Enphase Energy Stock: Avoid Catching Falling Knives (NASDAQ:ENPH)

Investment thesis

I was very bullish about Enphase Energy (NASDAQ:ENPH) in 2023, but it did not age well as the stock price declined by 29% since my first thesis went live in May. The latest thesis, as of early September, aged slightly better but substantially underperformed the broader U.S. market. Today, I want to update my thesis because many crucial developments unfolded over the last four months. The weak Q3 revenue dynamic is not a big problem, in my opinion, but weak guidance for several next quarters indeed revealed the fact that the company’s revenue mix does not protect its financial performance against unfavorable swings in the macro environment. The high level of political uncertainty is another unfavorable factor for ENPH because there is a high probability that the current president of the U.S., who is a big supporter of clean energy adoption, might not be reelected. Furthermore, my valuation analysis suggests that ENPH is significantly overvalued, with a 19% downside potential. All in all, I must admit that I was wrong in my bullish opinions last year and to downgrade ENPH to a “Sell” rating.

Recent developments

The latest quarterly earnings were released on October 26, when the company showed below-the-consensus revenue but outperformed in terms of the bottom line. Revenue declined by 13%, and there was a massive Q4 guidance cut due to the weakening demand across Europe and the U.S.

Despite a notable revenue drop in Q3, profitability metrics were resilient, and the operating margin remained above 20%. However, since the Q4 revenue is expected to be about half on a YoY basis, the adjusted EPS is also poised to nosedive from $1.51 to $0.56. The good part here is that Enphase has a fortress balance sheet to weather the storm. The liquidity position is strong, with a half-a-billion net cash position and firm current and quick ratios. Therefore, I do not expect Enphase to face any liquidity problems with liquidity in the foreseeable future even despite an expected massive revenue drop. The earnings release for the upcoming quarter is scheduled for February 7.

During the latest earnings call, the management also underlined their expectations of a weak Q1. Overall, consensus estimates expect FY 2024 revenue to decline by 17%. At the same time, Wall Street analysts expect a solid ENPH revenue rebound in 2025. I like the fact that the management responds adequately to the top-line pressure by restructuring its costs. A couple of weeks ago, the company announced a 10% headcount cut, which will help mitigate the adverse effect on the bottom line due to the revenue drop.

It is important to underline that the solar energy industry is cyclical and significantly depends on the health of the broader economy. However, even a strong U.S. economy in 2023 did not help ENPH sustain its revenue growth, with sales expected to stay flat for the full year. The fact that a mild recession in 2024 is still not off the table does not add optimism for the solar energy industry bulls. The fact that in the first nine months of 2023, international sales contributed almost 38% to the total is a good indicator of the increasing geographical diversification. However, a major part of it is represented by Western Europe, where inflation is still hot, meaning that the pivot in ECB’s tight monetary policy is unlikely to be sharp. That said, I do not see positive trends in the macro environment for Enphase and agree with cautious revenue consensus estimates for 2024.

At the same time, I have to acknowledge the company’s bright prospects over the long term. The company demonstrates stellar profitability and a strong ability to reinvest in profitable growth, which clearly indicates the business model’s high quality and the management’s exceptional execution. The only weakness of the business model that the current crisis revealed is the overreliance on the limited number of products and high dependency on the U.S. residential markets. The company’s revenue mix was unable to protect the company from a deep and sharp drawdown in revenue, which should be a “lesson learned” for the management. From the secular perspective, the company is one of the leaders and most innovative players in the global solar energy industry, which is expected to compound at an 11.5% CAGR by 2030. However, I think that the level of uncertainty is also extremely high given the approaching presidential election in the U.S. in late 2024. The current president, Joseph Biden, who is well-known for his clean energy priorities, ended 2023 with a 39% approval rating, which is much lower than when he started his term. In my opinion, the deteriorating approval rating substantially decreases the probability for Mr. Biden to be reelected for one more presidential term.

Apart from the vast uncertainty regarding Enphase’s earnings prospects after 2024, it is also crucial to underline the current overly positive sentiment in the U.S. stock market. CNN’s Fear and Greed index is sky-high, indicating that the market is substantially driven by FOMO [fear of missing out], which is usually unsustainable. It seems that all positive catalysts are already priced into the current S&P500 levels, and a notable potential market correction is probable, in my opinion. High-beta names like Enphase will highly likely be among the biggest losers in case of major indices drawdowns.

Valuation update

ENPH tanked by almost 50% over the last 12 months, substantially lagging behind the broader U.S. stock market. The start of 2024 also does not look so optimistic, with a YTD 12% stock price decline. The current valuation ratios look substantially lower than historical averages, but that does not necessarily mean that valuation is attractive, given that there were multiple guidance downgrades in 2023.

The discounted cash flow [DCF] approach is the best option for growth companies, and I would like to go ahead with a simulation. I use a 12% WACC, within the range recommended by valueinvesting.io. This WACC is higher than I used last time because of several consecutive disappointing earnings and guidance releases. An 11.5% revenue CAGR projected by consensus looks fairly conservative to me. I use an 11.8% TTM FCF ex-SBC margin for my base year. I also use a more conservative 75 basis points yearly FCF margin expansion instead of the 100 basis points I used last time because of the company’s operating margin volatility in recent quarters.

According to my DCF analysis, the company’s business fair value is $12.8 billion. This is around 19% lower than the current market cap, which indicates substantial overvaluation. I arrive at a fair price of around $94 per share when I discount the current share price of $116 by 19%.

Risks to my bearish thesis

The transition to cleaner energy, which also includes solar energy, is massively supported with incentives by governments across the whole developed world. Stocks of companies with strong exposure to solar energy historically demonstrated upswings when new packages of governmental incentives were announced. That said, there is always a risk that governments of the world’s largest economies might potentially expand clean energy incentive programs, which can be a strong positive for ENPH. However, it is challenging to expect new large governmental incentives in 2024, the year of presidential elections in the U.S.

ENPH’s fair value significantly depends on interest rates because it is an apparent growth stock. That said, any hits from the Fed pivoting toward a more dovish sign might be a solid catalyst for the stock price.

Bottom line

To conclude, Enphase is a “Sell” at the moment. While I understand that the company operates a high-quality business model with strong management, the current revenue weakness underlines that the business is far from flawless, as the revenue mix does not protect the company from adverse swings in the macro environment. Furthermore, my valuation analysis suggests the stock is still substantially overvalued, even after the recent weakness.