SHLS - Shoals Technologies Is Too Good To Ignore

2023-11-07 12:30:52 ET

Summary

• Investing in renewable energy companies has yielded disappointing returns in the past decade, leading to waning investor enthusiasm. As a long-term-oriented investor, I am not ready to give up yet.
• Shoals Technologies offers innovative products that simplify solar installations and reduce the cost of energy, making it a key player in the renewable energy sector.
• The company remains behind the scenes for now and does not attract the same attention as high-flying solar energy companies or EV makers, but Shoals is carving out competitive advantages.
• After losing almost 35% of its market value this year amid rising interest rates, Shoals is becoming attractive from a valuation perspective.

Investing in renewable energy companies has been a popular theme for years. Unfortunately, though, many of the seemingly attractive investments in this space have yielded disappointing returns over the past decade. This lackluster performance could be the main reason behind the waning enthusiasm about investing in the renewable energy space today. A careful evaluation of the prospects for this sector, however, suggests that long-term-oriented growth investors should gain exposure to the renewable sector with the global energy sector undergoing a major transformation.

Investing in this sector should not be all about finding the next new energy company that will replace an existing source of energy for good in the coming years. It should not even be about finding the next EV maker that will mimic the success of Tesla, Inc. ( TSLA ) either. Behind the scenes, a few companies are playing an integral role in the global transition toward renewable energy, but most of these companies fail to attract investors. Mr. Market can be oblivious to the progress made by these companies too, at times, which gives us opportunities to invest in fast-growing, profitable companies at bargain prices. Shoals Technologies Group, Inc. ( SHLS ), in my opinion, is one such company that deserves more love in the market.

The Business

Close followers of Shoals will have a good understanding of what the company does and how it makes money, but since this article is likely to be read by some of my followers who are not familiar with the company, I thought it best to start this analysis with a brief introduction into Shoals and its business.

Shoals Technologies is a leading provider of electrical balance of systems or EBOS solutions for solar energy projects, primarily in the United States. EBOS encompasses all of the components that are necessary to carry the electric current produced by solar panels to an inverter and ultimately to the power grid. Shoals has 26 years of experience in the industry and has been involved in some of the largest EBOS projects in the world, such as the 333 MWAC Chichester project in Australia. Shoals offers a range of innovative products that simplify solar installations and reduce the levelized cost of energy (LCOE), such as the Big Lead Assembly (BLA), the Interconnect System, and the Snapshot I-V Solar PV Health Monitoring Solutions. Shoals also manufactures cable assemblies, inline fuses, combiners, disconnects, recombiners, wireless monitoring systems, junction boxes, transition enclosures, and splice boxes.

Exhibit 1: Products developed and sold by Shoals

The company earns revenue by selling its products to solar developers, engineering, procurement, and construction firms (EPCs), independent power producers (IPPs), and utilities. Shoals Technologies has two main product categories: System Solutions and Components.

System Solutions include the company's proprietary combine-as-you-go (CAYG) system, which consists of the BLA, BLA+, and other plug-and-play products that simplify the installation and operation of solar projects. System Solutions also include wire harnesses, combiner boxes, junction boxes, and monitoring solutions. System Solutions revenue is derived from the sale of these products based on contractual agreements with customers, which typically specify the price, quantity, and delivery terms. The delivery period varies from one to three months and the value of contracts ranges from several hundred thousand to several million dollars.

The components segment includes various electrical products that are used in solar projects, such as connectors, cable assemblies, fuses, fuse holders, surge arresters, and grounding lugs. Components revenue is derived from the sale of these products to distributors or directly to customers based on purchase orders.

The Promising Industry Outlook

EBOS, or Electrical Balance of System, is a pivotal component of solar, electric vehicle charging, and energy storage projects. Regardless of their size, location, or the technology deployed, all such projects require a robust EBOS infrastructure. This is a testament to the fundamental role EBOS plays in ensuring the seamless operation and safety of these systems.

