Is The Solar Industry Dead?

Talk about sticker shock.

The solar company rep gave his best Zig Ziglar presentation to pitch me on an $18,000 solar panel package for my house.

But his closing argument was weak. Spend $18,000 to save $50 a month on my electric bill?

No thanks.

Oh, and get this. The solar panel package he was proposing didn’t even power my entire home. To do that it would set me back roughly $40,000. It should be mentioned that I didn’t have enough sunlight blistering my roof to switch to all solar.

Of course, I didn’t have to stroke a check for $18,000 on the spot. At the time (2019) solar companies offered enticing financing options.

In fact, for many people solar panels made complete sense. You could finance them for cheaper than your power bill. Not to mention the tax benefits.

Eliminating your power bill coupled with cheap financing helped solar-powered homes explode in popularity.

But like most things, the good times didn’t last forever.

The Federal Reserve went berserk with interest rates. Increasing them at the fastest pace in history. It killed those sweet financing options that solar companies could offer homeowners.

The ripple effect was a devastating blow to the solar industry.

As you can see, the Global X Solar ETF (Nasdaq: RAYS) lost half its value over the last two years.

Were solar-powered homes were just a fad? Is the industry dead?

I don't think so…

Everyone, from individuals to municipalities to corporations to entire countries are trying to "go green." And thanks to major advancements in solar panel technology, solar is one of the easiest ways to do it.

Plus, solar panels on a roof are a loud statement to neighbors displaying that you are doing your part to protect the environment. So, unless we start putting giant windmills on our roofs to power our homes, solar panels aren't going anywhere.

The History Of Solar

While solar-powered homes are still relatively new, the solar panel itself is not…

In fact, it was first discovered in the late 1860s when Willoughby Smith found that bars made from selenium allowed electricity to flow through when exposed to light.

He published his findings in the Journal of the Society of Telegraph Engineers.

American inventor Charles Fritts stumbled upon his work a few years later. Intrigued, he built upon Smith's findings. Fritts was successful and is credited with building the world's first solar panel. In 1884, Fritts installed the first solar panels on a rooftop in New York City.

As neat as it was to create energy from light, it was terribly inefficient. Fritts' solar panels achieved an energy conversion rate of just 1% to 2%. For comparison, the world's main source of power — coal — sports an efficiency of up to 40%.

Back then, the biggest problem for solar was that no one quite understood how it worked. Sure, they knew that coating selenium with a thin layer of gold produced power, but that was the extent of it.

It wasn't until some guy named Albert Einstein published some brilliant research in 1905. In his paper, Einstein broke down the inner workings of solar. He demonstrated that light contains packets of energy, which he called light quanta (now called "photons").

Einstein's research, coupled with the discovery of the electron, helped scientists understand how Fritts's solar panels worked. With a clear understanding, research into solar panels exploded. But it was short-lived. Scientists failed to find a material that delivered efficiency anywhere near that of coal.

Of course, times have now changed. Today's solar panels are now 20 times more efficient than the ones created in the early 1900s. And much more practical. And with those advancements, interest in solar technology has soared again.

Solar 101

While we call them solar panels, most panels you see on houses are photovoltaic ("PV") panels, which turn light into electricity. (Solar panels turn sunlight into heat.)

Each PV panel is basically a sandwich made up of two slices of semiconducting material — usually silicon, the same stuff used in most chips that go into smartphones, televisions, and computers.

Think of this PV panel as a peanut butter and jelly sandwich. The bread is the silicon wafer. On one piece of bread, we spread phosphorous (peanut butter for those still following my silly analogy). Phosphorous contains extra electrons, giving that layer a negative charge. The other piece of bread gets jelly, or boron — an element with fewer electrons and thus a positive charge.

This perfect combination creates an electric field. When sunlight hits the panel, it knocks an electron free. This energy creates electrical charges, causing energy to flow. (That energy is captured by metal conductive plates and passed onto wires, which feed your home).

The problem is the electricity that this creates is direct current ("DC") electricity rather than the alternating current ("AC") that your house runs on. As the name suggests, DC is how electricity flows — direct — in one direction, like a river. The electricity in AC, in contrast, can change direction.

