As one of the leaders in the residential- and commercial solar industry, SolarEdge continues to ride the tailwind of the green energy transition. Will the political agenda continue to create amble opportunities for SolarEdge? Are they innovative enough to keep the competition at bay? The story of the Israeli company is an interesting mix of entrepreneurship and getting lucky on riding a global tailwind.
The Political Aspect
The green energy transition, shifting from traditional fossil fuel based energy towards a supply based more on renewable energy sources, is "alive". The question is no longer "if" it will happen, but more "how much?" Especially in the latest years, there has been no lack of political attention on this topic, and many verbal commitments has been made by governments and global institutions.
A few of the major agreements worth mentioning are:
"The Paris Agreement", a legally binding treaty signed by 196 parties at the UN Climate Change Conference in Paris in 2015 (COP21), agreed with the purpose to "hold the increase in the global average temperature to well below 2°C above pre-industrial levels" and pursue efforts "to limit the temperature increase to 1.5°C above pre-industrial levels." The agreement is still a cornerstone for the discussions on global efforts to combat climate change.
"The European Green Deal", was announced by EU in 2019, and sets the goal for the European Union to be the first continent to be carbon neutral by 2050. The deal includes a pledge from the Commission to mobilize EUR 1 trillion in sustainable investments over the next decade. Within the umbrella of this deal, and to support the path towards carbon neutrality on more short term, the EU commission also released the "Fit-for-55" legislation package, which put actual plans to reduce emissions in EU with 55% before 2030. In EU the war between Russia and Ukraine, and the focus on energy security coming from that conflict, have pushed further investments into the energy sector with the "REPowerEU" in 2022, especially within the renewable sector where an increased target share of renewables in final energy consumption to 45% by 2030, exceeding the 40% currently under negotiation will require almost 600 GW of solar PV and 500 GW of wind capacity by 2030.
"The Inflation Reduction Act" (IRA), announced in 2022 was initially the USA's plan to fight the increasing inflation, but includes significant elements of energy transition, with USD 370 billion assigned to secure energy security, local manufacturing and to reduce carbon emissions with roughly 40% by 2030, and it's incentives provide unprecedented policy certainty, boosting PV (and other renewables) deployment.
Beyond the above mentioned a vast amount of acts, agreements and treaties have been announced globally including Japan’s Green Transformation (GX) programme, Korea’s aim to increase the share of nuclear and renewables in its energy mix, and ambitious clean energy targets in Africa, Middle East, China and India.
The conclusion for me is, that I believe the political agenda is going to drive a multi decade tailwind for SolarEdge and other renewable industry players. The only question is how much SolarEdge will be able to use that tailwind for their own long term profitable growth.
The Idea, Product and Potential
Let's start with the SolarEdge mission statement, which was actually changed while I was doing the research. "The mission is to develop and scale renewable energy technologies that improve the way we generate, store and use electrical power in every aspect of our lives". I do like the change of mission, as the new mission has a broader scope than just inverters and solar, which was my worry with the old one. Even though the old one was narrow and focused, I like when the mission leaves some room for exploring new untouched avenues.
The history of SolarEdge is a quite interesting one, as it starts with 5 colleagues (Guy Sella, Lior Handelsman, Yoav Galin, Meir Adest and Amir Fishelov) working in the Israeli military and decided to leave the military to pursue their dreams of starting a company themselves. They actually formed a company in 2006 without any idea as to what they were going to do, just following their entrepreneurial spirit. Started brainstorming ideas, researching the technological ideas more in detail, usually just to find out that the idea was already patented by someone else or that there was no real market for the idea. They did come up with an interesting and novel product of power management in mobile devices, but the investors and venture firms they pitched it to were not as enthusiastic about the product market as the 5 co-founders were. What they learned in the process though was, that one of the ideas far down their idea list could be very interesting. That idea was linked to solar energy, as all back then competed exclusively on inverter efficiency. Solar energy was though miniscule in Israel, and the team did not know much about it back then, and it was only due to Guy Sella's thoughts on the future of Solar that they moved the idea up the list and started to explore possibilities and researching solutions. Here they found a market that was mainly doing standard string converters and was competing on the efficiency of the inverter. Whereas the SolarEdge team found, that their power management topology, from their other product idea, could be used to optimize the system by using power optimizers and inverters combined. These power optimizers and inverters, with the first commercial shipments going out in 2010, are what has driven SolarEdge to where they are as a company today. In March 2015, SolarEdge had an initial public offering of 7,000,000 shares of its common stock at a price to the public of $18.00 per share, raising $126 million.
