2023-06-20 14:34:12 ET
Summary
- I rate NOVA an attractive buy.
- Strong residential solar demand to continue driving growth in FY 2023 and beyond.
- Even with highly conservative assumptions, my FY 2023 target price of $20.16 per share still presents an estimated 5% upside.
Sunnova (NOVA), a Houston-based company, is a leading energy-as-a-service / EaaS provider. With 10 years of experience and 300,000 customers nationwide, it ranks among the largest solar companies in the US.
The company went public on NYSE in 2019. Since then, the share price has gone through a period of highs and lows, though overall it has seen gains. It reached ~$40 to ~$50 per share on a few occasions in 2021, but share price gradually declined and has been consolidating around $17 - $19 levels most recently, reflecting a ~59% upside from its IPO price.
Given the broader macro-driven energy transition tailwind in the US, NOVA has experienced significant revenue growth since its IPOs. Growth accelerated from a +20% level at IPO to +50% and ~130% in 2021 and last year in 2022 respectively.
In this first coverage, I give NOVA an overweight rating. I anticipate a few catalysts in play that may deliver outperformance, while also being slightly cautious about the development of several risk factors.
Catalyst
I believe that the US solar industry will continue to benefit from the secular tailwind due to the increasing consumer demand for energy independence and resilience.
NOVA, in particular, is very well positioned to capture this growth opportunity. As it stands, it is one of the largest residential solar companies in the US, with over 309k customers and 19.5 GW solar power generation under management as of Q1. Since the strategic SunStreet acquisition in 2021, NOVA has seen accelerating growth. Revenue has grown at triple-digit growth rate in recent times, including in Q1, where revenue grew at 146% YoY.
Though I expect revenue growth to decline to a more sustainable level in the future, at the current rate, I think that it is likely for growth to rather fluctuate or only come down slightly in FY 2023. In Q1, we learned that the overall demand continues to be exceptionally strong even outside areas like California or Puerto Rico, where NOVA has a strong penetration rate :
Yes, that's interesting. Well, I would say let's take each of those that you mentioned, Florida first. The growth has been huge. 100% growth in that market, and it was actually over that. Year-over-year, we had one of the major dealers up 400%. I mean these are eye-popping numbers for us, I think for anybody. The TPO, and this is true across all these markets, has just skyrocketed. It's jumped up multiples of where it was just a year ago. And really in all cases, even where it was in Q4.
Source: Q1 2023 earnings call.
It is also noteworthy that serving the rapidly growing demand seems to have put short-term and temporary pressures on NOVA's reported profitability.
However, as is the case for high-CAPEX companies operating in a nascent high-growth energy-transition sectors like solar, I think that it is important to look into operating and non-operating elements separately to understand better the overall health of the company.
It is my view that operating-wise, NOVA has actually been quite disciplined in improving the fundamentals and bottom line. From non-operating perspective, NOVA continues to maintain the most crucial item, net interest expense, at a manageable level. As per its 10-K , net interest expense represents interest on borrowings under all debt facilities, amortization of debt discounts and deferred financing costs and realized and unrealized gains and losses on derivative instruments. Due to NOVA's high-CAPEX business that typically requires high debt level and interest payment, NOVA regularly engages in derivative instruments (possibly swaps) to manage interest rate risks.
I think that overall, these actions should suggest a better visibility to a path toward future profitability.
Adjusted EBITDA, for instance, has actually doubled from +$59.5 million in 2020, to +$119 million in FY 2022, demonstrating continual operating improvements if we look at the business separately from the non-operating items such as non-cash compensation, asset retirement obligation expense, or credit loss provisions. As these non-operating items trended upwards, the net losses narrowing by ~57% over the same period and EBITDA turning positive further point to various operational efficiencies taking place.
The operating improvement continued in Q1. Adjusted EBITDA continued to improve by +16%, and while net loss seems to have widened significantly due to non-operating item such as the rising net interest expense, the main issue there was a non-cash loss in derivative transaction rather than the actual interest payment. As I would later highlight on the risk section in this coverage, I continue to view increasing interest expense as a key risk given NOVA's debt level. However, I feel that NOVA is more than capable in managing it, as it has proven in recent times.
Moreover, as far as non-operating performance is concerned, I expect NOVA to also benefit from another massive lever of improvement, having secured the $3 billion loan guarantee commitment from DOE . But more importantly, the initiative has also made NOVA a mission-critical tool for the current US administration to demonstrate its commitment to increase access to clean energy across households.
As obvious as it is, loan guarantee would alleviate concerns about default risks from its lenders, allowing NOVA to reduce its cost of capital. Suffice to say, that NOVA has also maintained its TTM blended unit economics at a healthy level to-date.
While the deployment of the $3 billion loan guarantee has yet to come, at such a scale, I expect NOVA's unit economics to benefit materially from lower cost of capital at full implementation, which will lead to significant margin expansion from non-operating elements.
Increasing product and service upsell activities should also allow NOVA to see margin improvement through maintaining a more efficient customer acquisition cost by tapping into its existing client base for more sales. NOVA has set an expectation to double the number of services sold per customer to 7 by 2025 .
