The electric vehicle (EV) and solar industries are both playing pivotal roles in the energy transition. However, rising interest rates have dampened growth rates. Tesla (TSLA +3.93%) finds its margins compressing to multiyear lows due to steep price cuts. Enphase Energy (ENPH +2.76%) and SolarEdge Technologies (SEDG +6.97%) are now in a legitimate downturn.
Even after last week's epic market rebound, Tesla has lost 12.6% of its value over the last month, while Enphase is down 30.8%, and SolarEdge has suffered a brutal 38.4% sell-off. Let's determine if you should buy the dip on the EV industry with Tesla or take a 50/50 split of Enphase and SolarEdge to bet on a rebound in the solar industry.
Image source: Getty Images.
Tesla's price cuts have taken a toll
When Tesla stock was hitting record high after record high, it was because everything was going well. Growth can do wonders for a company. In Tesla's case, top-line growth paired with scale (and a lot of lessons learned the hard way) eventually resulted in an absolute cash cow of a business model.
Tesla quickly went from an unprofitable company to a highly profitable, free-cash-flow-positive automaker with industry-leading margins, a net positive cash position on the balance sheet, and a multiyear head start over the competition in electric vehicles. It was the perfect storm for a surging stock.
The market was -- and still is -- willing to pay a hefty premium for Tesla relative to its peers. And in many ways, Tesla deserves that premium. But ignoring the challenges would be a big mistake, as Tesla's fundamentals have deteriorated by quite a bit.
Tesla's top- and bottom-line growth rates have ground to a halt, while its quarterly operating margin is now close to a three-year low.
TSLA Operating Margin (Quarterly) data by YCharts.
At least in the short term, Tesla's results are breaking the investment thesis. But it's important to understand that Tesla's declining margin is largely a result of slowing demand paired with price cuts. Tesla is merely responding to economic conditions, as it depends on sales growth to fund manufacturing expansions and other growth plans.
Tesla's balance sheet is in good shape largely because the business has been performing so well in recent years. It has been able to fund its aggressive growth plans mostly from its operations (not relying on debt), which is an incredible achievement considering how ambitious Tesla's plans are. Meanwhile, other automakers have been turning to the capital markets to fund their EV initiatives.
So while Tesla's present challenges certainly don't derail the long-term investment thesis or the electrification of the auto industry, they do impact its ability to grow as quickly as Tesla may have hoped. Over time, slower-than-expected growth may reduce Tesla's advantage over the competition and, in turn, lead to permanent margin compression.
NASDAQ: TSLA
Key Data Points
The solar industry is in a major downturn
Enphase and SolarEdge have a near duopoly over the solar inverter and power optimizer market. They make devices that convert the direct current power produced from the sun into the alternative current we use in our homes. Both companies have expanded to provide more electrification solutions, mainly through energy storage and EV charging.
Enphase is more exposed to the residential and small-scale commercial side of solar, while SolarEdge has more exposure to commercial, as well as Europe. However, both companies have seen slowing growth and margin compression.
Despite their industry-leading positions, both Enphase and SolarEdge are relatively small companies, with Enphase sporting just an $11 billion market cap compared to $4.3 billion for SolarEdge.
Enphase's CEO, Badri Kothandaraman, did an excellent job providing in-depth answers to analyst questions on the Q3 earnings call. On the call, management made it clear that Enphase is going to retain its high margins even at the expense of lower sales but that the industry could begin rebounding in the second half of next year.
Enphase and SolarEdge are facing a challenging cyclical downturn. But they have the market positions and balance sheets to outlast it.
The better buy
The EV industry and the solar industry are both under immense short-term pressure. And yet, Tesla stock is still up big on the year while Enphase and SolarEdge are hitting multiyear lows.
Tesla is one of the best-performing stocks in the S&P 500 this year, while Enphase and SolarEdge are the two worst-performing stocks in the index.
Granted, a lot of Tesla's strong year-to-date gain is due to a brutal sell-off in December of last year. And if we factor that out, the stock's performance would have been far less impressive. But still, there's a stark contrast between Tesla, which is up despite its results coming in quite worse than expected, and Enphase and SolarEdge, which are at multiyear lows.
This isn't to say that Enphase and SolarEdge couldn't fall further. But rather, a lot of the damage has been done, considering these companies still have a lot going for them long-term.
An argument against Enphase and SolarEdge is that they will face ongoing competition from China, which will result in lower margins over time. That could happen, but Tesla faces relatively greater threats from pure-play EV makers and legacy automakers alike. In short, no firm is impervious to competition. But there's a slew of companies trying to take a slice out of the EV pie from Tesla, including formidable companies in China. In contrast, Enphase and SolarEdge operate in a niche part of the solar system and don't face nearly as great of a threat.
Add it all up, and a 50/50 split of Enphase and SolarEdge looks far more attractive than Tesla stock at this time.
