Enphase Is Holding Up Well in This 1 Key Metric -- but Is It Time to Buy the Stock?

By now you may have heard about the ugly third-quarter 2023 financial update from residential solar inverter leader Enphase Energy (ENPH 3.80%), a report that was inauspiciously previewed by peer SolarEdge Technologies (SEDG 2.81%) the week prior. Long story short, a cyclical downturn has finally come for Enphase after several years of stellar growth, and the downturn is likely to last through at least the first quarter of 2024. I had a tiny Enphase stock position (a fraction of 1% of my portfolio) that I recently sold in preparation.

The good news is that things don't appear to be as dire for Enphase as they are for SolarEdge. That doesn't mean it's time to buy Enphase stock, though -- at least not yet. 

One Enphase metric that actually looks pretty good

Enphase's bread and butter is residential solar inverters, an electronic device that converts power from a solar panel array to usable electricity in a home or small commercial building. Enphase's specific technology is microinverters, one of which sits behind each solar panel, different from the singular string inverter that peer SolarEdge makes.  

Enphase has branched out into other products in recent years as well, offering batteries for backup power and excess power that can later be sold to a local utility, and personal electric vehicle charging stations. The company also derives most of its revenue from the U.S., 64% in Q3 2023 specifically, up from 59% in Q2 2023.

Understanding both the product mix and geographical distribution of Enphase is important for understanding one key standout metric: gross profit margin -- the percentage of money generated from a sale after the cost of manufacturing the product is deducted, but before sales and administrative expenses are deducted. Gross margin is an important metric for a company that sells products, as it measures the efficiency of its manufacturing processes and distribution networks. 

You see, Enphase's gross profit margin is far higher than SolarEdge's, and thus far in this cyclical downturn, has held up well. Despite Q3 revenue tanking from the previous quarter, and anticipated to fall sharply again in the final months of 2023, it appears gross margin will remain near all-time highs for the once fast-growing solar business. 

Data source: Enphase Energy.

Data by YCharts.

Compare this to the revenue and gross margin of SolarEdge, which is far less profitable than Enphase despite higher revenue, and which translates to a smaller bottom line for shareholders (more on that below).

Data by YCharts.

Will Enphase remain profitable?

There are a lot of reasons why Enphase would have a higher gross margin than its peers. One key difference is the higher price it charges for its microinverter technology versus competing solar inverters. However, factors like new product launches (those batteries and EV chargers) and entry into new geographical markets (for Enphase, various countries in Europe, Australia, and South America) are also key.  

A new product launch or entry into a new country generally carries a lower profit margin than a well-established market. Thus, with certain products still in growth mode (its IQ battery sell-through to installers was up 34% in Q3 versus the prior quarter) and Enphase systems launching in new countries (the U.K., Sweden, Denmark, Greece, and Australia), expansion in those areas is likely equating to rising gross margin. That's likely offsetting weakness in core markets (California in the U.S., and Germany in Europe), where gross margin is now suffering from lower sales.

Enphase is also getting a benefit from the U.S. Inflation Reduction Act (IRA), which aims in part to bolster solar power by incentivizing companies that manufacture and sell solar products in the states. Enphase anticipates a hefty 8 percentage point bump in gross profit margin in Q4 thanks to the IRA, increasing what would otherwise be a 38% to 41% gross margin up to 46% to 49% expected in the final months of 2023.

Things are looking ugly to close out the year. Nevertheless, at the low end of guidance ($300 million in revenue, gross margin of 46% with benefit from IRA), Enphase management expects its GAAP operating loss to be $4 million. Not great after the lucrative year it had up to this point, but not nearly as bad as the GAAP operating loss of at least $9 million and as much as $28 million SolarEdge was anticipating for Q3 2023, not to mention implications for deepening losses in Q4 for SolarEdge.

Data by YCharts.

Throw valuation out the window for now

This profit and loss outperformance is the main reason I'm remaining focused on Enphase versus SolarEdge going forward. Nevertheless, I believe it's too soon to start shopping for Enphase stock again. While specific guidance wasn't provided for the start of 2024, management did say to expect similarly weak business conditions in the final months of 2023. 

Put simply, Enphase stock isn't as cheap as it may appear (21 times trailing-12-month earnings per share) since earnings are about to turn negative for at least the next two quarters.

The question now is just how bad will those earnings get before sales and gross margin stabilize. That will be key to monitor. And until the market gets a better idea of what to expect, Enphase stock could continue to fall. 

I'm staying away from this stock until then. I'll circle back around to it sometime early in 2024 when more insight is given on demand from customers for next year.