SolarEdge Technologies (SEDG) – A “picks and shovels” investment in Renewable Energy

Company:                                             SolarEdge Technologies Inc

Sector:                                                 Technology – Solar/Alternative Energy

Price/Market Cap:                                 $245/$13.1B

I first encountered SolarEdge in mid-2019 while reviewing a non-Wall Street report on the solar industry ecosystem.  I was reading the report purely out of curiosity. It was only after digging in that I realized there might be some decent investment ideas within the sector. I was not interested in solar panel manufacturers that would be heavily reliant on imported raw materials and subject to fluctuating commodity prices. The installers are services businesses, characterized as cyclicals with high operating costs and scalability headwinds. Cabling is commoditized. But when I read the section about power optimizers and inverters, I had an “Aha!” moment –These are the proverbial “picks and shovels” within the renewable industry. These devices are built using semiconductor technology that I am highly familiar with, and these systems are essentially the “brains” of the solar panels built with technology that can likely be applied to numerous other form factors in and out of the sector. Opportunity. 

Thesis

SolarEdge Technologies (SEDG), is a provider of power optimizers, solar inverters and monitoring systems for solar arrays. Their products increase energy output through module-level innovations that create more flexible and durable arrays. Every solar array needs an inverter, and SEDG developed a superior solution that supplanted existing options. SolarEdge invented an intelligent inverter solution that changed the way power is harvested and managed in a solar photovoltaic (PV) system. The SolarEdge DC optimized inverter system maximizes power generation at the individual PV module-level while lowering the cost of energy produced by the solar PV system. We originally purchased our shares in September 2019 at ~$86/share on the thesis that, while the market was growing in excess of 27%+, SEDG was growing at a rate of 50% and taking market share. The company’s growth exceeded our expectations. And now, with the stock down almost 40% from the peak amid concerns over rising interest rates and competition, we have come to an intriguing juncture to consider future prospects for the company.

Potential catalysts

• International addressable market presents tremendous opportunity as SEDG is pursuing international expansion faster than competitors.
• Expansion into residential energy storage is driving revenue gains. In their recent earnings report, management reported that they already have firm orders for megawatt (MW) volume that represents 60% of MW volume that they achieved for the entire year of 2021.
• Changes to California’s residential solar net metering policy could lead more customers to pursue solar energy storage for self-consumption. The value of this solution has been highlighted by recent climate disasters.
• Falling cost/kWh of battery-based energy storage solutions is driving demand for batteries for use in a range of electric grid ancillary services.
• Long term potential for market consolidation among installers and component manufacturers as commercial and residential consumers seek “one throat to choke” for simplified implementation of home energy management and storage solutions.
• Longer-term opportunity to provide comprehensive offerings for utilities.

Catalyst summary: Expanding geography, market share growth, new product segments, and increased share of wallet for both residential and commercial customers.

Company

Founded in 2006 and headquartered in Herzliya, Israel, SolarEdge develops microinverters for the solar industry for residential and commercial use.  The company also offers Power Optimizers, PV monitoring and storage devices. The company leverages power optimizers to maximize power generation from every roof panel regardless of shading or roof positioning.  And given that they convert current from DC to AC at the source, their products have proven to be safer than other inverter solutions.

Revenue Growth: 5 year 30% CAGR

Revenue by geography: 40% of their business is US (30% of which is California) and the other 60% is ROW.
Revenue by segment: Of their solar business, 20-25% (and growing) is commercial, with the remainder being residential focused and sold through solar installers.

Market

In 2021, the market for solar grew ~27% despite a 25% increase in module prices, an increase in raw materials (steel, copper, aluminum) and global supply chain constraints.  In 2022, the market is forecasted to continue to grow another 25% driven by existing project delays from 2020.  Companies within the market have adapted to supply chain shocks while diversifying their supply chains and last mile channels.  

Despite near term headwinds (including changes to California’s Net Metering policy and the failure of the Build Back Better Act[1]), long-term trends point to the inevitability of a worldwide shift to alternative energy solutions.  Over 130 countries have set, or are considering, a net-zero emissions policy within the next 20 years. China has committed to net-zero by 2060 and India by 2070. Almost 2/3 of companies within the S&P 500 have set targets to reduce greenhouse emissions.

