Enphase Energy: Overvalued But Worth Watching (NASDAQ:ENPH)

Enphase Energy, Inc. (NASDAQ:ENPH) is a global energy technology company. They attempt to provide a set of integrated solar technology which manages solar generation, storage, and communication on one platform.

Solar photovoltaic (PV) installation structure

Figure 1: schematic of a solar cell.

A solar cell is the singular unit of the solar PV installation.

Solar cells contain two semiconductors. Semiconductors are materials which conduct electricity more efficiently than an insulator (such as rubber), but less efficiently than a pure conductor (such as aluminum). Semiconductors in solar cells tend to use silicon. One semiconductor is referred to as P-type silicon, whilst the other is referred to as N-type silicon. P-type semiconductors have a vacancy of electrons, whilst N-type silicon has an excess of electrons. Figure 1 shows the structure of a solar cell.

When sunlight hits the solar cell, the solar energy triggers the electrons to move from the N-type silicon layer to the P-type silicon layer. As the N-type and P-type layers are connected with a metallic wire, the electrons are replenished at the N-type layer and thus able to create a flow of electricity.

Several solar cells can be joined together to produce a solar module. Several solar modules can be joined together to produce a solar array.

Products and services

String inverters

As solar PV installations can only produce direct current, DC, an inverter is required to convert DC to alternating current, AC, which can be used by the grid and appliances. There are two main types of solar inverters: string inverters and microinverters. String inverters are the most widely used. These rely on a centralized approach, with each solar module connected in series. Whilst this makes management of the solar PV installation easier (as if the installation breaks down, it is likely the inverter), as the inverter’s modules are connected in series rather than parallel, this means that the output of the group of modules is limited by the lowest performing module. This can occur when one module becomes shaded. Furthermore, string inverters do not allow for monitoring to the same extent as microinverters; if energy generation is low, it will likely go undiscovered for a long period of time.

Microinverters

Figure 2: microinverter and string inverter.

Enphase developed the microinverter. Microinverters convert DC to AC at each individual solar module. This provides several advantages. To begin, this ensures that the output of other modules is not affected by the output of one module. For instance, if one module is covered and therefore cannot produce electricity, this does not mean that other modules are unable to produce electricity. This allows for increased electricity generation. This is due to modules being connected in parallel rather than series (see figure 2). Next, advanced energy monitoring is enabled through a microchip being installed in every microinverter. This is applied through their ‘burst mode’ technology. Burst mode refers to the solar module being able to generate more energy in low-light conditions to ensure that there is always a steady electricity production. Finally, it is easier to expand the solar array with microinverters as the inverter is not constructed in series.

There have been 8 renditions of their microinverter thus far. The latest rendition, IQ8, has an integrated circuit chip which has its own micro-grid. This means that IQ8 homeowners can produce and use their own power and can provide electricity during a power outage without a battery. This is unique on the market. Future renditions of the microinverter aim to use gallium nitride, a chemical which increases the power available to semiconductors.

Other products and services

Enphase attempts to provide an integrated approach to energy solutions. They have several apps and services available for consumers. These include the Enphase Installer App, IQ Battery, IQ Combiner, IQ Gateway, and Enphase Enlighten.

Enphase Installer App

The Enphase Installer App is used to set up the various Enphase services.

IQ Battery

The IQ battery is a solar battery. This allows consumers to store electricity generated via solar panels to use later. The IQ battery has a “load control” function, which can be used through the IQ Load Controller. This allows consumers to decide which appliances are powered during an electricity outage so that the battery lasts longer.

The next rendition of the IQ Battery, IA9D-BAT Inverter combines battery and power management in a single board, replacing seven boards previously, therefore optimizing cost.

IQ Combiner

The IQ Combiner consolidates wires and other interconnection equipment. This reduces hassle and makes management easier.

IQ Gateway

The IQ Gateway sends data about solar energy generation and energy consumption to the Enphase Installer Platform.

Enphase Enlighten

Enphase Enlighten is a web-based application which allows consumers to view system status, historical production data, and see easy-to-read charts and trendlines showing solar power generation, energy storage and consumption.