For those that want to get the full story I can recommend listening to the podcast Startup Stories (link to podcast on Spotify) from 2019, where Lior Handelsman co-founder and at that point in time VP of Marketing and Product Strategy lays out the early days history of the company. He also makes it clear in the podcast, that the early days success story did include a significant amount of luck, as a global inverter shortage played out just as SolarEdge launched their solutions, which gave a head start for this new and at that time unknown brand.
Before going deeper into the SolarEdge solution, a bit of background information about inverters is important. There are 3 different inverter and power optimizer solutions that supply the PV industry today. They all generally converts the DC (direct current) electricity produced from solar panels to AC (alternating current). The below graphic nicely depicts the 3 alternative solutions.
String inverters is still the most common solution globally, while Micro Inverter and Power Optimizer solutions ("Module-Level Power Electronics" or MLPE's is the overarching name used for the 2 "new" module level solutions) are gaining ground. The issue with String Converters is that a failure on one solar panel will impact the other panels on the string negatively, making the electricity output drop to the "lowest common denominator". This "flaw" is essentially the root cause for the 2 other solutions to be pioneered. The Micro Inverter solution was basically pioneered by Enphase Energy in the late 2000's at the same time the Power Optimizer solution was pioneered by SolarEdge. The Micro Inverter solution is simply about putting a smaller micro inverter at each panel to avoid the unfavorable effect of the "lowest common denominator" from the string solution, while the SolarEdge solution is to put power optimizers, that makes each panel operate independently, while still having a central inverter. SolarEdge clearly believes their solution is the best of both worlds, as you get the performance secured with the optimizers, while at the same time doing it cheaper, as the solution do not require an inverter, no matter the size, at each panel.
Beyond the actual power optimizers and inverters comes a cloud-based monitoring platform for monitoring the performance of the system and reduces the need for operation and maintenance costs.
At the moment SolarEdge primarily sells residential and commercial solar installations, while small utility-scale solar installations is the potential next growth avenue together with battery solutions. For the battery solutions SolarEdge have been reporting increased battery attach-rates in their orders, which is an interesting sign. Some of those battery deliveries would be 3rd party batteries, while some others I would expect come from their 2021 acquisition of Kokam Lithium battery producer.
SolarEdge sells products indirectly through solar installers, large distributors, and electrical equipment wholesalers. These customers are leading providers of solar PV systems to residential and commercial end users, key solar distributors and electrical equipment wholesalers as well as several PV module manufacturers.
SolarEdge runs a contract manufacturing setup, which I would let SolarEdge describe themselves by this filing describing the current manufacturing footprint:
We currently contract to have our solar products manufactured by two of the world’s leading global electronics manufacturing service providers, Jabil Circuit, Inc. (“Jabil”) and Flex Industrial Ltd. (“Flex”). By using contract manufacturers, we are able to access advanced manufacturing equipment, processes, skills and capacity on a “capital light” budget.
Further, contracting with global providers, such as Jabil and Flex, gives us added flexibility to manufacture certain products in China and Vietnam, closer to target markets in Asia and the North American west coast, as well as other products in Hungary, closer to target markets in Europe and the North American east coast, in each case, potentially increasing responsiveness to customers while reducing costs and delivery times. In addition, as part of our manufacturing regionalization efforts, we are expanding our manufacturing capabilities with a new manufacturing site in Mexico, which is planned to start volume manufacturing during the second half of 2022. Once ramped, we believe this site will significantly increase our capacity and give us further flexibility to manage growing demand.