Our electrical grid uses AC. It's easy to convert AC to DC if need be, but it's expensive to convert DC to AC (one of the reasons solar panels were even more expensive in the past).

Now, remember, solar panels produce DC electricity. That means a solar-powered home needs devices called inverters that convert DC to AC. Historically, solar-powered homes had a single inverter, which means the entire system goes down if the inverter fails.

But this month's recommendation has created a revolutionary new inverter, called a "microinverter," that attaches to each PV panel. This means if one inverter breaks, the entire system continues to function (although perhaps not at full capacity).

This company is a leader in this space, with nearly 50% market share. IHS Research named it the number-one inverter supplier in the Americas. It works with every solar panel company manufacturer. And thanks to the recent weakness in the solar space, shares are trading at their cheapest valuation in over five years.

Profit From The Leader In The Clean Energy

If you've had solar panels installed on your roof, then there's a good chance you're using an Enphase Energy (Nasdaq: ENPH) product. The company's inverters convert the electricity from DC to AC to be used in your house. It also offers powerful batteries to store the electricity, software to manage it, and electric vehicle (EV) chargers.

But its bread-and-butter is its microinverters, which make up roughly 90% of sales.

We will roll up our sleeves and dive into the financials in a second. But first, let's talk about why now is a good time to jump into the solar industry…

Catalyst No. 1: Increasing Adoption

First, the low-hanging fruit, and that's the increasing adoption of solar. People aren't nearly as weary about bolting down solar panels on their homes. In fact, until interest rates soared, solar installations were having a real renaissance.

The residential solar market experienced its 6th consecutive record year in 2022, growing over 40% over 2021. The chart below shows the installation growth (and projected growth):

Despite that strong growth, just 3% of homes have solar. So, don't think the market is saturated. In fact, it's just getting warmed up. There's a long runway of growth for solar. And that's just the residential market… commercial and utility installations have also ramped up.

What the heck is H.R. 5376? Well, it's a government bill that passed in 2022. It's better known as the Inflation Reduction Act ("IRA").

Of course, the name of this government bill is a little deceptive. At first glance, you might be wondering what it has to do with solar (then, after reading the bill, you might be wondering what it has to do with inflation).

But buried in this 274-page bill is a sweeping $700 billion climate, tax, and health care package, half of which is allocated to climate initiatives.

This legislation is by far the largest investment addressing climate change in U.S. history. It includes provisions like a $7,500 tax credit for buying new electric vehicles ("EVs") and $4,000 credits for used EVs. There are also incentives for electric appliances, heat pumps, and other technologies to increase home energy efficiency.

But the biggest takeaway is that the government wants to spur massive new investment and innovation in the green energy space. And the solar industry should benefit immensely from these subsidies and tax credits.

Enphase is in a great position to benefit from this bill. New tax credits could cut the cost of producing a microinverter domestically almost in half.

Enphase's Financials

The company is the clear leader in the microinverter space. It has continued to gobble up market share, and sales have been the main beneficiary.

Five years ago (2018), Enphase pulled in $316 million in revenue. In 2022, that figure swelled to over $2.3 billion.

The company will report 2023 results on February 6, 2024, and they are expected to be flat year-over-year. And analysts estimate that sales will decrease in 2024, so that is a bit concerning, although not surprising (since interest rates are still expected to remain high and there are recessionary concerns).

The company isn’t sacrificing profits for that revenue growth, either. It's been profitable every year since 2019. In 2022, it produced operating profits of $453 million and net income of $397 million, or $2.77 per share.

Flipping over to the statement of cash flows, we can find one of my favorite line items in finance: cash from operations.

Why is it my favorite? Well, the more commonly used net income can be massaged to deliver whatever message management wants for that quarter or year. Cash flow on the other hand is much harder to manipulate, which is why I rely on this figure much more than net profits.

Back to cash flow… Enphase has been cash flow positive every year since 2018. And it has continually grown that figure at a nice clip. For example, five years ago, cash flow was just $16 million. In 2022, it did $745 million. And estimates are calling for over $834 million in 2023.