Enphase provides a warranty with microinverter units lasting 15 years for first and second generation microinverters, and 25 years for subsequent generation microinverters. This suggests that the products are likely to last for this period.

Enphase also provide various other services including electrical vehicle chargers, communication wiring, accessories, and clothing. All of these are defined under a single operating and reportable segment in their financial records.

Business model and strategy

Strategy

Enphase have had a consistent strategy for the previous years.

1. Best-in-class customer experience
2. Grow market share worldwide.
3. Expand product offerings.

Enphase want to capitalize on their presence in core markets, as well as increasing market share in Europe, Asia Pacific, and Latin America. They intend to expand into emerging markets.

Enphase differ from their competitors in that they provide a full-service approach to solar energy installations; they provide all of the components required for energy management.

4. Increase power and efficiency and reduce cost per watt

5. Increase storage density, reduce install time and cost per kWh

6. Focus on the consumer and installer partners

Badri Kothandaraman, CEO, mentioned that fleet analytics are an essential tool to the company. As of now, Enphase monitor: energy generation per home, energy consumption per home, system vitals and events, homeowner profile, errors and notifications, global weather data, grid performance, and installer stats and performance.

Revenue

Revenue is primarily generated through the sales of microinverters and storage systems. The main cost of revenues is due to product costs, warranty, manufacturing personnel and logistics, freight, and inventory write-downs.

Overall, across the previous three years, the US has represented a smaller portion of revenue, decreasing from 84% in 2019 to 82% in 2020 to 80% in 2021, despite total revenue increasing by $607,624 to $1,382,049 between 2020 and 2021. This likely represents efforts by Enphase to increase international market presence.

Mergers & acquisitions

Enphase have had six acquisitions thus far, all within the previous two years.

1. Enphase acquired Sofdesk Inc. in January 2021. Sofdesk provides design and proposal software.
2. Later, in March 2021, Enphase acquired DIN Engineering Services LLP which provide proposal and permitting services and are particularly focused on automating the creation of permit plans sets to expand the installer base.
3. In December 2021, Enphase acquired 365 Pronto which match cleantech asset owners to a local and on-demand workforce of service providers using a predictive software. Enphase expects that this acquisition will offer installers an online platform to service their maintenance contracts and gives access to a labour pool that can perform these services.
4. Later in December 2021, ClipperCreek Inc. was acquired. ClipperCreek offer electrical vehicle charging solutions. This has allowed Enphase to enter the EV charging market.
5. In 2022, Enphase acquired SolarLeadFactory LLC. SolarLeadFactory is a solar lead company who are attempting to accelerate the adoption rate of solar power.
6. Enphase then acquired GreenCom Networks AG, a company which optimises energy management and consumption to reduce electricity off-take from the grid.

Additionally, SunPower, the fourth largest retailer in California’s residential market, made a deal with Enphase in 2018 for Enphase to be the sole supplier of microinverters for a period of five years. Given SunPower’s large share in the residential market, this gives Enphase guaranteed sales.

Manufacturing, supply chains and customers

Enphase outsource manufacturing to several partners. Flex Ltd and Salcomp Manufacturing India Pyt Ltd are the primary manufacturers. They are responsible for assembling and testing the microinverter AC battery storage systems and communications products. Hong Kong Sinbon Industrial Limited manufacture custom AC cables, and Amperex Technologies Limited supply lithium-ion batteries. Enphase claim that this diversification of the supply chain can help them better serve customers through cutting down on delivery times.

Enphase mainly sell to leading solar and electrical distributors, installers, original equipment manufacturers, strategic partners, and homeowners. Though, it is important to note that in 2021, one customer accounted for an estimated 34% of total net revenue.

Financials

Revenue and expenses

Despite net revenue increasing by 78.5% between 2020 and 2021 (from $774,425,000 to $1,382,049,000), net income only increased by 8.5% (from $133,995,000 to $145,449,000). This can be attributed to increased operating expenses (research and development, sales and marketing, and general and administrative), increased interest expense, and loss on partial settlement of convertible notes.

