2023-06-28 04:21:13 ET
Summary
- The solar industry is experiencing a significant shift away from fossil fuels, with solar power investment set to surpass oil for the first time ever.
- Solar companies Enphase and Sunrun have seen a decline in their shares this year, despite the 2022 Inflation Reduction Act's tax credits and subsidies for solar power.
- The decline in shares is attributed to three factors: rising interest rates, changes in California's solar policy, and concerns about profit margins. While Sunrun is cheaper, Enphase is growing at a faster rate and has a stronger cash position and lower debts.
- The market is waiting to see the impact of California's solar reforms, but there is optimism that Enphase could outperform its guidance and reinvigorate its shares.
- Both companies could potentially benefit from a broad market rally if the Federal Reserve pauses its rate hikes and if concerns about a slowdown in California's solar market are overblown.
The solar revolution describes the ongoing generational transition away from fossil fuels to zero-carbon power derived from the sun. The last decade has seen solar grow from just under 4% of US additions of new electric generating capacity to 50% of all new capacity in 2022. This growth has been led by a material and sustained decline in the cost of solar. Solar panels are now 90% cheaper than they were in the 90s and currently cost less than 50 cents per watt. Solar companies Enphase ( ENPH ) and Sunrun ( RUN ) both represent different ways to gain exposure to this revolution. Both tickers have collapsed since the start of the year with Fremont, California-based Enphase down 39% year-to-date with Sunrun sporting a 23% decline over the same time frame.
This pullback comes against the package of tax credits and subsidies for solar provided by the 2022 Inflation Reduction Act. Critically, this is set to supercharge the rollout of solar net zero, forming a critical pillar of growth for an industry already seeing a generational ramp in adoption. The act could see green energy grow up to reach 80% of US electricity production as soon as 2030, up from around 20% of production currently. San Francisco-based Sunrun's approach to this revolution is through the retailing of residential solar systems. The company enables US households to generate energy from their home and handles the whole process from site survey to installation to the generation of the first KWh.
Enphase retails microinverters, which allow solar panels to convert DC power to AC power. These microinverters are installed on each individual solar panel to offer no single point of failure. They allow both its residential and commercial customers to produce energy consistently during their lifetime of ownership versus string inverter systems which have a single point of failure. Both companies also sell batteries to allow the storage of energy which smooths out the inherent intermittency of solar power. The growth dynamics of the industry have never been better, with global solar power investment set to beat oil for the first time ever and with the industry realizing its best-ever first quarter in the US with 6.1 GW of solar installed. This was a growth of 47% over its year-ago comp and constituted 54% of all new electricity generating capacity added to the US grid during the period.
So, Why Are Both Falling?
Three reasons. Interest rates, California, and margin concerns. The decision on which ticker to pick will hinge on their comparative valuations, growth rates, and overall operational gearing especially with both facing different levels of competition in their adjacent markets. Sunrun is the cheaper company with an enterprise value to trailing 12-month revenue multiple of 5.79x versus Enphase's 8.16x multiple. However, Enphase last reported revenue growth for its fiscal 2023 first quarter that was 3.4x higher than Sunrun. The Fremont company saw revenue of $726.02 million , up 64.5% over its year-ago comp and a beat by $5.51 million on consensus estimates. Sunrun brought in revenue of $589.85 million , up 19% over its year-ago quarter and a beat by $72.07 million on consensus estimates.
So whilst Sunrun is cheaper, Enphase is by far the faster-growing company. Indeed, Enphase bulls could argue that the valuation distance between both companies is not far enough with its EV/sales multiple being only 1.4x higher compared to its revenue growth rate that's 3.4x greater. The rapid rise in interest rates has undoubtedly had a dampening effect on market sentiment for solar picks with ten consecutive hikes of the Fed funds rate to its highest level since 2008 at 5% to 5.25% driving a marked pullback for sentiment towards Enphase and Sunrun. At the peak of the pandemic euphoria of early 2021, Enphase was swapping hands at an EV/sales multiple of around 35x with Sunrun at around 28x.
Profitability between both firms is also very different. Enphase held a gross profit margin of 44.95% for its first quarter versus a gross profit margin of 5.58% for Sunrun. This structural divergence in profitability sits at just under 4000 basis points and reflects Sunrun's business model that's dependent on selling a relatively commodified product with very little product differentiation between a plethora of competitors. Sunrun is competing against a more expansive list of companies including publicly listed SunPower ( SPWR ), Sunnova ( NOVA ), and Pineapple Energy ( PEGY ). The residential solar business model is essentially a highly levered laddering of income expected from solar system repayments and the cost of financing. The companies borrow money to buy off-the-shelf solar components which are then provided under long-term leases to households.
Sunrun offers a $0 upfront payment monthly lease plan for solar components that cost thousands to purchase and install. The company held total debt of $9.34 billion as of the end of its first quarter versus total debt of $1.32 billion for Enphase whose list of competitors is materially smaller. Enphase dominates the market for microinverters with close to 50% of the US inverters market. Enphase and its main competitor SolarEdge ( SEDG ) hold a combined 95% of the global inverter market share.
What A Recovery Would Look Like
Gross margin concerns have contributed to driving Sunrun lower with first-quarter gross profit being the lowest in over five years and set against quarterly interest payments that are being pushed to new records. Net interest expenses for Sunrun at around $140 million for its first quarter was the highest ever quarter and was up 555% from its year-ago comp. This figure was a profit of $10.88 million for Enphase with the company holding cash and equivalents of $1.78 billion as of the end of its first quarter.
California NEM 3.0 took effect on the 15th of April and applies only to new solar systems from this date. It includes a 75% reduction in export rates earned by households for the excess electricity they push onto the grid. This is expected to weaken household demand for solar systems as it radically extends the payback period for households purchasing any such system in the leading US state for residential solar installations. Hence, whilst Enphase does not face the same extent of margin concerns as Sunrun, the market is pricing in weaker microinverter demand on the back of a slowdown in the Californian residential solar market. The company's second-quarter revenue guidance is for revenue to be below analyst consensus at between $700 million to $750 million. Gross margin is expected to be between 41% to 44%, this would be below its first quarter at the midpoint.
Sunrun reported a net loss of $240.4 million for its first quarter, up from a loss of $87.8 million in the year-ago comp with a cash loss from operations at $439.3 million. Enphase's recorded a net profit of $146.9 million, an increase of 183% from its year-ago comp with positive cash from operations of $246.2 million more than double its year-ago figure. The market will likely wait to see the overall impact of California's reforms with the prospect of Enphase outperforming its guidance a hope by bulls to reinvigorate its flagging shares. I'm leaning towards Enphase here due to its strong cash position and lower debt burden in an elevated interest rate environment versus Sunrun. Further, Sunrun's rapidly declining gross profit margins provide a reason for taking a pause on building a position on weakness. This is impacting core profitability for a business that depends highly on leverage for its returns. I'd imagine both firms will be lifted by a broad market rally if the July 26th FOMC meeting sees a second pause to the Fed funds rates with renewed bullish guidance about its direction. Any such rally would be heightened if concerns around a slowdown in California are proved to be too gloomy.
For further details see:
Enphase Vs. Sunrun: Both Have Collapsed, Which To Buy As Solar Revolution Ramps Up?