SOLAREDGE TECHNOLOGIES; SEDG: NASDAQ

COMPANY ANALYSIS – JUNE 27, 2017

An inverter is needed to convert the Direct Current (DC) of all the PhotoVoltaic solar panels (no other kind, ahem) to the Alternating Current (AC) that we humans use in our homes and businesses.

SolarEdge developed a “power optimizer” for solar panels to feed DC to the inverters steadily, which maximizes power.  And they have been very successful at selling optimizers and inverters.

It’s a capital light business; capex is only about $13 million on $120 million in revenues.  Only 46 million shares out.

Another important factor is that SEDG has a lot of international business; they expect to be 50-50 United States-Rest Of World by the end of 2018 (now just over 25%).  US solar business is falling this year after The Great Rush of 2016 To Beat The Tax Breaks (which were extended for 5 yrs anyway).  Business in Asia and Europe is picking up and taking over the slack from the US.

The threat of Chinese competition and deflation are constant however, and that seems to be keeping a lid on valuation at 8x EBITDA.

This is a small position for now.  It’s a solid company that is constantly innovating, e.g with a new generation of inverters (the HD Wave) which management says are smaller, cheaper, faster and more reliable.  They are slowly increasing revenue, managing the balance sheet very well, keeping gross margins steady and have an international reach.  Those are great places from which to start.

QUICK FACTS

Share Price:                                                  $20.20

Basic Shares Outstanding:                       46 million

Market Cap:                                                 $929 million

Cash and Investments (Mar ’17):          $245 million

Enterprise Value (EV):                               $684 million

2016 EBITDA:                                              $88 million

2017 EBITDA Est:                            $85 million

Average Annual Capex:                $13 million

http://investors.solaredge.com

POSITIVES

– Fantastic balance sheet

– Generating lots of free cash flow

– The lead player in string optimizers

– Big growth potential in rooftop solar power

NEGATIVES

– Intense competition and minimal barriers to entry

– Government subsidies being pulled could impact economics for solar

– Solar panel installers/providers (SolarEdge’s customers) could develop their own inhouse optimizing solutions

WHAT THEY DO

SolarEdge was formed in 2006 in Tel Aviv, Israel.

The company is a supplier of DC/AC inverters and DC optimizer solutions for commercial and residential rooftop solar systems.

Let me attempt to explain what the technology involved here does.

First, what are inverters?

An inverter plays a crucial role in any solar energy system and is considered to be the brains of the project.

An inverter’s basic function is to “invert” the direct current (DC) output that is provided by the rooftop solar panel and turn it into alternating current (AC).

AC is the standard used by all commercial appliances, which is why many view inverters as the “gateway” between the photovoltaic (PV) system and the energy off-taker.

Inverter technologies have advanced significantly, and in addition to converting DC to AC, they provide a number of other capabilities and services to ensure that the inverter can operate at an optimal performance level.

These would include such things as data monitoring, advanced utility controls, applications and system design engineering. Inverter manufacturers also provide post-installation services that are integral to maintaining energy production and a high level of performance for the project, including preventative maintenance.

There are three main types of inverters:

  • String
  • Microinverter
  • Central

Residential and commercial markets mostly use string inverters, while utility scale systems mostly use central inverters.

 

The US residential market is roughly equally split between string inverters, string + DC optimizer, and microinverters.

Microinverters are a newer technology and more expensive, but offer efficiency advantages, easier installation, and can use less space.

String Inverter:  A string inverter converts power from DC to AC at the inverter, which is usually located on the side of the house/office near the meter.

String inverters are the cheapest solution, but also the least sophisticated.  The primary drawback of a string inverter is that if the inverter fails, the entire system goes down due to the single point of failure design.

There are other limitations to a string inverter used without an optimizer (more on optimizers shortly).

Solar panels generate DC power, and the output of panels varies due to the

natural variances in the panel itself, the time of day, and issues like shading.

A solar array that only uses a string inverter will operate less efficiently as

output from lower power producing panels puts a cap on the output of the

entire system.

This is where the optimizer comes into play.

DC optimizers improve string inverter performance.  A DC optimizer is a device that is installed either as an internal component of a solar panel or added to the panel when installed.

An optimizer goes on each solar panel.

The DC optimizers modulate the output of each panel so that a constant voltage DC current is transmitted along the string to the inverter.

In a perfect scenario, optimizers are a strong balance of performance and affordability.

