Enphase Energy: Target Price Downgrade Reflects Fundamentals (NASDAQ:ENPH)

Sundry Photography Introduction I had a ‘Sell’ thesis for Enphase Energy (NASDAQ:ENPH) in March. The stock delivered a 3% gain in line with the S&P 500 since mid-March, making my thesis not look very good. On the other hand, the company continues navigating a challenging environment as residential solar market struggles to bounce back. There are a few robust indicators suggesting that it might take longer for the industry to recover. The company delivered disappointing latest earnings and the next quarter is not expected to be much better as revenue is poised to fall further with a significant magnitude. The valuation still does not look attractive, and I am inclined to reaffirm a ‘Sell’ rating. Fundamental analysis There are factors suggesting that unfavorable trends are likely to persist for the residential solar industry. According to pv-magazine.com, global polysilicon prices (‘GPM’) declined significantly YTD due to the weak demand. China Mono Grade Polysilicon also demonstrates weakness in 2024, indicating that demand for solar panels is weak across the world. Polysilicon is a fundamental element for solar rooftop equipment production and sharp decline in its price is a strong evidence of the weak demand from end markets. pv-magazine.com Moreover, as interest rates in the USA and Europe are still high, the demand for residential solar will likely continue experiencing softness, which might delay industry’s recovery. Another bearish factor that I want to highlight is that ENPH’s revenue is expected to decline much deeper in 2024 compared to the expected industry contraction. According to consensus, the topline will likely contract by 35.5% in FY 2024. This is a way deeper drawdown compared to a 13% contraction in residential solar market in 2024 predicted by Wood Mackenzie. With such an expected weakness compared to the industry in 2024, I have doubts that ENPH will be able to deliver a 45.8% revenue rebound in FY 2025. Moreover, Wood Mackenzie forecasts that there will be a more modest 13% industry expansion in 2025. With a notable discrepancy in 2025 ENPH and industry outlooks, there is a risk that the company’s 2025 revenue estimates will be downgraded soon. SA ENPH struggles to navigate industry headwinds as its last quarter’s financial performance was disappointing. The company missed consensus estimates, which almost never adds optimism to investors. Revenue decreased almost 64% on a YoY basis. 10-Q report, Q1 2024 The gross margin did not suffer much but the decrease in operating expenses was marginal. This has led to a negative operating income, something that has never happened to ENPH since 2017. However, in 2017 the company was much younger, and its revenue was much lower. That said, the management does not demonstrate sufficient flexibility in operating expenses to sustain profitability. During the earnings call, the management did not outline any concise cost savings plan. This does not look shareholder-friendly, in my opinion. I believe that any management should react by presenting cost efficiencies when its revenue is contracting at a rapid pace. Apart from late 2023’s information about a 10% headcount cut, there was no news about new layoffs. This looks disproportionately low compared to a 64% YoY revenue decline in Q1. Data by YCharts Moreover, the pain will not be over in Q2. The management expects revenue in the range between $290 million and $330 million for the quarter. The midpoint of the range is $310 million, around 56% lower compared to revenue generated during Q2 2023. For Q3 2024, consensus estimates expect revenue to decline by 24% YoY. Having no plan to reduce costs amid several quarters of high to mid double-digit revenue decline is a bad sign, in my opinion. It means that profitability is likely to struggle further. Valuation analysis My previous share price estimate for ENPH was $118. Let me recalculate my discounted cash flow (‘DCF’) model to assess how has the fair value changed over the last three months. Future cash flows will be discounted using a 9.5% WACC. There was a massive decline in consensus estimates for FY 2024 compared to my previous DCF, from $1.62 billion to $1.48 billion. This also adversely affected an FY 2025 revenue estimate, declining from $2.33 billion to $2.15 billion. For the years beyond FY 2025 I reiterate the same 15.1% revenue CAGR. Despite temporary weakness, I think that secular residential solar trend is robust and reiterate a high 6% constant growth rate for the terminal value (‘TV’) calculation. The TTM levered FCF margin also dipped, from 15.57% to 13.53%. I use the 13.53% level for FY 2024 and reiterate a one percentage point yearly expansion due to secular tailwinds. According to Seeking Alpha, there are 136 million ENPH shares outstanding. Calculated by the author With all the unfavorable changes in assumptions, I am inclined to significantly downgrade my fair share price estimate for ENPH, from $118 to $84. The new target price indicates a 32% downside potential, meaning that ENPH is significantly overvalued. Examining ENPH’s valuation ratios also does not help to see any undervaluation. The forward P/E ratio is close to 100, which is high for a company experiencing decline in revenue and profitability shrinking. Consensus expects the P/E to contract to as low as 16 by FY 2027. However, this will be the case if the adjusted EPS almost triples between FY 2024 and FY 2027, from $2.88 to $7.51. This is a challenging task, especially as headwinds expected to persist further. SA Mitigating factors The Fed will likely start cutting rates soon, which is a potential strong catalyst for all growth stocks. Despite ENPH facing severe headwinds, they are likely temporary. From the secular perspective, the company has potential to deliver growth over the long term. ENPH still shows solid profitability despite rapid revenue shrinking. Its solid financial position can withstand a turbulent environment, which is also a fundamental strength. Therefore, ENPH can potentially become one of the darlings of easing monetary policy. Yahoo Finance Solar energy in the U.S. and EU is heavily dependent on governmental support. Therefore, an expansion of governmental incentives for faster solar residential adoption might help the industry to recover faster, and it will lead to reassessment of FY 2024-2025 revenue forecasts. This can significantly positively affect the NPV of future cash flows and boost the target share price, and my thesis will not age well in this case. Conclusion ENPH continues absorbing broader industry’s weakness, but it appears that the management does not plan to at least partially mitigate massive revenue drop with cost saving initiatives beyond a modest 10% layoff last December. The valuation does not look attractive as well, and my target price for ENPH is $84.

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