EBOS encompasses a wide array of elements, including panels, mounting systems, inverters, and chargers. The compatibility of EBOS with various components is a testament to its versatility and essential nature. Failure in any aspect of the EBOS can result in dire consequences, ranging from loss of revenue and equipment damage to more severe outcomes such as fire damage, injury, or even loss of life. Hence, the importance of a well-constructed EBOS cannot be overstated.

From a financial perspective, EBOS constitutes approximately 6% of the total project cost, with individual components accounting for less than 1%. Each EBOS system is uniquely tailored to its specific project requirements, necessitating significant upfront engineering efforts to ensure that it functions optimally.

The market outlook for EBOS through 2025 reveals its growing relevance across multiple segments. This includes a 12% share within the U.S. Solar Market. Solar energy projects in the United States heavily rely on EBOS to ensure their functionality, making up a substantial portion of the market. Additionally, an extra 1% is attributed to Ground Mount Solar, a significant part of the renewable energy landscape, contributing to the demand for EBOS. The growth of energy storage solutions, encompassing new projects and retrofits, contributes to an 8% market presence. When existing systems face failures, EBOS is crucial in revitalizing and replacing the damaged components, which is a market segment that accounts for around 1.5% of the demand for EBOS.

Overall, the EBOS market is projected to experience substantial growth. Solar EBOS alone is expected to register a 23% CAGR through 2025. The total EBOS market is expected to grow at a stellar CAGR of 28% through 2025.

Exhibit 2: Expected growth of the EBOS market

The long runway for growth will certainly attract newcomers to the industry, but Shoals is continuing to make the most of first-mover advantages in this market.

Shoals Is Leading The Way With Smart And Cost-Effective Solutions

Shoals Technologies is not just another player in the renewable energy sector; it's a true frontrunner. The company has a powerful edge when it comes to product innovation and quality. This advantage allows Shoals to provide solutions that outperform competitors while keeping costs low. At the heart of Shoals' success is the art of simplification. The company has developed a plug-and-play system to streamline the installation and operation of solar systems, achieving a twofold goal: reducing labor and material costs while enhancing energy output and system reliability. Shoals also has a proprietary monitoring platform that enables real-time data collection and analysis of the system's performance and health.

Let's break down the traditional problem with EBOS. While the components themselves may be budget-friendly, the installation process often brings significant costs, averaging 1.7 times the cost of the product itself. This happens due to the need for specialized installation methods, which often involve electricians and specific tools. Additionally, the presence of redundant wiring not only wastes valuable time but also consumes extra materials. Furthermore, a substantial portion of the work is conducted in the field, where maintaining stringent quality control can be challenging.

Exhibit 3: The expensive installation cost of EBOS

Shoals Technologies offers an efficient solution to these longstanding issues with its Combine-As-You-Go System. This innovative approach translates into remarkable benefits, including a substantial 43% reduction in installation costs and a commendable 20% savings on materials. Such savings are not only financially advantageous but also enhance the overall efficiency of renewable energy projects.

The company has fortified its position by creating a competitive moat through a robust portfolio of intellectual property. With 85 issued and pending patents, Shoals is unequivocally recognized as the standard bearer of EBOS innovation. The company’s IP portfolio extends its protective reach, catering to both domestic and select foreign markets, ensuring its leadership globally.

In addition to its groundbreaking solutions, Shoals has gained substantial trust and recognition from industry leaders. An impressive 17 out of the top 25 EPC companies have chosen Shoals as their trusted partner. That speaks volumes about the company’s reputation and reliability. Additionally, Shoals manufactures its products in the U.S. which aligns seamlessly with evolving regulations such as the Infrastructure Investment and Jobs Act, further solidifying the company’s significance in the current renewable energy landscape.