However, they are also the most complicated small or medium system to install, have the most non-panel based points of failure, and still can be taken offline by a single point of failure in the inverter or along the string.

Microinverter:  A microinverter is installed on each panel in a solar array and converts electricity from DC to AC at the solar panel. Power output is transmitted in low voltage AC over the rooftop into the meter individually from each panel.

The benefits of microinverter installations are:

-each panel can perform optimally regardless of the others

– there is no single point of failure

– installations can be smaller requiring no bulky inverter

– installations are safer, operating with low voltage AC

– installations are easier for the contractor – closer to plug and play.

Micro inverters are a more elegant approach, but also more expensive than string inverters plus DC optimizer solutions.

With both microinverter and optimizer based systems, the additional unit must either be installed on panels by the manufacturer or retrofitted by the PV installer.

SolarEdge is currently the biggest supplier of string plus optimizer technology.  Enphase (ENPH-NASD) is the big player in microinverters.

Both technologies have the following advantages over simple central and string inverters:

  • Ability to monitor and control each independent module in the system
  • Ability to remotely turn power off at the module (emerging fire safety requirement)
  • Ability to maximize module performance when not all modules are facing the same direction or have varying tilts
  • Ability to maximize system performance when some of the modules are shaded

On a cost per watt basis simple string and central inverters are the way to go.  On performance they aren’t, inverter plus DC optimizer or microinverters are better.

In particular, a DC optimizer or microinverter is needed for decent performance in installations where there is partial shading, which tends to be in most residential installations.

In the past there have been two main alternatives for shading solutions: an Enphase microinverter or a DC optimizer (made by SolarEdge or Tigo)

The string inverter plus optimizer and microinverters can significantly improve safety as well as increase the energy ratings of the systems.

When it comes down to string plus optimizer versus microinverters the market share is moving towards the string inverter plus optimizer.  There are a few reasons for this:

First, in a typical system with 10 or more panels, optimizers deliver a compelling cost advantage at the time of installation over the microinverter.

Second, the long-term failure rate of optimizers is likely to be substantially below that of microinverters. With installers selling 20 to 30 year energy contracts to customers, keeping future repair costs low is obviously really important.

Now that the string plus optimizer has kind of won the inverter race (ENPH stock has a horrible chart, clearly not doing well)  the M&A space is starting to heat up. In 2016, one of the leaders of the microinverter space, SMA Solar Technology AG, announced that it is making an equity investment in optimizer player Tigo.

With a $20M deal for 27% equity, SMA also got a board seat, exclusivity for marketing certain products, and an agreement to work together with Tigo on various products and technologies.

A large Chinese company, Huawei, is also expected to announce an optimizer solution in the second of this year. In all the sell-side research I read, this was a common and large fear.  For now, Huawei is not expected to have a product to market until late Q1 2018.

While the market seems to be moving towards optimizers, that doesn’t guarantee long-term success for SolarEdge—who is the current leader.  The intellectual property behind inverter implementations does not create a sustainable barrier to entry.

This is a business where cost competition will potentially get fierce.  But their new HD Wave product line of inverters—smaller faster cheaper better—combined with more automated production, has the potential to keep gross profit margins steady, even as SEDG management guides to an 8-10% decline in ASP this year; Average Selling Price.

Central Inverters: Central inverters are only used for utility scale power plants that are 2MW and larger. As the name implies, a central inverter collects all the

DC power generated by a large installation of solar panels and converts it to

  1. SolarEdge is not in this business and doesn’t compete directly with the major players in it.

The equipment can weigh thousands of pounds and may require a large crane for installation.  Unfortunately, there is a history of unreliable performance of central inverters, and for every day that a central inverter is down, a project owner loses ~$10,000.

One alternative for utility scale solar power plants is the use of a series of string inverters.  Multiple string inverters can be installed for a similar or cheaper price than a central inverter, and string inverter systems are easier to maintain. If a central inverter fails, only an engineer from the company that manufactured the inverter can service the device.  If a string/microinverter fails, it is quite easy for one or two nominally trained workers to substitute the inverter with a spare.

As a direct result of incessant performance issues, in 2015 the most experienced European solar project investors decided to require 100% string inverters, even for 50MW+ projects going forward.

The graphic below provides a clear visual of the difference between a central and string inverters.

The utility inverter market is dominated by “big metal” players such as ABB, Huawei, SMA Solar, and Sungrow. The rate of innovation in this extremely cost-sensitive market has been limited and low-cost Chinese players are starting to gain market share.

