greatly favor the attachment of home battery systems to solar installations, along with intelligent systems that can determine the best times to send electricity back to the grid, and when to store it for later. That could potentially benefit SolarEdge, because batteries store DC energy, and every time DC is converted to AC or vice versa, a little bit of power gets lost -- between 5% and 15%. Since Enphase's microinverters transform DC to AC at the panel level, that electricity has to be converted back to DC to be stored in a battery, then reconverted to AC to be used. That's three conversions to use power, as opposed to one conversion with SolarEdge's system, which can route DC power straight to a battery.
Now, Enphase could potentially make up for this extra conversion loss with technological advancements, since Enphase does seem to have more advanced tech. However, on balance, it appears as though it will have to work harder to offset the efficiency losses that come with battery storage.
Both could be buys for the long term
Over the long term, companies with leading technology and pricing power tend to be the best buys. That would typically mean investors should favor Enphase's stock. However, it looks like SolarEdge may actually be the better buy over the next few quarters or even years due to its geographic and market positioning.
Still, the fates of both of these stocks will be heavily influenced by the growth trends of residential solar generally, as well as by these companies' abilities to maintain their duopoly. In that light, long-term investors interested in the space should look at both stocks during this dip.