And once we account for capital expenditures, we can find free cash flow. This is the money left over after all bills have been paid. Money that can be used to reinvest into the business, pay down debt, or give back to shareholders in the form of dividends or share repurchases.

Enphase currently doesn't pay dividends. It has repurchased shares in the past, but not with any sort of consistency. But it generates solid free cash flow, which it can pour back into R&D to defend (and grow) its market share.

Free cash flow in 2022 was $698 million, more than double what it generated in 2021.

Finally, management has done a good job not overloading the company with debt (it has a history of this, which I'll touch on). At the end of the third quarter (2022), it had nearly $1.8 billion in cash on hand and just over $1.3 billion in total debt.

One Of My Favorite Investing Themes: Crisis Investing

Over the years I stumbled upon a common thread… investing in companies suffering from a crisis.

You see, every now and again you’ll see wonderful companies (those that generate boatloads of cash) in the headlines. And it’s not because of charity work or donations. It’s because they’ve stumbled.

Usually something bad happened and the company’s reputation is taking a massive hit. Think Facebook and its multiple PR stumbles. Wells Fargo and its deceptive practice of opening fake accounts. Boeing’s 737 Max plane crashes, etc.

I love a good crisis. Why? Because it presents opportunity.

You see, investors are humans. Humans are emotional. And that emotion spills over into selling shares of the stock. Creating a potential opportunity to buy a wonderful company at a fair — or even bargain — price.

When this happens I do my best to take the emotion out of it and see if this “crisis” is something that will materially impact the company’s business in the long run or if it’s a situation that I believe management can pull itself out of.

Now, I don’t want to knock myself over patting myself on the back, but I’ve had damn good success investing in companies that are in crisis.

For example, back when American Express (NYSE: AXP) and Costco (Nasdaq: COST) got a divorce (2016) I bought shares in September 2016. The stock is up more than 200% since then.

In June 2021, I bought the most hated utility company in America in PG&E (NYSE: PCG) — the company responsible for the massive California fires. I ended up closing that investment out for a nice 52% gain in less than two years.

I bring this up, because in 2017 Enphase went through its own mini-crisis that nearly put the company out of business. The culprit was its balance sheet.

It had $50 million of debt and less than $10 million in cash. All the while, it was ramping up two new product lines, which burned through cash.

To survive, Enphase had to raise $30 million. It replaced its founding CEO, Paul Nahi, with its then COO, Badri Kothandaraman.

Kothandaraman came from Cypress Semiconductor — the same place as Enphase chairman and Cypress founder T.J. Rodgers. Cypress went public in 1986 and ultimately rose 3,386% before getting acquired by Infineon (INFN) in 2020.

The bottom line is that once Kothandaraman stepped in, they've righted the ship and executed at a high level ever since (just scroll back up and look at the revenue and cash flow charts to see what I mean).

My Warning

Enphase is a killer business operating in a burgeoning market. But that doesn't make it a sure thing. The stock has been crushed over the past nine months. Take a look:

As you can see, shares are down over 60% from their highs set in December 2022. And the truth is they could keep falling.

I don't know if this is the bottom or if it will fall another 20%-30%. But what I do know is this…

If you know about the 50/80 rule, then you know we could be close to the bottom.

What is the 50/80 rule, you might ask. Here it is:

• It's a general rule stating that once a stock hits a significant top, there's a 50% chance that it will fall by 80%.

• And an 80% chance of it falling by 50%.

It's already down over 50%. If it does end up falling 80% from its December high, that puts it at around $67 per share, which is still nearly 50% below its recent price.

So, there's still plenty of downside risk to consider.

If the stock did fall that far, it would be trading at valuations last seen in 2017 when it was on the verge of bankruptcy. I don't think it will get there, but it's still a risk to consider.

The company is much healthier today than in 2017. It's growing sales, profits, and cash flow at a nice clip (even with recent headwinds in the industry). Plus, it has the IRA bill as a nice tailwind that should keep it from falling that far.

In short, I think we are much closer to the bottom. And while most investors have left this company for dead, I think patient investors could make a handsome return.