SHLS - Shoals Technologies: Reasonably Priced Ticket To The Renewables Sector

2023-10-30 12:55:43 ET

Summary

• Shoals Technologies Group provides EBOS solutions in the renewable energy and EV charging markets with a well-patented portfolio of products.
• The company's financials have been strong with very high revenue growth and good margins.
• Shoals' valuation doesn't seem to fully price in the company's very good long-term growth prospects.

Shoals Technologies Group, Inc. ( SHLS ) provides EBOS solutions for renewable energy plants. The company operates in a high-growing segment of the energy sector with a well-patented portfolio of products. Shoals' financials have been exceptionally good as the company's hypergrowth has been coupled with very good margins. In this analysis, I construct a discounted cash flow model to analyze the company's valuation compared to its future prospects.

The Company & Stock

Shoals manufactures and sells Electrical Balance of System (EBOS) solutions for renewable energy use cases. The company's offering competes in a growing EV charging and renewable energy storage segments with a portfolio of well-patented components. Often, Shoals sells its products in complete systems instead of a single product - 78% of Shoals' revenues come from system solutions as stated in the company's Q2 investor presentation . Shoals' products include wireless monitoring devices, cable assemblies, splice boxes, and transition boxes among other products:

Shoals' products are patented quite well. In the United States alone, Shoals has 19 patents , with eleven of the patents being for either the combiner box or the company's interconnect system. In addition, Shoals' accessories are well-patented with four patents in the US, nine patents in Brazil, and six in the European Union. The good amount of patents provides a moat for Shoals, increasing the chances that the company can achieve a good market share in the sector.

Since Shoals' IPO in early 2021, the stock has performed quite poorly among most other growth stocks. From the first day of trading, Shoals' stock has decreased in value by 62%:

Financials

Shoals' growth has been phenomenal. With basically completely organic efforts, the company has achieved a compounded annual growth rate of 35.7% in revenues from 2018 to LTM figures as of Q2/2023. Further, the growth seems to only have accelerated; for the past four quarters, Shoals' revenue growth has been over 50% in every quarter, and the company is guiding for revenues between $480 million and $510 million for 2023, with the middle point representing a growth of 51.4%. In addition, Shoals' backlog grew by 67% year-over-year in Q2 of 2023.

While aggressively growing revenues, Shoals has achieved a very good profitability level. The company's current trailing EBIT margin stands at 24.7%, after mostly consistent yearly increases in the margin:

As Shoals' operations have scaled up, the company's gross margin has increased significantly. In 2018, the gross margin was 30.6%, while the margin currently stands at 42.8%. As Shoals should experience a very significant amount of growth in the future, I believe that the company could still have further operating leverage incoming. Sales prices are the most significant factor that could affect Shoals' margins; as more competitors come into the sector, prices could come down lowering margins. Because Shoals has a good amount of patents for its competitive products, I don't see further competition as too large of a risk though.

Valuation

Along with the stock price, Shoals' forward P/E ratio has come down. From the IPO level of 151.2, the ratio has come down to a current forward P/E of 21.8:

As Shoals should have a significant amount of growth ahead, the P/E of 21.8 seems quite low in my opinion. To further analyze the valuation and to estimate a rough fair value for the stock, I constructed a discounted cash flow model. In the model, I estimate Shoals to grow by 55% in 2023, representing the upper half of Shoals' current revenue guidance. After 2023, I estimate the growth to slow down in steps with a 2024 estimate of 35%. The growth slows down further in the coming years, with the growth ending up at 7% in 2032. From 2022 to 2032, the estimated growth represents a CAGR of 20.8%.

For Shoals' EBIT margin, I estimate some further leverage from the current trailing level of 24.7%. For the current year, I estimate an EBIT margin of 25.1%, signifying slight leverage in the second half of 2023. After the year, I estimate further operating leverage, as in the DCF model the EBIT margin rises to a level of 27.1%, achieved in 2025. Shoals has a low amount of capital expenditures , so I estimate the company's cash flow conversion to be good in the future.

For the terminal value, I input an exit EV/EBIT multiple of 15, instead of my usual method of a perpetual growth rate - I believe that this approach is better suited for companies with high long-term growth. I believe that the multiple is representative of a fair valuation as the company is still growing slightly in 2032 in my estimates. The mentioned estimates along with a weighted average cost of capital of 16.57% craft the following DCF model with a fair value estimate of $18.94, around 25% above the price at the time of writing:

The used weighted average cost of capital is derived from a capital asset pricing model:

In Q2, Shoals had $6.5 million in interest expenses. With the company's current amount of interest-bearing debt, Shoals' annualized interest rate is approximately 12.36%. The interest rate seems to include interest from operating liabilities, but as I don't see any other rate as fit for an estimate, I use the high figure; the interest expenses high in any case, whether they're caused by financing or operative purposes. Shoals uses debt quite moderately, and I estimate a long-term debt-to-equity ratio of 10%.

On the cost of equity side, I use the United States 10-year bond yield of 4.85% as the risk-free rate. The equity risk premium of 5.91% is Professor Aswath Damodaran's latest estimate , made in July. Yahoo Finance estimates Shoals' beta at a high figure of 2.07, as energy investments can be cyclical. Finally, I add a small liquidity premium of 0.3% into the cost of equity, making the figure 17.38% and the WACC 16.57%. I believe that Shoals' beta and cost of debt have room to shrink in the future, making the WACC lower and the DCF model fair value estimate higher. For the time being, I still use the current figures.

Takeaway

Shoals seems to be positioned well to capture a good share of the growing renewable energy sector as well as the EV charging market. Although the company's future margins could potentially see pressures through rising competition as the industry matures, I believe that the current risk-to-reward seems good for the stock. My DCF model estimates the stock to be undervalued, even though the model uses a very high WACC of 16.57% that should eventually be lower. I believe that the stock could be in for a rally at some point in the short- to medium-term future, and have a buy rating for the time being.

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