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

Introduction

I had a Thesis “Sell” for Enphase Energy (NASDAQ:ENPH) in March. The stock is up 3%, in line with the S&P 500 since mid-March, which makes my thesis bleak. However, the company continues navigating a challenging environment as the residential solar market struggles to rebound. There are some robust indicators suggesting that the industry’s recovery may take longer. The company reported disappointing results and the next quarter isn’t expected to be much better as revenue is poised to fall significantly again. The valuation still does not look attractive and I am inclined to reaffirm a ‘Sell’ rating.

Fundamental Analysis

Some factors suggest that unfavorable trends will likely persist for the residential solar sector. According to pv-magazine.comglobal polysilicon (“GPM”) prices have fallen significantly since the start of the year due to low demand. China’s monograde polysilicon also demonstrates weakness in 2024, indicating that demand for solar panels is weak globally. Polysilicon is a fundamental element for the production of rooftop solar equipment and the sharp drop in its price constitute strong evidence of low demand from end markets.

Additionally, as interest rates in the United States and Europe remain high, demand for residential solar will likely continue to slow, which could delay the industry’s recovery.

Another bearish factor I want to highlight is that ENPH’s revenues are expected to decline much more in 2024 compared to the expected industry contraction. According to consensusrevenue will likely contract by 35.5% in fiscal 2024. This is a much larger decline compared to a 13% contraction in the residential solar market in 2024 predicted by Mackenzie Wood. With such expected weakness relative to the industry in 2024, I doubt ENPH will be able to generate a 45.8% rebound in revenue in fiscal 2025. Additionally, Wood Mackenzie forecasts that There will be a more modest 13% industry expansion in 2025. With a notable gap between ENPH’s 2025 outlook and that of the industry, there is a risk that the company’s revenue estimates for 2025 will soon be revised downwards.

ENPH is struggling to face headwinds in the sector while its the last quarter financial performance was disappointing. The company missed consensus estimates, which almost never adds optimism to investors. Revenue declined nearly 64% on an annual basis.

The gross margin did not suffer much but the reduction in operating expenses was marginal. This led to a negative operating result, which has not happened to ENPH since 2017. However, in 2017 the company was much younger and its turnover was much lower. That said, management does not demonstrate sufficient flexibility in operating expenses to maintain profitability. During the earnings call, management presented no concise information cost savings plan. This doesn’t sound shareholder-friendly, in my opinion. I think any management should respond by presenting cost savings when their revenues are declining at a rapid rate. Apart from the information from the end of 2023 on a 10% reduction in workforce, there was no news of further layoffs. This seems disproportionately small compared to a 64% year-over-year revenue decline in the first quarter.

Additionally, the pain will not stop in the second trimester. Management expects revenue between $290 million and $330 million for the quarter. The midpoint of the range is $310 million, approximately 56% below revenue generated in the second quarter of 2023. Q3 2024, consensus estimates call for a 24% year-over-year revenue decline. Not having a cost reduction plan in the midst of multiple quarters of double-digit revenue declines is a bad sign in my opinion. This means that profitability may still be in trouble.

Valuation analysis

My previous estimate for ENPH stock price was $118. Let me recalculate my discounted cash flow (“DCF”) model to assess the change in fair value over the past three months. Future cash flows will be discounted using a 9.5% WACC. There has been a massive drop in consensus estimates for FY 2024 compared to my previous DCF, from $1.62 billion to $1.48 billion. This also negatively impacted the revenue estimate for fiscal 2025, falling from $2.33 billion to $2.15 billion. For years beyond FY2025, I reiterate the same Revenue CAGR of 15.1%. Despite temporary weakness, I believe the secular trend in residential solar is robust and I reiterate a strong constant growth rate of 6% for the Terminal Value (“TV”) calculation. TTM leveraged FCF margin also declined, from 15.57% to 13.53%. I use the 13.53% level for FY 2024 and reiterate a one percentage point annual expansion due to secular tailwinds. According to Seeking Alpha, there are 136 million shares of ENPH stock outstanding.

Given all the adverse changes in assumptions, I am inclined to significantly lower my estimate of the fair price of ENPH stock, from $118 to $84. The new price target indicates a 32% downside potential, meaning ENPH is significantly overvalued.

Examination of the ENPH valuation ratios does not reveal any undervaluation either. The forward P/E ratio is close to 100, which is high for a company experiencing declining revenue and declining profitability. Consensus expects P/E to contract as low as 16 by FY 2027. However, this will be the case if adjusted EPS nearly triples between FY 2024 and FY 2027, passing from $2.88 to $7.51. This is a difficult task, especially as headwinds are expected to persist.

Mitigating factors

The Fed will probably start cutting rates soon, which is a powerful potential catalyst for all growth stocks. Although ENPH faces serious headwinds, these are likely temporary. From a secular perspective, the company has the potential to generate long-term growth. ENPH still shows solid profitability despite a rapid decline in revenue. Its strong financial position can withstand a turbulent environment, which is also a fundamental asset. Therefore, ENPH can potentially become one of the darlings of monetary policy easing.

Solar energy in the United States and European Union relies heavily on government support. Therefore, an expansion of government incentives for faster adoption of residential solar could help the industry recover more quickly and would result in a reassessment of revenue forecasts for the 2024-2025 fiscal year. This can significantly and positively affect the NPV of future cash flows and increase the target stock price, and my thesis will not age well in this case.

Conclusion

ENPH continues to absorb weakness in the industry as a whole, but it appears management has no plans to at least partially mitigate the massive revenue decline with cost-cutting initiatives beyond a modest layoff of 10 % last December. The valuation also does not look attractive and my price target for ENPH is $84.