Within the US, residential installers have reported increasing attach rates of customers adopting energy storage systems along with new residential solar systems. Larger installers have reported attach rates greater than 30% (up from 10-15% in 2019) and attach rates are expected to reach 50% by the end of 2022.  There are multiple competitors in the residential energy storage solution market, including Generac and Enphase in 2020, and SolarEdge in 2021, in addition to incumbent solutions such as the Tesla Powerwall.

Cumulative installed base of energy storage is expected to grow from 11GWh in annual deployments in 2020 to 96GWh in 2025, a 55% CAGR[2].

Products

Solar panels capture the sun’s energy and turn it into electricity in the form of direct current (DC). The global power grid system, however, runs on alternating current (AC) since it’s less expensive. Because of that, the solar industry uses inverters to convert DC electricity into AC.

Initially, solar companies would string several solar panels together with a central inverter at the end (known as a string inverter system). Although this is an inexpensive option, it’s also the least efficient since issues with one panel affect the entire system’s output. And each panel must be the exact same distance (wire/string length) from the central inverter, or the system will not function. Another option is to install microinverters on every panel. While microinverters increase efficiency, it’s more expensive.

SolarEdge developed a third option: power optimizers. These components, which get installed on each panel, help improve efficiency. Even though a system with power optimizers still requires a string inverter at the end, it’s cheaper than using microinverters. That combination of increased efficiency over a string inverter system at a lower cost than microinverters gives power optimizers an edge.

The three types of inverter systems:

1. Centralized String Inverters – Cost effective and more efficient for larger array systems. But generally considered inflexible and have limited monitoring capabilities for each specific panel. Panels wired in series in a string. The entire system output is limited and can be significantly affected by shading debris. Problems in one part of the string can shut down the entire array (think of old school Christmas lights). When one panel goes down, the whole array stops working.
2. Microinverter – Scales down functionality of traditional string inverter so that each panel is controlled individually with a microinverter at each panel. The drawback is significantly higher up-front cost. Because DC is converted to AC at the source, there is no high voltage DC running across your roof. This is much safer than string inverter systems. Panels can be set in any direction to optimize sunlight.
3. Power Optimizer Systems – Consisting of string inverters and power optimizers, this system is designed to optimize the power of each individual panel, allow for similar installation to traditional inverters (same cables and connectors), and at a cost comparable to string inverter solutions. The power optimizers are attached to each panel to allow for real time tracking and adjustment at each panel. A simplified inverter is installed like the string inverter, but it’s only responsible for DC/AC conversion and connection to the grid.

SolarEdge inverters are Power Optimizer systems. The SolarEdge DC optimized inverter system maximizes power generation at the individual PV module-level while lowering the cost of energy produced by the solar PV system.

SolarEdge (and competitor Enphase) make what are called module-level power electronics (MLPE) systems. Combined, the two companies collectively have about 95% global market share in this category, with SolarEdge claiming the lion’s share. MLPEs have become dominant in the U.S., particularly in California, where over 80% of installations involved MLPEs last year. But elsewhere, it is still simple string inverters that dominate the market, with an estimated 85% to 90% of the global market. Worldwide, SolarEdge only has about 4% market share of the overall inverter market, giving it plenty of room to grow to address the inefficiency of legacy string inverter systems which are the dominant incumbents globally. One market research firm suggests the MLPE market will grow at a 14.7% annual rate through 2024. Not surprisingly, SolarEdge’s management says the company is growing faster than the market and taking share.

Additional offerings

SolarEdge’s main products are power optimizers, which are attached to each solar panel on a roof to maximize the electrical output of the entire system. The company has expanded into other products, like monitoring and inverters, but its business is rooted in those optimizers. Each time a new system installer like SolarCity or Vivint Solar decides to integrate SolarEdge’s product into their systems, it can result in massive amounts of growth for the company.