Research and design have marginally increased in expense as a proportion of revenue across the previous three years, increasing from 6.5% in 2019, to 7.2% in 2020, to 7.6 in 2021. The financial notes section comments that research and development expense consist primarily of product development personnel costs, including salaries and benefits, stock-based compensation, other professional costs and allocated facilities costs. Management goes on to comment that research and development employees are engaged in the design and development of power electronics, semiconductors, powerline communications, networking and software functionality, and storage. Substantial resources are provided to improving existing products and developing new ones.

Management comment that general and administrative expense include personnel-related expenses for executive finance, human resources, IT and legal organizations, facilities costs, and fees for professional companies.

Interest expense has been increasing as a proportion of incomes from operations across the previous three years, increasing from 9.4% in 2019, to 11.3% in 2020, to 20.9% in 2021. This represents increased levels of debt within the company.

Debt

Non-current debt increased from $4,898,000 to $951,594,000 between 2020 and 2021. Management note that this will be used to fund operating activities, working capital, acquisitions, and purchasing property and equipment. They anticipate that future capital needs from the debt market will be more limited.

Risks

Competitors

Enphase is primarily a company concerned with inverters and energy storage. Thus, competitors can be categorized into these two markets.

1. Inverters

Threat in the inverter market occurs from various companies including SolarEdge Technologies Inc., Fronius International GmbH, SMA Solar Technology AG, and Tesla. Notably, these companies produce string inverters rather than microinverters as Enphase does, thereby giving Enphase a unique advantage. However, SolarEdge’s leading product is their “power optimizer.” This is an inverter which first optimizes the DC current, and then fully converts it to AC at a central converter. This has a similar output to Enphase’s microinverter.

Hoymiles, headquartered in Hangzhou in China, is another competitor. They undertook an IPO in December 2021 in which they raised almost the equivalent of $1 billion, the largest Chinese IPO ever at the time. Importantly, Hoymiles also produce microinverters for a variety of countries, and can generate electricity during a power outage – both of which are USPs of Enphase. This may present challenges to Enphase, especially if Hoymiles are attempting to expand into foreign markets. Though, it is important to note that as of now, Enphase have a more holistic approach towards solar installations than Hoymiles; Enphase has a wider array of products and apps.

2. Energy storage

Enphase list several competitors in the storage market, including Tesla, SolarEdge, LG Chem, Sonnen and Generac. Enphase’s battery capacity lies towards the lower end of the range at 3.5 – 10.1kWh (see figure 3).

Company	Battery capacity (kWh)
Enphase Energy	3.5 – 10.1
SolarEdge	10.0
Tesla	13.5
Sonnen	5.5 – 22.0
LG Chem	8.6 – 17.2
Generac	18.0

Click to enlarge

Figure 3: battery manufacturers and battery capacity.

Though, all these companies, except for SolarEdge, produce products relating to a variety of industries. For instance, LG Chem produces a wide variety of petrochemicals, advanced materials, and equipment for the life sciences. This gives Enphase an advantage in the sense that they have a niche area within the solar industry in which they can focus on. SolarEdge, however, occupies this area too.

Semiconductor supply chain issues

According to S&P Global, experts predict that supply chain challenges across the semiconductor industry will last until late 2023 and early 2024. The constraint on the supply chain has already adversely affected Enphase, and could further affect component availability, lead times and cost, therefore increasing the probability of unexpected delays or cancellations of key components.

To mitigate these risks, Enphase has extended purchase agreements and placed non-cancellable advanced orders. Though, this may mean that Enphase are unable to use newer technology.

Small number of outside contract manufacturers

As Enphase lack the capabilities to manufacture internally, they rely on external contract manufacturers – Flex, Salcomp, Sinbon Industrial Limited, and ATL. Notably, Enphase lack long-term supply contracts with these manufacturers, meaning that they are under no obligation to supply products to Enphase for any period. In the future, Enphase is vulnerable to supply chain issues. Furthermore, Enphase constitutes a small portion of the revenues of these manufacturers. Therefore, Enphase is likely not a priority, and this presents risks with delays in the supply chain. Diversification of the supply chain would do well to mitigate this risk.