During 2021, we reached full manufacturing capacity in our manufacturing facility located in the North of Israel “Sella 1”, from which we began commercial shipments to the U.S. of optimizers and inverters in 2020. The proximity of Sella 1 to our R&D team and labs enables us to accelerate new product development cycles as well as define equipment and manufacturing processes of newly developed products which can then be adopted by our contract manufacturers worldwide. , the facilities in which our products are manufactured are located outside of the U.S., currently in China, Vietnam, Israel, Hungary and most recently, Mexico, where the ramping up process has recently begun.
As of the date of this research paper SolarEdge has shipped over 43 Gigawatt (‘‘GW’’) of its inverter systems and its solutions have been installed in solar PV systems in 140 countries.
But where is the market heading? That is very difficult to say exactly, but it will probably be somewhere between the very conservative forecasts that are out there and the aggressive "Net-Zero by 2050" forecast put forward by IEA (International Energy Agency) in their 2021 roadmap report. There is no doubt that things over the past years have moved extremely quickly in the Renewable space in general, but especially for Wind and Solar the adoption has been immense, due to the significant LCoE (Levelized Cost of Energy) reduction over the last decades. As mentioned by Michael Taylor from IRENA (International Renewable Energy Agency) in the Watt Matters podcast no. 43 (link to podcast on Spotify), nobody two decades ago expected that Wind and Solar would be where they are today, literally much cheaper than traditional fossil fuel based electricity. It reminds me of Bill Gates old saying: "We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten."
To give a sense on the opportunity (TAM) in front of solar, I decided to bring the below graph showing the required energy sources to reach the NZE scenario (Net-Zero by 2050).
An immense build-up of solar PV is needed to get there. I do recognize that the NZE scenario is a very aggressive estimate, but IEA does also work with other scenarios, ex. APC (Announced Pledges by states) and STEPS (Stated Policies already announced by states), and the expectations gives the same picture; the transition to renewables will hugely benefit the Solar industry.
Looking a bit more specifically into the Solar PV, the yearly capacity additional is expected to more than double by 2030 and quintuple by 2050. Just getting near those estimates would be an unprecedented tailwind.
The penetration will not be equally split across regions, though all regions will see an uptick from current levels, global presence is a competitive advance going forward.
To better understand the current penetration of each of the Solar PV types, the below data from IEA shows utility scale Solar PV takes up slightly more than half of the global installations, while commercial/industrial and residential takes the rest, with commercial/industrial a bit higher than residential.
The different Solar PV types have very different economics, which will naturally also impact future growth, below shown by Lazards latest LCoE analysis April 2023.
I expect an increase of share in utility capacity as well as for commercial/industrial compared to residential, which is maybe not 100% aligned to the current SolarEdge activities, but as also mentioned earlier, utility penetration is a huge potential for SolarEdge, and while the share might reduce, there seems to be plenty of growth ahead for all types.
Specifically for the "Module-Level Power Electronics" (MLPE's), which only covers a part of the global inverter market (String inverters being the other) SolarEdge and Enphase collectively have about 95% global market share in this category, with SolarEdge claiming the lion's share. MLPEs have become dominant in the U.S., particularly in California, where over 80% of installations involved MLPEs last year. But elsewhere, it is still simple string inverters that dominate the market, with an estimated 85% to 90% of the global market. Worldwide, SolarEdge only has about 4% market share of the overall inverter market, giving it plenty of room to grow, but as one might understand, neither SolarEdge nor Enphase is a global top 10 (top 10 covering more than 80% market share) manufacturers of inverters, though clearly taking the market for MLPE's.
There are obviously many different competitors in the different offerings, and below is a non-comprehensive list of random examples that I have collected from search:
Solar Inverters:
Enphase Energy
Top 10...(above figure)
Storage Solutions:
AES Corp
Enphase
EOS Energy Enterprises
Fluence Energy
Generac
Siemens
Stern Inc.
SunPower
Tesla
Power Optimizers:
Maxim Integrated
Tigo Energy (private)
In this research paper I will not go into the details of the full supply chain of developers, solar panel producers, cables etc., but due to the obvious competition between SolarEdge and Enphase in the MLPE market, it is natural to compare the two companies for better performance evaluation.
