SolarEdge: I Was So Wrong, But This Is Too Much (NASDAQ:SEDG)

Is there a more beaten-down growth stock than SolarEdge (SEDG)? 2023 saw tech stocks across the board recover much of their losses suffered in 2022. SEDG appears to be experiencing a delayed reaction, with its stock undergoing the same valuation reset that tech stocks experienced during the crash. There are a lot of similarities this time around, with the higher interest rate environment being the key culprit in collapsing consumer demand. With its growth story clearly broken in the near term, SEDG is a painful reminder that cyclical stocks might not look so cyclical under the favorable guise of zero interest rate policy. The beatdown looks overdone here, however. Long-term investors should be looking for opportunities in the crash. I rate SEDG a strong buy in anticipation of a dynamic recovery, though patience is needed here.

SEDG Stock Price

SEDG crashed, then crashed, then crashed again. Tech investors may recognize that stock price movement from 2022 when it took several quarters for investors to fully understand the impact of higher interest rates on underlying growth rates. SEDG had avoided the slowdown for much of 2022 but one cannot escape destiny forever.

I last covered SEDG in August where I rated the stock a strong buy due to valuation. I clearly misjudged the extent of the cyclical downturn and more importantly, simply underestimated the cyclicality of the business. The company does have resources at its disposal to weather the storm, and the sun will eventually shine once again on this solar winner.

SEDG Stock Key Metrics

In its most recent quarter, SEDG finally saw an abrupt pullback in end-market demand. Units shipped declined sequentially as customers chose to cancel orders.

As disclosed in their preliminary release, SEDG saw revenue come in far short of guidance, declining 13.3% YoY to $725.1 million.

SEDG also saw its gross margin deteriorate in the quarter, falling over 1,200 bps sequentially. On the conference call, management explained that the cost of goods sold includes costs that do not adjust in tandem with shipping volume, including warranty costs, contract manufacturer claims, and others. It is in these difficult times that investors are reminded to appreciate the unappreciated executional prowess of peers like Enphase (ENPH) that are able to command – and sustain – elevated unit-level margins even in times of distress.

Unsurprisingly, the disappointing top line and gross margins led to operating income all but vanishing in the quarter.

SEDG ended the quarter with over $800 million in net cash. They will need to lean on their strong balance sheet position to handle what is to come ahead.

Looking ahead, management is guiding for the pain to increase exponentially. Revenue is expected to decline by over 60% to $325 million at the midpoint. The company is expected to lose over $100 million in operating income on a non-GAAP basis.

What happened? While approximately 11% of their Israeli workforce was called up for reserve duty, management noted no disruptions from the war. Management was optimistic about a quick recovery just three months ago, and in no way shape or form foreshadowed such a collapse in demand. Management explained the struggles as follows. The solar industry had been suffering from supply constraints heading into 2022, setting the stage for “an unprecedented surge in demand.” That led management to believe that 2023 would also be a blockbuster year, especially given that the company had released a new residential offering in the year. First half shipments hit record levels and management sought to execute the typical playbook of “increasing capacity to meet the elevated channel demand.”

Historically, the company experienced a high level of seasonality that typically suggested a surge in demand in the third quarter. That made it difficult for management to predict the bloodshed to follow. Management noted that while orders are “technically binding,” they needed to accommodate the requests in order to preserve the relationships. The stock had previously enjoyed a premium valuation relative to solar panel peers due to the perception that the company could command stronger pricing power, but that has gone out the window when it is needed most.

SEDG hasn’t seen weakness in all of its markets – management noted that Germany and Austria continue to be strong growth drivers. But the company has struggled in many of its core markets where a combination of higher interest rates and reduced government credits have decimated consumer demand. These issues should eventually be resolved in time with or without a decline in interest rates as utility costs rise, but that time can be costly.

Management suggested that in a “non-inventory challenged environment,” the company might be operating at a revenue run rate of $600 to $700 million per quarter. Management also predicted that the correction could take 2 to 3 quarters to resolve itself, but investors can be forgiven for holding little trust in management guidance for a while.

Management disclosed that the Board of Directors has authorized a $300 million share repurchase program – my personal opinion is that such a move may prove risky given the projected operating losses and limited net cash on the balance sheet, regardless of how cheap the stock is trading at. Management did suggest that they can somehow increase their cash balance in the coming quarters due to, ironically, the fact that they will not be growing. The idea is that during growth periods CapEx is elevated in order to increase capacity but that is no longer at play, at least in the near term. Management also noted that they are expecting some accelerated payments from customers due to having allowed for deferred payments in prior quarters. Color me skeptical, but I certainly wouldn’t complain if the balance sheet isn’t critically tested in the coming quarters.

Is SEDG Stock A Buy, Sell, or Hold?

As demand grows worldwide for electricity, I find it hard to believe a scenario where renewable energy generation is not larger – much larger, rather – in the future.

SEDG is well positioned to capitalize on this trend, offering a complete solar product portfolio highlighted by its inverter solution.

SEDG has also targeted commercial customers with plans to sell to utilities as well but residential customers remain the most important segment.

These all suggest long-running secular tailwinds for the stock, even if this latest cyclical downturn proves extremely nasty. But could SEDG survive until a recovery? If management’s assertion that they will generate, not burn cash over the coming quarters is true, then long-term-minded investors may find the stock attractive here. The stock traded hands at around 24x earnings estimates, with rapid growth expected from operating leverage.

Consensus estimates see revenue growth recovering within a couple of years.

To illustrate just how cheap the stock has gotten, assuming a recovery to just 10% revenue growth, long-term net margins of 15%, and a 1.5x price to earnings growth ratio (‘PEG ratio’), I see fair value hovering at around 2.3x sales, well above current levels. SEDG traded at blistering valuations following the pandemic, but now trades at cheap valuations – valuation isn’t the problem here.

What are the key risks? This cyclical downturn creates the potential for great complications. Besides the large projected operating losses over the coming quarters, there is also the risk that once the environment improves, the inverter market may see intense price competition to seize market share. The entrance of Tesla (TSLA) with their own string inverter product seems to suggest that SEDG is more at risk than ENPH. This might mean that the long-term profitability of the company may be impaired. If I adjust my above valuation model to instead incorporate expectations of 12% long-term net margins, then the fair value declines to 1.8x sales. It is also possible that this cyclical downturn causes the stock to trade at depressed cyclical multiples even in a recovery. The stock can only deliver spectacular returns if it can either return to 15% to 20% top line growth rates or command healthy valuation multiples, and ideally both.

Ideally, there would be more net cash on the balance sheet to lend comfort amidst this downturn, but the stock appears attractively valued if management can execute on a recovery within 2 to 3 quarters. I rate the stock a strong buy as a rare entry point into this long-term compounder.