Enphase Energy’s Stock Has Plenty More Room To Tank (NASDAQ:ENPH)

Investment thesis

My previous bearish thesis about Enphase Energy (NASDAQ:ENPH) aged well as the stock price declined by 4% over the last three months, substantially underperforming behind the broader U.S. market. A lot of developments happened since early January and today I want to share my view on them. My analysis of recent developments suggests that the company still struggles to deal with the current headwinds. Moreover, my valuation update suggests that the stock is almost 30% overvalued even if aggressive assumptions are incorporated into the financial model. All in all, I reiterate my “Sell” rating for ENPH.

Recent developments

The latest quarterly earnings were released on February 6, when the company missed both revenue and adjusted EPS estimates. Revenue dropped by massive 58% YoY and the adjusted EPS dropped by around three times, from $1.51 to $0.54. The operating margin shrank YoY from 22.3% to 1.5%.

The good news here is that ENPH has a solid financial position to weather the storm in earnings. Enphase had $1.7 billion in cash as of the 2023 year end, which was around $377 million higher than the company’s total debt. Liquidity and covered ratios are solid, meaning investors should not worry about ENPH running out of cash any time soon.

The upcoming earnings release is scheduled for April 26. Consensus estimates expect Q1 revenue at $279 million, meaning the company will highly likely record a 61.5% YoY revenue decline. The adjusted EPS is expected to drop by more than three times, from $1.37 to $0.40. The extremely bearish sentiment around the upcoming earnings release is highlighted by 19 downward EPS revisions over the last 90 days.

In my previous thesis, I emphasized that the management’s move to layoff around 10% of the workforce at the end of 2023 was a sound decision in light of the softening demand. However, as we see, the situation in the macro environment does not demonstrate signs of improvement and in April 2024 the decision to lay off 10% of the headcount looks substantially insufficient. I have not found any news regarding planned new layoffs, and now I think that the management might be lagging in this difficult decision. Consensus estimates forecast that ENPH will generate around $1.6 billion revenue in FY 2024, which is about 20% higher than FY 2021 revenue. However, in the below screenshot we can see that ENPH’s current headcount is around 50% higher than in FY2021. Therefore, I think that December 2023 10% layoff round is an insufficient measure and a new layoff round should have been already announced in light of the expected to fall by 61% Q1 revenue.

Recovering the company’s profitability as soon as possible is crucial for the long-term success. Enphase’s success in previous years was ensured by its unmatched ecosystem and technological edge, which was achieved by massive reinvestments in R&D. As the company’s profitability has dipped sharply and the management is lagging in its cost-efficiency measures, there is the risk that investments in innovation might be decreased and it is the risk to lose the technological advantage.

I was also disappointed to see in the latest earnings call transcript that nothing has been said by the management about fortifying its revenue mix, which I have underlined as a notable strategic weakness in my previous thesis. I understand that shifts in revenue mix is not an overnight process, but the management mostly highlighted the international opportunities and some complementary products to the existing line. I agree that Enphase’s potential for international expansion is notable, but this will be once again with highly cyclical revenue mix. This does not solve the substantial cyclicality problem for investors, in my opinion.

The high cyclicality of the current revenue mix is multiplied by the effect of sky-high inventory levels which grew exponentially in 2023. As I mentioned earlier, in FY 2024 Wall Street analysts expect revenue to drop to FY 2021 levels. At the same time, we can see that the current inventory levels are multiple times higher than they were in 2021. That high inventory and declining revenue with high cyclicality risk looks like a very bearish bundle of signs to me. Performance of recent quarters revealed substantial vulnerability of the business to high interest rates, and recently Jerome Powell said that Fed does not need to be in a hurry to cut rates, which is another strong headwind for ENPH.

From the perspective of the stock itself, the momentum is weak. This looks fair given rapidly deteriorating revenues and shrinking profitability. I think it will take several quarters of confident revenue growth and profitability expansion before the sentiment around the stock improves. Since in FY 2024 a 30% revenue decline is expected, I think that the sentiment around the stock will likely start improving only in 2025 in case revenue starts rebounding rapidly.

Valuation update

ENPH currently trades three times cheaper than its November 2022 highs. The stock lost 42% of its value over the last 12 months and had a weak start in 2024 with -15% YTD. The stock’s current valuation ratios, which are substantially lower than historical averages, should not mislead readers. Valuation ratios are still extremely high compared to the sector median, with a 35 forward non-GAAP P/E and almost 34 forward Price to Cash Flow relationship. ENPH’s valuation ratios look high compared to close peers like SolarEdge (SEDG) and First Solar (FSLR) as well.

As we see, ratios might be misleading sometimes. Therefore, I must have outcomes from an alternative valuation approach. I prefer the discounted cash flow [DCF] model here because ENPH is an apparent growth stock. I use an 11% WACC, which is in line with the recommended by valueinvesting.io range. Since I am bearish about ENPH, I want to balance out and be more optimistic in my revenue growth assumptions. A 17% CAGR projected by consensus estimates for the next decade looks too optimistic, but I am using this assumption to be more conservative in my bearish views. I am using a 6.3% TTM free cash flow [FCF] ex-stock-based compensation [ex-SBC] for the base year and expect a one percentage point yearly expansion.

As my DCF suggests, the business’s fair value is slightly below $12 billion. This is notably lower than the current market cap and signals a 28% downside potential. I want to emphasize again that the underlying assumptions are very optimistic, meaning that ENPH is significantly overvalued.

Risks update

Enphase Energy was one of the best performing stocks of the decade between 2013 and 2022. The stock delivered several thousands percent in share price appreciation in these years and it is unsurprising that the stock has its vast fan base. Sometimes, the share price can be driven not by its fundamentals or valuation, but by the sentiment around it. With an extensive base of ENPH bulls it is not unrealistic that the stock might see short term price spikes driven by optimistic headlines. The stock is extremely volatile and in the below ENPH stock price chart you can see that it had one-day big upswings even during the last 30 days.

Readers should be aware that my bearish thesis is tactical, meaning that I am not betting that the stock is going nowhere over the long-term. Enphase’s profitability is still best-in-class, it has built a solid ecosystem which mixes both hardware and software. The stock likely has solid prospects over the next ten years. What I mean is that the company is not dealing well enough with the current headwinds [which are temporary] and its valuation is way unjustified. Therefore, if you are a long-term investor, who bought the stock 5-10 years ago, and is ready to hold for another decade, my thesis is not for you.

Bottom line

To conclude, ENPH is still a “Sell”. I see no signs of the macroenvironment improvement and ENPH does not demonstrate much resilience to these temporary [but still harsh] headwinds. The valuation looks too generous even for an “inherently overvalued” stock like ENPH.