Enphase has been very focused on the domestic US residential market. Supplying some of the largest US residential solar companies like Sunrun and SunPower, Enphase is gaining momentum in US residential solar. SolarEdge has a more extensive geographical presence, which I, according to my statement on global markets earlier, believe is a long term advantage. (68% international activities for SolarEdge vs Enphase's 24%) In the US, SolarEdge is trying to move more into the commercial utility market with a combination of their Power Optimizer products and storage solutions. See below the regional split and the split between residential and commercial orders for SolarEdge, showing the shift towards more commercial use-cases.
Another indicator of the SolarEdge shift towards commercial is the fact that SolarEdge ship 3 times as many batteries as Enphase.
Financials
My "Company Reports" file below, which I use for quarterly follow up on some of my investments, shows most of the important financial figures and will be commented below, while also benchmarking to Enphase as the most comparable competitor. (using Koyfin charts)
After 7 quarters of strong growth we have seen the revenue growth come down from 50%-60% to 44% in 2023Q1 and 36% in 2023Q2. Still strong growth rate, but like any other company with reduced growth rate one must be wondering whether competition have finally caught up with the two MLPE duopolies. Both SolarEdge and Enphase have similar growth rates since early 2021, and SolarEdge is still the bigger of the two in regards to revenue. With my knowledge from the Renewable industry I am not overly concerned about the short term growth cool-down, as all Renewable industries have faced difficult years with inflation, supply chain disruptions and Covid19, as I see the strong sentiment in the industry going forward.
On profitability SolarEdge have shown consistent positive EBIT over the last years. In 2023 the last two quarters have actually shown the strongest EBIT% since 2020Q1 (15% in Q1 and Q2), which is not indicating overly competitive price pressure. When comparing to Enphase though, it seems that Enphase have been able to run with better EBIT margins, which could indicate a slightly better product which brings better margins, or it could indicate that the more focused market approach towards the US market has some cost benefits linked to it. Finally, which though is to be seen in the future, is the fact that focus on the US market and thereby US manufacturing could leave some benefits from the IRA, that SolarEdge cannot capitalize on to the same extent yet, as they are only now exploring US contract manufacturing opportunities. In below I investigated whether the difference could stem from an increased spending in R&D which could leave some competitive advance for future, but both companies are spending in the 8-9% of revenue range.
Going through the cash flow statement I am concerned on the irregular operating- and free cash flows of SolarEdge. Compared to Enphase, who has a much more stable and upward trending cash flow profile, there is definitely something to look into.
According to the CAPEX spend above, that is not the main driver, hence a look at the more classical areas of working capital accounts payable, accounts receivable and inventories are required. Here it is obvious that a significant build-up of inventories and accounts receivable is taking it's toll on cash flows. After investigating a few quarterly conference calls it is mentioned by SolarEdge that they expect the inventory situation and thereby the cash flows to improve significantly from 2023Q3. This is still to be seen, and it is a warning sign that both inventories and accounts receivable spin out of control like this. This could be based on supplier and subcontractor commitments that have been higher than sales, hence avoiding liquidated damages by producing to inventory, but in the end it poses a risk to the company. If they are right though, we would see significantly increased cash flow margins in the coming quarters.
With a billion dollars in cash and cash equivalents SolarEdge is not going to run out of money the next quarters if this does not get better on the short term. The balance sheet is currently fairly strong with a net debt of -375 mUSD and current assets easily covering current liabilities. Compared to Enphase the net debt position in the below seems somewhat better, but it seems there is a calculation error on Koyfin's Net Debt calculation as I see it. The Net Debt of SolarEdge should be (debt - cash and cash equivalents) -377 mUSD according to my "Company Reports" file, which makes the two net debt figures pretty similar. Both having negative net debt, which is obviously solid in these high interest environments, making the companies less vulnerable.
To conclude on the financials I was actually pretty satisfied with the financials until I ran the benchmark to Enphase. Enphase seems to have lower revenue but stronger margins and cash flows which in the end are some of the ultimate parameters that I look at. That being said, I would phrase it like this: "I am still fairly satisfied with the financials of SolarEdge (improvements are definitely possible, but strong growth, profitable business and bright future), but the benchmark have shown, that I probably also need to look at a deep dive into Enphase for another potential investment case".