Customers

In the fiscal year ending December 31^st 2021, one customer accounted for 34% of sales. Further, as of the time of publishing of the most recent 10-Q, one customer accounted for 38% of total accounts receivable balance. The contracts for these are generally short-term rather than long-term. Therefore, a single customer having such a large share of sales subjects Enphase to a large amount of risk; if this customer stops buying, then total revenue and shareholders are likely to suffer. Diversifying the customer base is the best solution. This can be achieved through marketing and reaching out to potential commercial customers who may be willing to make a deal.

Reduction, elimination, or expiration of government subsidies

Government subsidies in the form of feed in tariffs, rebates, tax credits and other incentives have meant that there is an increased demand for solar installations. Reduced government subsidies may reduce this demand and thus decrease revenue for Enphase.

Recent expansion into new and existing markets

Enphase is attempting to expand into other international markets. This presents several problems associated with international business in general, including acceptance of microinverters in a new market, competing in a new market, adapting to new regulatory requirements, unfavorable intellectual property protection, and others.

Failure to realize benefits from SunPower deal

In 2018, Enphase and SunPower made a deal for Enphase to be the sole supplier of microinverters for a period of five years. The benefits from this transaction will only be realized if Enphase abide by the rules of the SunPower Master Supply Agreement, “MSA.” Completing the terms under the MSA is complex and time-consuming. Delays or breach of obligation under the MSA could have an adverse effect on Enphase.

SWOT analysis

Strengths

• Enphase is well established as a market leader, is innovative, and has a good reputation amongst consumers.
• Enphase’s USP is microinverters – a product which is mostly unique to them.
• Microinverters have better data analytics in comparison to string inverters and maximzse electrical output.
• Solar energy is clean and limitless in daylight conditions.
• A holistic approach to solar installations means that consumers are likely to buy more than one product from Enphase.
• A series of acquisitions means that Enphase is likely to strengthen its existing business and undergo market diversification.
• The SunPower deal means that Enphase have some guaranteed sales across the next five years.
• Enphase have over 230 US patents and 75 non-US patents; their technology is well protected.
• There has been very little legal action taken against the company.

Weaknesses

• Most customers buy in the short-term rather than the long-term. This means that long-term sales are unpredictable.
• As microinverters work at the level of each solar module, they are more likely to fail.
• Microinverters cost more than string inverters which may push away customers.
• Limited suppliers mean that Enphase is vulnerable to supply chain issues if problems occur with these suppliers.
• International supply chain is prone to delays.
• Enphase require distributors, installers, and providers of solar financing to aid in selling products. A breakdown in relations with these companies could cause issues for Enphase.
• Potential issues with international strategies.
• As a significant proportion of future revenue relies on R&D, investment returns are not guaranteed.

Opportunities

• To capture the remaining consumer base who do not want to buy microinverters due to hassle or monetary reasons, Enphase could sell string inverters.
• Given the SEC’s approval, a merger between Enphase and SolarEdge, two market leaders in this field, could eliminate competition and provide benefit to both companies through a bigger set of intellectual property and better scale of economies.
• Increased R&D funding could provide more effective technology.

Threats

• One customer accounts for 34% of revenue.
• Competition from other solar technology companies.
• Threat of alleged patent infringement by other solar technology companies.
• Breach of contract of the MSA with SunPower could result in litigation.
• Semiconductor supply chain constraints.
• Reduction of government subsidies for solar installations could reduce demand.
• Issues with international trade, such as US tariffs, could cause supply chain issues.

Valuation and conclusion

Enphase has a Seeking Alpha Valuation Grade of D- and a Quant score of 3.43 and Quant rating of “hold.” According to Seeking Alpha, Quant ratings beat the market. Since Enphase has a Growth score of A+ and a Profitability score of A-, as well as my interesting analysis above means that I would have to agree with the Quant rating of hold for now. However, the stock will go to the top of my watchlist, and as soon as the Valuation Grade or the Quant score improves, I will likely then move the rating to a Buy. I like the business model of Enphase Energy, Inc. and the firm has many strengths. Clearly, though, this appears to be already factored into the valuation for now.

Important links

Investor day 2021 presentation

2021 10-K

Deal with SunPower

MSA between SunPower and Enphase.