SolarEdge: Initiating Coverage With Strong Buy – This Selloff Is A Gift (NASDAQ:SEDG)

It took a while, but SolarEdge (NASDAQ:SEDG) has finally seen its stock get impacted by the broader valuation reset among growth stocks. It is curious that SEDG is seeing the stock price weakness just as many tech stocks look to be finishing up their own stunning recoveries, but it does make some sense given that the company is only now beginning to see tangible headwinds from the higher interest rate environment. I expect SEDG to see choppy growth rates in the near term as it adjusts to operating in a different consumer financing environment, but the company’s duopolistic positioning in the solar inverter market bodes well for the company over the long term, and the next several quarters may eventually make for easy comparables. I rate the stock a strong buy as it is undervalued to peers and on an absolute basis.

SEDG Stock Price

For much of the past year, SEDG was one of the few stocks that showed hyperbolic growth (and stock returns) through the pandemic but held on to those stock price gains. Those days are over.

SEDG is one of those names which I regret not investing in many years back, as in hindsight, it offers an intersection of duopolistic positioning in the inverter market alongside the long-term growth tailwinds of solar overall. This latest pullback may hurt for current investors but offers a gift to investors like myself who have been waiting patiently for reasonable valuations before jumping in.

SEDG Stock Key Metrics

SEDG stock sank after releasing its latest earnings results, as revenue came far short of guidance of $1.01 billion, ultimately coming in at just $991.3 million. SEDG had guided for $215 million in non-GAAP operating profit but was disappointed on this front, delivering just $191 million in non-GAAP operating profits.

Even with the guidance misses, SEDG still managed to deliver 36% YOY revenue growth, which was driven by record revenues in Europe that were offset by declining revenues in the United States and others.

SEDG is seeing this deceleration in revenue growth just as it is finally starting to post solid profit margins (lower profitability relative to its biggest peer had historically been a bearish point).

SEDG enters this difficult time of the market with a solid balance sheet, highlighted by $853.5 million of net cash and investments.

We can see below that units shipped have begun to taper off sequentially (the first quarter was the first “wake-up call” for investors).

Looking ahead, SEDG is guiding for third quarter revenues of up to $920 million, implying just 10% YOY growth.

What happened? SEDG had previously been a rapidly growing name, capitalizing on both the long-term growth story of solar as well as the move within the industry towards more efficient energy management.

The problem is quite simple, actually. The higher interest rate environment has impacted both housing as well as SEDG for the same reasons, as higher financing costs have effectively slowed down consumer demand. That means both slower home sales as well as greater buyer hesitancy, as solar panels are often purchased with financing.

On the conference call, management also noted that they are seeing tough comparables due to having benefitted from component shortages during the pandemic, as well as seeing energy prices shift from high to more moderate recently. The slowdown in demand has resulted in excess inventory, not too dissimilar with what happened at semiconductor names like AMD (AMD) and Nvidia (NVDA) several quarters ago. Unlike NVDA (and in some respects AMD), SEDG cannot call generative AI a tailwind, at least not at this time.

Management noted that distributors have taken a “more cautious approach” in purchase orders, a drastic change from the past where distributors had previously placed aggressively large orders to meet demand. Management expects the inventory adjustment period to continue over the next several quarters in both Europe and the United States. That said, management sees this time as an opportunity to grow market share, as distributors are reducing the number of products offered and focusing on larger operators. I have seen this dynamic also benefit larger names in the enterprise tech sector as well.

Management has guided for cash generation to pick up starting in the upcoming quarter but noted that they had no plans for share repurchases due to viewing M&A as offering greater potential for shareholder returns. Management did reiterate expectations for 20% to 22% EBIT margins exiting 2023, which may be a double-edged sword as the stock might sell off hard if management is forced to later withdraw that guidance as well.

Is SEDG Stock A Buy, Sell, or Hold?

SEDG is a global energy company most well-known for its inverters that are typically installed in solar products.

Electricity demand is expected to grow rapidly over the coming decades due to various tailwinds such as urbanization, population growth, and the ongoing growth of electric vehicles.

Renewable energy sources are expected to grow in line with that demand, to the benefit of the solar sector.

Readers can think of SEDG as being an enabler of “smart solar” as its inverters help customers fully capture the energy generated from the sun. Together with Enphase (ENPH), SEDG operates in an effective duopoly due to the two having the best products in the industry. While there are many technical differences between the two, an easy way to differentiate the companies is that whereas ENPH has larger US exposure, SEDG has more exposure to Europe.

Over the long term, SEDG expects to expand its product offerings from residential customers to the utilities directly, helping utilities to harness solar energy themselves.

The solar thesis is compelling (the sun won’t stop shining) and that has historically led to SEDG trading at a nosebleed valuation. The headwinds sprung about from the higher interest rate environment have led the stock to trade at its most reasonable valuations in years (though I note that the stock is still multiples higher than it was 5 years ago). SEDG recently traded hands at just 19x this year’s earnings estimates.

That is in spite of consensus estimates calling for healthy double-digit top-line growth for many years.

I am doubtful that SEDG will ever return to the previous 35% to 45% top-line growth rates, at least on a sustainable basis. But even just a 20% forward growth rate can justify a 6x sales multiple (based on 20% projected long-term net margins and a 1.5x price to earnings growth ratio), implying considerable upside. It is notable that SEDG trades at a steep discount to the 7x sales multiple that ENPH trades at – this might be due to ENPH having a more substantial history of profitability (but it is not clear if it is deserved given the duopoly).

What are the key risks? The most clear risk in my opinion is that of a worsening macro environment. The higher interest rate environment has already disrupted the financing-heavy transaction flow, but a worsening economy might lead to further disappointments. As stated earlier, management has not yet fully pulled the rug so to speak, with a possibility that the company is unable to achieve 21% EBIT guidance exiting this year. It is also possible that we still haven’t seen the bottom for the solar inverter market, as it remains unclear how much impact the higher interest rate environment will have. Perhaps this industry eventually sees far worse deceleration in growth than expected, like that seen in e-commerce and much of tech. I find any downturn to likely prove cyclical as the long-term secular drivers are hard to ignore. We mustn’t ignore competitive risks, as it is possible that ENPH begins to take market share, or even for the duopoly to eventually face stronger competitors. ENPH has guided for gross margins to move lower over time, and perhaps my 20% net margin assumption may prove too optimistic. However, even using an anemic 10% net margin still implies an upside from current levels. But if growth turns out to be just 10% moving forward, then my new price target would be $100 per share, implying ample downside.

I am initiating coverage on SEDG with a “strong buy” rating due to the attractive valuation against undeniable long-term solar tailwinds. There is room to the downside if growth disappoints, but the net cash balance sheet cannot be ignored either.