ENPH: Inventory Correction Over, Stock Likely to Stay Rangebound
ENPH 0.00%↑ 2Q results were mixed, with top-line figures landing at the lower end of their guidance and missing street estimates. The primary narrative over the past year has centered on end demand and channel inventory. Despite the somewhat conservative guidance for 3Q, the company has already booked 85% of its projected revenue, suggesting a cautious but potentially optimistic outlook. Global channel inventory normalized by the end of 2Q, with a $92 million reduction and $396 million in total end market sell-through. U.S. revenue increased by approximately 32% QoQ as under-shipments declined and NEM 3.0 demand stabilized, with California sell-through up 7% QoQ. European revenue was flat QoQ, but sell-through increased by 3% QoQ, driven by market share gains in a relatively weak European residential market.
The spotlight now shifts to 4Q, where the ability to provide domestic content-qualified products for the IRA’s 10% domestic content adder could serve as a significant tailwind. Enphase has been proactive in ramping up U.S. manufacturing, giving it a head start against competitors. This positions the company to potentially increase its market share in the TPO market, with lease/PPA providers likely seeking as many domestically manufactured inverters and batteries as possible in order to qualify for the tax incentives offered under IRA.
Enphase's gross margins remained resilient, with management expecting continued improvement through cost reduction programs and potential IRA credits. Despite the slightly below-consensus 3Q guidance, the anticipated revenue ramp from resolving the channel inventory overhang seems to be on the horizon. The residential solar industry's short-term trends appear lackluster, but Enphase's ability to maintain superior gross margins and positive free cash flow during this down-cycle are impressive.
Battery storage was a spotlight with shipments reaching 120 MWh, a 59% increase QoQ and 46% YoY, exceeding guidance and previous estimates. Under NEM 3.0 battery attach rates in california are over 90% driven by policy change that makes it less financially attractive to export excess solar energy back to the grid. Under NEM 3.0, the compensation for sending surplus energy to the grid is reduced, encouraging homeowners to store their excess solar power in batteries instead. According to managment commentary ENPH has 50% market share in California but competitive pressures going forward will increase as TSLA 0.00%↑ introduces Powerwall 3 into the market. Enphase's domestically produced batteries, slated for a Q4 release, could help mitigate this competition, but it’s too early to tell how the competitive dynamics will shake out.
The IQ9 inverter is slated to be released in 2025, which will use Gallium Nitride, allowing these devices to produce more power while being cheaper to make. GaN allows for more power and lower costs because it has superior electrical properties compared to traditional silicon. GaN can handle higher voltages and switch faster, making devices more efficient. This efficiency means that GaN-based microinverters can convert more solar energy into usable electricity. Additionally, GaN components can be smaller and lighter, reducing material and manufacturing costs. These benefits lead to higher power output and lower production costs (higher profits) for Enphase's new microinverters.
Enphase remains the market leader in residential solar inverters, commanding over 50% market share in the U.S. The company's premium software-defined hardware solution for small-scale solar addresses many limitations of traditional string inverters, offering enhanced safety, reliability, and monitoring features. This market leadership creates brand awareness, product familiarity, and scale, fostering continued innovation. Despite anticipated pricing pressures due to competition, Enphase seems to be well-positioned to defend its margins, benefiting from the IRA 45X investment tax credits and potential cost savings with the GaN technology transition. Customers are likely to continue paying a premium for Enphase's high-reliability products. The company also sees growing opportunities in battery storage from increasing attachment rates and market share gains.
Despite the weaker-than-expected current quarter results, the market was relieved by the end of the inventory correction, which pushed the stock up 8%. My valuation stance remains largely unchanged since my previous analysis in September 2023. At that time, I was concerned that topline estimates were too high—a concern that has been validated. I also expected GM to decline due to increased competition, which hasn't happened yet. Revenue estimates have been significantly adjusted and now appear more realistic given the current solar demand cycle. However, GM estimates are still above 50%, and I remain skeptical, leaning towards a lower GM expectation. ENPH is trading at a $13.7B enterprise value, with sell-side estimates projecting just under $1B in EBITDA and $720M in FCF by 2026. This equates to multiples of 14x 2026 EBITDA and 19x FCF. These seem fair for a company that is a leader in a sector characterized by commodity-like features and intense competition. I view the valuation range as $130/share on the high end (where the stock becomes a sell) and $90/share on the low end (where it becomes a buy).