NB!!! In the last days of writing this research piece, more specifically on the 19th of October, SolarEdge announced preliminary financial results for 2023Q3 to the market (link to announcement). The announcement made it clear that: "During the second part of the third quarter of 2023, we experienced substantial unexpected cancellations and pushouts of existing backlog from our European distributors", and that "As a result, third quarter revenue, gross margin and operating income will be below the low end of the prior guidance range. Additionally, the Company anticipates significantly lower revenues in the fourth quarter of 2023 as the inventory destocking process continues". The new mid-range revenue outlook for the quarter is 725 mUSD vs the 900 mUSD (almost a 20% drop), and it is expected that there will be an operating loss of 9-28 mUSD. This is naturally extremely disappointing and the stock fell more than 30% on the announcement. This is a clear indication that the high interest environment that we are currently in, is having a bigger impact on the solar PV installations that was anticipated by SolarEdge. It is concerning that the market forecasting ability of SolarEdge is not better than that. It makes it even more concerning, when SolarEdge have been building up inventory levels quite significantly over the last quarters in anticipation to consume those in the coming quarters. This inventory must now be expected to increase. One of the biggest financial threats when running a "lean" contract manufacturing setup, is when you do not fulfill your minimum commitment of orders to contract manufacturers, you are exposed to liquidated damages for order shortages. It will be extremely interesting to hear what SolarEdge say about that in their upcoming 2023Q3 earnings call on the 1st of November. The challenge is now to make a judgment on how long this order dry-out is going to last. But I will not be surprised if the next 3-4 quarters could come out on the light side. So even though this hick-up does not change my long-term expectation to solar PV growth, the short-term struggles clearly has an impact on the valuation, whether we like it or not.
On top of the announcement from SolarEdge, Enphase came out on 26th of October 2023 with their Q3 numbers hitting only 1 mUSD above the lower part of their revenue guidance. On top of that they cut their Q4 revenue expectations to 300-350 mUSD, a significant drop qoq and yoy.
Management and Culture
The company is still Israeli led and has it headquarters in Herzliya in Israel. The current CEO Zvi Lando stepped into the CEO position, first in 2019 as interim for founder and CEO Guy Sella, who stepped down due to prolonged cancer and sadfully passed away only days later. Later in 2020 Zvi Lando, who was previously VP of Sales officially stepped into the position. He has been with the company since 2009 and has significant company history and culture on his resume. From the 5 founders two is still with the company, Yoav Galin looking into future technologies and Meir Adest as Chief Product Officer. Almost the entire management team from CEO, CFO, CTO, CPO to CRO has more than 10 years with the company, so it would be fair to say that the original entrepreneurial culture is still intact to some extent.
Generally the leadership and company score of 4.1 on Glassdoor is decent. Especially the CEO score is good (92%), while the recommendation to friends (76%) leaves something to wish for. Most of the inside ownership has long been sold off and only 1,17% of ownership today sits with directors and executives, which is a bit disappointing.
Risks
There are naturally several risks that needs to be addressed is this research paper. First of all I believe the risk of commoditization of the MLPE market is the biggest one, combined with the fact that the String Inverter market is dominated by Chinese companies, that might shift course and invest in MLPE products. SolarEdge and Enphase together has the majority market for sharing, and I believe that the reason for the competition not being able to advance is, that the two MLPE companies have a product edge over any competition, an edge that might continue might persist.
Until now it has not seemed like an issue that 90% of all panel producers are Chinese, but it is worth considering what would happen if Chinese inverter manufacturers were to enter the market for MLPE for real. On the other hand, the high level of geographical concentration in the global PV supply chain has led the European Union, India and the United States to introduce policy incentives to support domestic PV production. This could result in an unprecedented expansion of PV manufacturing outside of China in the next five years, which would though require a drop in production costs.
Another risk is linked to utility scale Solar PV market opportunity for SolarEdge. This is a new scope and a completely different size of liability towards bigger and more professional customers. Hence this opportunity could actually pose a risk to the balance sheet of SolarEdge.
As mentioned in the Financials section Enphase seems to have better performance on several parameters, especially EBIT margin, FCF and the Return on Capital Employed (RoCE). This could pose a risk for SolarEdge to be overtaken by Enphase in the mid- to long term. Though it seems there is currently room enough for both the two MLPE experts in the market, that could change.
