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Will the Sun Shine Again for SolarEdge Stock?

CEOs are paid exorbitant amounts of money and therefore expected to execute flawlessly. When external factors affect a company, we expect management to be transparent and use their industry expertise to navigate investors through tough times. When guidance gets adjusted three times in a row (cough, cough Planet Labs) it shows that management is detached from operations. This breeds distrust among investors.

When we invest in companies, we trust what management says until they give us a reason not to. After all, if management has a history of incompetency, we wouldn’t have invested to begin with. That’s why today’s article will focus on what SolarEdge (SEDG) management is telling the markets about their current situation. With negative gross margins and revenues all but disappearing, we need to understand how bad the situation is and how management plans to guide the company through severe times of turmoil. Only then can we decide if it’s time to add shares, hold and pray, or bail entirely.

Surviving, Not Thriving

Let’s rehash the problem. SolarEdge was growing like mad selling solar hardware when things took a turn for the worse as high interest rates threw a monkey wrench into solar projects. As demand for solar hardware fell off a cliff across the globe, revenues for solar hardware manufacturers plummeted with geographical diversification not providing any benefits. Below you can see just how dramatic the drop has been for SolarEdge (Q1-2024 estimates in black).

Bar chart showing revenue growth for SolarEdge
Credit: Nanalyze

What you see above is solar hardware demand drying up, but SolarEdge doesn’t stop producing it. So naturally, they are now accumulating large amounts of inventory that sits there gathering dust. Cost of goods sold (COGS) includes variable and fixed costs, meaning that the dramatic decline of revenues has resulted in negative gross margins. To control costs, the company laid off 16% of their employees and has shuttered factories, both of which concern investors who see this as a sign that demand won’t be increasing anytime soon. A best-case scenario would be for things to return to normal before the company runs out of cash which could trigger certain events such as:

  • Raising more capital by issuing debt
  • Selling depressed shares which dilutes existing shareholders and causes shares to fall further
  • Declaring bankruptcy where investors take a near total loss

We wouldn’t want to add shares of this company if the first two options are likely to happen, and we’d definitely want to exit if there’s a reasonable chance option three could happen. Turning to the latest earnings call gives us the best indication of what management expects to happen, and it’s not what we expected. They’re planning to buy shares, not sell them.

“… we expect to start executing our $300 million stock repurchase program in the first quarter of 2024.”

Credit: SolarEdge Earnings Call

SolarEdge Buys Back Shares

The reason to buy back shares is obvious. Shares of SolarEdge have been punished due to temporary inventory problems that resulted from a drop in demand for their products. The duration of that demand drop needs to be probed (more on this in a bit), but SolarEdge assumes that the 70% drop of their stock over the past year represents what Buffett calls “value-accretive prices.” Their plan to buy back shares was understandably challenged by an analyst who asked if the company would find itself in a situation where they needed to raise capital after using their cash to buy back shares. This is precisely the concern we raised earlier.

Investopedia tells us that “revenue is recognized on the income statement in the period when realized and earned—not necessarily when cash is received.” This is where “accounts receivable” tells us how much money a company is owed by their customers that hasn’t been paid yet. SolarEdge has been offering customers extended terms on money owed because “some of our customers are seeing difficulties, but we’re confident in our ability to collect those.” (Let’s certainly hope that’s the case.) While revenues are being demolished, management summarizes their cash outlook in more favorable terms considering lower capital expenditures which translates to “low usage of cash, high generation of cash, and a very measured and responsible purchase of shares.” If we trust what management says, then the likelihood of the company needing to raise capital remains low, and their ability to survive the macroeconomic headwinds seems high.

Solar Growth Stabilizes

You can always torture the data to make it say what you want, and you can always find research that supports your thesis. In the bearish camp, you’ll find research firm Wood Mackenzie telling us that solar growth stabilized across all regions in 2024 and the growth spurt is largely over. Their aptly titled report, Three predictions for global solar in 2024, says that Europe and the U.S. should see growth rates of 4% and 6% respectively over the next five years, hardly the compelling growth thesis we’ve been visualizing for solar.

Bar chart showing annual solar PV installations by region
Credit: Wood Mackenzie

SolarEdge’s largest market, Europe, saw retail electric rates decline “as much as 40%” which means fewer solar projects will be profitable. The growth of utility-scale solar in Europe is being “limited by grid infrastructure capacity,” which is an opportunity for SolarEdge’s “Energy Storage” segment which operates at a significant loss and fell just short of double-digit growth in 2023.

Then there’s the United States, SolarEdge’s second-largest market, where the Inflation Reduction Act (IRA) of 2022 was expected to accelerate the growth of solar. The plan has been short on execution with the IRS “issuing multiple sets of guidance over the last year with still more to come. While the early-stage pipeline of utility-scale solar projects has increased over 40% since late 2022, the pipeline of contracted projects has actually decreased.” It’s tough for various stakeholders to agree upon things when the incentives are uncertain. The result is that SolarEdge is focused on manufacturing in the United States to take advantage of IRA benefits while they see current and continued strength in commercial solar (but not residential).

On the latest earnings call, SolarEdge talks about the complexities of navigating the European market where each country has its own supply and demand drivers. A political change of guard in the Netherlands is creating uncertainty, while zee Germans should see higher electricity prices this year which should help improve the ROI for solar projects. In short, market complexity and unpredictability highlight why “solar manufacturing is known as being a notoriously challenging business.” And to make matters worse, you can always make the forecast rosier by citing someone else’s research. According to SolarPower Europe, the global demand for solar power is healthy as ever over the next five years.

Bar chart showing world annual solar PV market scenarios 2023-2027
Credit: SolarPower Europe

Adding Shares of SolarEdge

“SolarEdge seems to be emerging as a global leader in solar infrastructure with plans to diversify into complementary areas that can provide growth when the solar infrastructure boom subsides.” That’s what we said several years ago, and last Spring, we noted that their non-solar segments weren’t seeing much growth. Hardware companies without recurring revenues can get into deep trouble when demand subsides, and that’s what’s happening here. Utility-scale solar remains the most promising of all renewable energies based on costs and growth forecasts, though experts are providing conflicting opinions about whether solar continues its strong growth.

We exit a stock for two reasons – if revenue growth stalls or if our thesis changes. Revenue growth has hit a brick wall, but if management is to believe, then this is a temporary problem they’ll successfully navigate in 2024 with the possibility of growth resuming in 2025 (depending on which set of experts you believe). The biggest problem here is one we acknowledged prior to investing in this business – there are no recurring revenues to support the business once demand for hardware dries up.

Conclusion

Should SolarEdge achieve their targeted “underlying business run rate of $600 million to $650 million in the second half of the year,” they’ll get back to those 30% positive gross margins and likely have survived the industry turmoil. Next, they’ll need to start showing consistent double-digit annual growth to merit a growth valuation. If growth flatlines or stays in the mid to low single digits, then they’ll be perceived more as a value company and the share price will reflect that. In our summary of this article sent to Premium subscribers, we’ll let you know if we decide to add shares.