The Attractive Margins

Shoals Technologies operates with a lucrative business model, boasting an adjusted gross margin of 42% in the second quarter of 2023 , up from 39% in the same period the previous year. This upward trend is indicative of the company's commitment to efficiency and profitability. Notably, second-quarter revenue surged by a remarkable 62%, underpinned by a growing appetite for domestic solar EBOS solutions and, in particular, its innovative combine-as-you-go system solutions.

In the last couple of years, Sohals has hit a purple patch from a revenue growth perspective, which is evident from how growth has accelerated in recent quarters. The favorable long-term outlook for the company has been boosted by ongoing regulatory support for the renewable energy sector. Not only in the U.S. but on a global scale, policymakers are actively looking for opportunities to increase the penetration of renewable energy to hit their ambitious net-zero emission goals.

Table 1: Historical revenue growth

Source: Seeking Alpha

Shoals Technologies is poised for significant growth in the coming years, driven by a combination of a strong backlog and organic expansion. In 2023, the company is expected to generate approximately $529 million in revenue. This comprises $327.66 million from the backlog, accounting for a 60% utilization rate, and $201.80 million from organic growth based on a 62% YoY growth rate. Over the following years, this growth is projected to continue. By 2027, Shoals is expected to achieve revenues of around $2.3 billion, reflecting its sustained momentum in the EBOS market and favorable positioning in a lucrative market segment.

With the company’s gross margins trending in the right direction, it is reasonable to expect Shoals’ earnings to grow alongside the expected growth in revenue.

The timing of revenue recognition is influenced by delivery periods, which may impact when backlog orders are realized. It's essential to bear in mind that while these projections are based on historical and projected data, they are subject to market fluctuations and external influences.

Shoals is also strategically attuned to the transformative landscape of electric vehicle adoption and charging infrastructure. As the U.S. invests heavily in the growth of EVs, with spending expected to surge from $0.78 billion in 2020 to $3.9 billion in 2025 at a remarkable 41% compound annual growth rate, Shoals is poised to participate in this growth meaningfully. Of this planned expenditure on EVs, 44% will be directed toward hardware, while a substantial 56% will be allocated to EBOS, installation, and operation and maintenance (O&M). Shoals' strategic focus on innovative solutions for EV charging infrastructure not only aligns with the evolving needs of the electric vehicle industry but also positions the company to play a pivotal role in supporting the growth of sustainable transportation solutions.

Exhibit 4: Spending on EV infrastructure

Shoals recently made a significant announcement regarding its collaboration with the U.S. Department of the Air Force. The company will deploy its innovative Fuel by Shoals eMobility solution to support an EV Charging-as-a-Service (EVCaaS) pilot project initiated by Leidos, a prominent science and technology leader. This project is designed to create a modern, resilient, scalable, and secure power infrastructure, enabling the Air Force's non-tactical vehicle fleet to be charged and ready for use across various U.S. installations. Fuel by Shoals was selected by Leidos due to its cost-efficient and schedule-friendly above-ground EV charging infrastructure, designed with secure raceways and power stations. This solution is tailored to the unique needs of each installation and utilizes analytics and engineering to reduce the strain on local power grids. By integrating ChargePoint EV chargers, this project aligns with the Air Force's objective to transition its substantial fleet of non-tactical vehicles to zero-emission as part of its Climate Action Plan, contributing to a more sustainable future with ambitious carbon reduction targets.

Takeaway

Shoals is continuing to grow while forming strategic partnerships to drive revenue growth. Mr. Market, however, has not been kind to the company this year. Shoals has lost almost 35% of its market value this year with the renewable energy sector recently coming under pressure amid rising interest rates. The company's market-leading position in the EBOS space positions it well for substantial revenue growth in the coming years, and I do not believe the company is trading at a premium valuation today at a forward P/E of around 28. Shoals has quickly become profitable in the last few years on the back of stellar revenue growth, and I believe this is just the beginning of a long journey where Shoals will emerge as a key enabler of the global energy transition.

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