For the last few months, shares of Enphase Energy (ENPH 3.80%) have been in free fall. From installers, to panel manufacturers, to renewable electric utilities, to inverter makers like Enphase, the broader solar industry is now in a major downturn.
In 2020, Enphase booked $774 million in revenue, followed by $1.38 billion in 2021 and $2.33 billion in 2022. But if it hits the midpoint of its latest fourth-quarter guidance, 2023 revenue will come in at just $2.31 billion, the first year-over-year annual decline since 2017.
Management had a lot to say on the recent third-quarter earnings call. Here's one of the hidden nuggets on the call that could indicate where Enphase is headed and what to do about the stock now.
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A pivotal strategic decision
Enphase investors don't have a lot to smile about right now. But they might appreciate the detailed answers that CEO Badri Kothandaraman often provides to analysts' questions. And the third-quarter conference call was no different.
If you're an investor in Enphase, it's a good idea to listen to the earnings calls, and not just read the transcripts of earnings press releases, because you'll get a much better idea of management's headspace.
One of the most important parts of the call was when an analyst asked, "Are you sure that your business couldn't perhaps generate higher bottom-line earnings if you simply grew it more quickly and allow, say, a 35% gross margin? I'm just curious as to your philosophy as to why the gross margin has to stay [higher]."
Kothandaraman responded:
It is the eternal question. Can I grow faster if I drop prices, right? I mean, for us, it is pricing based on value. The moment we've stopped generating value, it is over. So that's why ... I don't base it on cost. The moment you base it on cost, it's a problem. Then you forget about the value drivers [such as our] microinverters and battery and software. ... Innovate or die. We are that company. That's our philosophy. So we believe high quality is high volume and high price...
To me, this shows that Enphase is committed to keeping prices high. And because of that, its revenue is probably going to continue suffering more than it really needs to. It also means that valuing Enphase purely on a price-to-sales ratio is a big mistake because Enphase itself is saying it is focused more on gross margin than sales.
Management's rigid stance on margins exudes a ton of confidence. It shows that the company doesn't care about appeasing Wall Street or short-term-minded investors, and it is perfectly fine if its stock price suffers for it, at least for now.
How to approach Enphase stock
If you're going to invest in Enphase stock, I think you have to agree with management's pricing strategy. Its decision to maintain high prices even during a downturn is similar to a company like Apple, which is going to rely on the power of its brand and product innovation to justify charging a premium price.
The strategy relies on the market agreeing that Enphase's offering really is better than the competition's, which the company believes is true. And the downside is that the strategy leaves sales on the table.
Enphase has repeatedly said that is it focused on investing through the cycle. And for now, that strategy hurts its near-term results. For that reason, the stock is probably going to be challenged, but the long-term investment has become even better.
As utility rates rise, the benefits of Enphase's latest microinverters paired with its energy-storage products improve. The company continues to innovate and expand geographically, which sets it up nicely when the industry turns around. Its Q3 2023 international revenue was actually higher than a year ago. And as a percentage of revenue, international made up 36.4% of total revenue compared to just 28.9% in the 2022 third quarter -- a sign that Enphase is becoming less dependent on the U.S. solar market.
How Enphase stock could start to look cheap
Management expects its inventories to normalize around the 2024 second quarter and for the business to return to the $450 million to $500 million quarterly revenue range. If we assume that Enphase can retain its high margins and earn around $2 billion in 2024 revenue, then the stock's current $10.9 billion market capitalization looks like a fairly reasonable price for those results -- especially during a downturn. But only if you believe Enphase has growth potential.
However, if you believe it can continue growing over the next several decades and retain high margins, then the stock is a steal at these prices. Just know that the company's lower revenue and earnings on the basis of generally accepted accounting principles are going to make its price-to-sales and price-to-earnings ratios look high in the near term, even after the stock's brutal sell-off.
The Enphase game plan
The silver lining for the bleak guidance and the stock's sell-off is that expectations are very low. And when that's the case and a stock has already gotten clobbered, it sets the stage for a turnaround if Enphase can return to growth.
If you agree with management's high-margin strategy at the expense of revenue growth -- and you have a high risk tolerance and a long-term outlook -- than buying the stock could be a good move.
But if you think Enphase should be more sensitive to lower demand and should cut prices to boost revenue growth, then you might want to avoid the stock and consider other ways to invest in the solar industry.