The Stock and Valuation
Even after the recent 19.10.2023 and 26.10.2023 announcements, the stock level is still up more than 240% over the last 5 years. In the period between end 2021 and mid 2023 the stock circled around the 280'ish on average but has come down significantly over the quarter and is on date of the release of this review 74'ish.
Let's look at a bit more historic price levels before we look at the future. The P/E ratio with TTM earnings and current pricing (after the market drop) is 14x for SolarEdge compared to Enphase 19x. We already know that the next few quarters for SolarEdge and Enphase will come out short of expectations and therefore significantly lower earnings. As FCF has been very volatile over the years, and several quarters have shown negative FCF, the Price-to-FCF ratio for SolarEdge is quite inconsistent (but extremely high when registered), while the Price-to-FCF for Enphase is showing a consistent downtrend, and now roams at a decent 13x. Not a high level if growth continue at reasonable levels after short term weakness.
Beyond the Price-to-FCF I evaluated the past Return on Capital Employed (RoCE), and it turns out that SolarEdge the last few years have been at unsustainable sub-10% levels. Furthermore comparing to Enphase it seems that Enphase are better capital allocators than SolarEdge, which is slightly concerning for SolarEdge, especially on the longer term. Koyfin calculates Total Capital differently than I do Capital Employed, but I show here below the Koyfin version anyway, as the level is fairly similar and the trends are similar. (Koyfin uses Equity+Debt, while I use Equity+Non-current Liabilities)
Using a simplified approach to valuation with a reverse discounted cash flow model is quite difficult in this case, as the FCF have been negative over the trailing twelve months. Zooming in on the last 2 quarters SolarEdge have made 250 mUSD in net result, while FCF being generally negative, heavily impacted by 250m build of of inventories and 250m build up of trade receivables. Assuming that SolarEdge would be able to bring at least 30% of their annual net result to FCF, if they were to resume control of operational metrics, I believe an assumption of 150 mUSD annually would not be totally off at current revenue level. Using a discounted cash flow model with 3% terminal growth and 10% discount rate it would require an approximate of 12% growth rate year 1 to 10 to reach the current stock price. 12% growth rate CAGR over the next ten years is understated in my opinion, looking into the investments continuing into the Solar PV industry, so I believe the current level is a good opportunity to get in, if you are not already invested. The same would apply for Enphase, without though having done a further deep dive on Enphase (yet).
To give another view on the current valuation I ran a very high level discounted cash flow model. I ran 3 scenarios (see a few assumption examples in below table) and compared those with the current share price. The base case gave me a 303 USD price, while low and high gave a range of 40-959 USD. Hence a quadrupling of the share price if the base case happens. Please do bear in mind that the assumptions are completely subjective, and that these are based on the future. Also bear in mind that I am generally bullish on the future on the Solar PV industry as already described, hence even the base scenario has assumptions on extended growth for the industry. (do your own DD)
Conclusion on the share price is, that the latest share price reductions after SolarEdge's and Enphase's announcements, has put the current share price at an interesting level. That naturally depends on whether the MLPE producers will regain growth, which is still to be seen.
MoGeBat Score: 66
66 as a MoGeBat score is only just in the investible range. The reason for not going higher is generally the size of competition, the sloppy cash flow performance and low inside ownership amongst others.
Based on the MoGeBat score at 66, the fairly low share pricing in my opinion, the enlightenment of Enphase as a better financial performer and the bright future of the Solar PV industry this is a very complex investment case. It is not a screaming by, but at the same time a very strong contender for a stock for the future.
I generally consider a MoGeBat Score of above 75 is highly investable, 65-74 investable, 55-64 only investable in very special circumstances (investing with the heart instead of the brain).
As usual comments are more than welcome... Furthermore you can subscribe to the Stock Research page to get notified when new research papers are available.
Disclosure: Morten Gerdes Bach might own shares of the companies mentioned. The information expressed herein are opinions and not financial advice.
Remember: If you want to do your own due diligence you can download the "MoGeBat Score" and "Company Results" files in the download section of my homepage.
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