As a result, we should then see a continuing uptrend of NCCV / net contracted value per customer, which stood at ~$8,500 per customer in Q1. I think that the upsell initiatives sound like a sensible approach. The demand for battery and energy management systems alone, in addition to the existing solar PV / photovoltaic equipment, for instance, should increase due to two possible factors.
First, since NOVA will continue to expand and grow nationwide, residential customers in states with higher solar irradiation than the others should naturally require additional energy storage systems to store excess electricity generated for later consumption. Second, some customers feeling higher pressure from the rising electricity rates and living in the states challenging the net metering rates policy will choose to avoid exporting electricity back to the grid at lower rates and instead use solar-generated electricity for self-consumption.
Finally, a lot of these future demands will also be facilitated by the DOE-guaranteed backed loans to increase solar access across more income levels, effectively enabling NOVA to establish a virtual power plant / VPP taking advantage of the distributed solar generation. Since NOVA will require customers to install a tool to track energy usage to be eligible for the loan, this may also mean another upsell opportunity for NOVA.
Risk
As part of its dealer-network business model, NOVA has been quite dependent on some dealers, Trinity Solar and Windmar PV Energy, to generate a sizable amount of its net originations. 19% of NOVA's net originations came from Trinity in FY 2022 and 15% in FY 2021, reflecting an uptrend YoY. NOVA did not report how much of its net originations came from Trinity in Q1, though it is possible that the figure may increase further. Meanwhile, the share of net originations from Windmar also increased from 11% to 13% in FY 2022.
I continue to view this as one of the key risk factors in NOVA. While it remains important for NOVA to maintain good relationships, the cost to maintain them may become quite expensive. In FY 2022, for instance, NOVA agreed to provide +$150 million in bonus payments to Trinity over the next five years to perform exclusive services for NOVA.
Furthermore, while adjusted EBITDA may continue to improve, I also expect NOVA to remain unprofitable on a reporting basis for some time, especially given its hyper-growth situation. The operating loss continued to widen in Q1, and the biggest drag to it has been G&A / general and administrative expenses, which also include various non-cash and non-operating items. I expect this to continue increasing as NOVA aims to serve more residential solar demand nationwide.
As with typical companies operating in the high-CAPEX sector, NOVA is also highly leveraged, with a debt-to-equity ratio standing at ~4.6x in Q1.
Consequently, I expect interest expense to see a steady increase going forward as NOVA increases its debt level to fund its growth. It seems likely that interest expense may increase in FY 2023. Interest expense was ~$31 million in Q1, which on an annualized basis was ~$124 million already, reflecting a projected ~15% increase from FY 2022 on a gross basis - There is of course a possibility that on a net basis, the increase is softer than what is expected here, given NOVA's activities in managing derivative transactions to manage its credit risks. Nonetheless, I still consider this as a risk, since in the absence of satisfactory execution there, net interest payment will pressure net profitability.
Valuation / Pricing
To estimate the target price for NOVA in FY 2023, I assume the following bull vs bear scenario:
-
Bull scenario (70%) - NOVA to finish FY 2023 with a revenue of $842 million (50% YoY growth), which is the average aggregate estimate for FY 2023. I assign NOVA a P/S of ~3.3x, where it is currently trading at.
-
Bear scenario (30%) - NOVA to finish FY 2023 with a revenue of $624.3 million (~12% YoY growth), which is at the lowest end of the estimate. I assign NOVA a P/S of 2x, a lower figure than its all-time-low P/S of 2.5x seen in 2023.
author's own analysis
Consolidating all the information above into my model, I arrived at an FY 2023 target price of ~$20 per share. Since NOVA is trading between +18 to +$19 per share currently, it presents a 5% to 11% upside from the current level.
At this point, I would rate NOVA a buy. It is noteworthy that while it is relatively difficult to project NOVA's growth for FY 2023 given no guidance and the recent hyper-growth performance, I believe that the figures I selected for my target price model were highly conservative.
For instance, I assumed a 30% chance for NOVA to grow its revenue by merely ~12% under the bear scenario despite the currently very strong momentum in the business. Though growth already decelerated slightly in Q1, revenue still grew by 146%.
In my projection, I also assumed that revenue growth would decline closer to its FY 2021 figure as it approaches a more sustainable level. As such, my assumption suggests that even if NOVA struggles to maintain its current growth rate and ends up finishing FY 2023 at the same level as it did in FY 2021, the stock still presents at least a 5% upside.
Conclusion
NOVA has experienced strong revenue growth since its IPOs, with acceleration from +20% at IPO to +50% and ~130% in 2021 and 2022 respectively. Considering the energy transition tailwind, I give NOVA an overweight rating, expecting potential catalysts for outperformance. However, the company's dependence on certain dealers poses a risk. Given no guidance, I maintained conservative assumptions as I derived the FY 2023 target price. And yet, the stock still presents a ~5% upside based on my target price model, leading me to rate NOVA as an attractive buy.
For further details see:
Sunnova: Very Strong Secular Demand