SolarEdge And Rooftop Solar Growth Prospects

SolarEdge began commercial shipments of its DC optimizers + string inverter solution in 2011.  The company went public in March of 2015.

In its first five years of sales, SolarEdge has sold approximately 513,000 inverters and 12.5 million DC optimizers, growing to supply about 1/3 of US residential PV inverters, installed with their integrated DC optimizers.

SolarEdge has roughly an equal market share with Enphase, their chief competitor and microinverter company.

SolarEdge mostly sells to large installers and engineering-procurement construction (EPC’s), distributors and wholesalers, and panel manufacturers for embedding.

The growth rate for solar in recent years has been exceptional.  Residential panel installations in the U.S. grew 71 percent in 2015 as the falling cost of panels made the power they generate more competitive.

An even better figure is the 1,000 percent growth solar has experienced since 2010.

In December, Congress unexpectedly extended a tax credit set to expire at the end of 2016. Panel buyers will get reimbursed for 30 percent of the cost of new solar panels through 2019 and at least 22 percent through 2021.

That good news will actually slow solar’s growth in 2017 when total sales are expected to increase by only 0.3%.

The reason for this actually makes a lot of sense.  The industry lost its ability to create urgency for people to install.  Prior to the extension people were motivated to install before the tax credits ended.

Now companies need a new sales pitch.

The falling cost of solar installations is the most obvious sales pitch which will continue to win business long term.  Solar is already competitive with coal and natural gas and is likely—but not for sure—to get better.

The lack of growth in 2017 is a pause moment.  Only 1 percent of U.S. households have solar panels so this industry is just barely getting started.

FINANCIAL STATEMENTS – VALUATION 

SolarEdge’s balance sheet is beautiful.  At March 31, 2017 the company was sitting on $245 million of cash and investments (Treasuries, corporate bonds) and had no debt.

That means that $5.32 of SolarEdge’s $20 share price is covered by cash and investments.  The business is being valued by the market at $15 per share or $684 million.

Here is that beautiful balance sheet.

For the $684 million valuation investors today are getting a business that generated $85 million in EBITDA last year and expects to do roughly the same again this year.

Analysts expect $104 million in EBITDA in 2018.

That would mean the company is trading (relative to enterprise value) at 8 times current EBITDA or less than 7 times 2018 EBITDA.

What does that tell me?

Well, first off…..who says you can’t find a profitable solar energy company?  This one is generating a lot of cash and has a great balance sheet as well.

I would also suggest that this seems very inexpensive for a company operating in an industry with the kind of growth that solar power has in front of it.  On a price to earnings basis SEDG trades at only 70% of the S&P market multiple.

It is hard to imagine that a company with this kind of balance sheet operating in an industry that has just reached a 1% saturation point should trade at a discount to the overall market…..but it does.

So why the inexpensive valuation?

It isn’t because the business is particularly capital intensive.  The company has spent roughly $12 million on capex over the past couple of years on average.  You will often see a cheap multiple of EBITDA for capital intensive companies that must reinvest a lot of cash continually into capex.

I believe that the concern here (and a valid one) is competition and risk of technological obsolescence.  Of particular concern is the likelihood of Chinese companies coming in and offering optimizers at a discounted price.

My understanding is that the intellectual property here does not provide a huge barrier to competitors.

Discounted pricing won’t ruin SolarEdge, but it will force the company to do the same which will eat into cash generating ability.  The market is clearly saying with its valuation of SolarEdge today that it expects competition to do just that in the years ahead.

There is no growth priced into this company.

STOCK CHART

CONCLUSION

SolarEdge has net cash, is cash flow positive and trades at a reasonable multiple (8x EBITDA) in a market that could (should?) have stellar growth in the coming decade.

When I’m looking for exposure to solar, this ticks a lot of the boxes.

The one thing I haven’t talked to here in this report is the opportunity that electric vehicles (EVs) have for SolarEdge inverters.  It’s just too tough to say if they will have any success here.  Even though I’m becoming increasingly convinced EVs will take market share very quickly, little SEDG will be competing against the likes of Delphi (DLPH-NYSE) so not sure just how well that will go.  Management would say however that SolarEdge is not a solar technology; rather it’s a power conversion and management technology whose first niche is solar.

I am long 5000 shares of SolarEdge at $19.50.

STOP LOSS = $17.25

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