Residential Products	Commercial Products
Smart Modules with integrated power optimizers Solar Inverters and EV Charging Energy Bank Battery Smart Energy Devices Monitoring platform	Power Optimizers Inverters Monitoring Platform Commercial Gateway Environmental Sensors and Satellite based PR Grid interaction

Key Advantages

The key advantages of the SEDG solution include:

• Maximized PV module power output.  SEDG power optimizers provide real‑time adjustments of current and voltage to the optimal working point of each individual PV module. This enables each PV module to continuously produce its maximum power potential independent of other modules in the same string. This reduces the impact of partial shading on complex roof installations.
• Optimized architecture with economies of scale.  SolarEdge systems shift certain functions from the traditional inverter to the power optimizer while leaving the DC to AC conversion at the inverter (for safety reasons). This shift leads to smaller, more efficient, and reliable optimizers, a development which provides SEDG with cost/price advantages. The solution scales for commercial and utility scale applications.
• Enhanced system design flexibility.  Traditional inverter systems require each string to be the same length, use the same type of PV modules, and be positioned at the same angle towards this sun.  This can obviously be cumbersome and limiting for a large percentage of applications.  SEDG flexibility:
  • Increases the amount of the available roof that can be used.
  • Reduces the number of field change orders caused by inaccurate remote measurement or unexpected rooftop obstructions.
• Reduced balance of system costs. This minimizes the cost of cabling, fuse boxes and other ancillary electric components.
• Continuous monitoring and control to reduce operation and maintenance costs. The SEDG cloud‑based monitoring platform provides full data visibility at the module level, string level, inverter level, and system level.
• Enhanced safety. SolarEdge Systems contain module‑level safety mechanisms to protect installers, electricians and firefighters. Each power optimizer is configured to reduce output to 1 volt unless the power optimizer receives a fail‑safe signal from a functioning inverter.
• High reliability.  SEDG power optimizers dissipate much less heat than microinverters because no DC‑AC inversion occurs at the module level. As a result, less heat is dissipated beneath the PV module, which improves lifetime expectancy and reliability of power optimizers.

Business Model

SolarEdge sells products indirectly through solar installers, large distributors, and electrical equipment wholesalers. These customers are leading providers of solar PV systems to residential and commercial end users, key solar distributors and electrical equipment wholesalers as well as several PV module manufacturers. These partners offer PV modules with SEDG power optimizers physically embedded into their modules. In 2020, Consolidated Electrical Distributors represented 14.8% of revenue (down from 20.4% in 2019). SEDG has no other 10% customers.

SEDG exhibits strong pricing power.  Management recently initiated price increases to offset increased manufacturing costs.  These price increases have easily been absorbed into an increasing demand outlook.  These price increases will impact results in Q3 2022.

Competitors

SEDG primarily faces competition across two verticals: inverters and storage solutions, with additional specialized competition within the power optimizer niche.

Solar Inverters:

• Enphase Energy (USA)
• SMA Solar Technology (Germany)
• Sungrow (China)

Storage Solutions:

• AES Corp
• Enphase
• EOS Energy Enterprises
• Fluence Energy
• Generac
• Siemens
• Stern Inc.
• SunPower
• Tesla

Power Optimizers:

• Maxim Integrated (subsidiary of Analog Devices)
• Tigo Energy (private)

Within the US market, the company’s closest competitor, and best comp, is easily Enphase (ENPH). It’s informative to drill deeper through a head-to-head comparison.EDGE and ENPH are the two largest solar inverter companies globally. SEDG is ~40% larger in terms of revenue. However, Enphase is growing faster and commands a larger market cap and Enterprise Value (valuation premium).  Combined, the two hold 95% of the global inverter market share. In the US, Enphase has a 48% share and SolarEdge has 40%. Enphase overtook SEDG in terms of market share for the first time in October 2020.   

The chart above refers to domestic sales only.  Globally, SEDG is the #1 provider while ENPH ranks 4th.

As mentioned previously, microinverters and Power Optimizers are frequently referred to as Module-Level Power Electronics (MLPEs). Both Enphase and SolarEdge solutions are MLPEs; however, SolarEdge inverters are Power Optimizer systems and Enphase is a pure play microinverter technology.

The US residential solar market is incredibly important for MLPE companies given the sheer size of the total addressable market. While that market share comparison appears to show SolarEdge losing momentum to Enphase in the US inverter market, the strategies for the companies are different. Enphase has focused much of its attention on the domestic residential market[3]. With the company supplying some of the largest US residential solar companies like Sunrun (RUN) and SunPower (SPWR), it is not surprising to see Enphase gaining momentum in US residential solar.

SEDG has a more diversified product portfolio and geographical presence. In the US, SolarEdge is vectoring towards commercial applications with a longer-term strategy of addressing the commercial utility market with a combination of their Power Optimizer products and storage solutions. Additionally, SEDG has taken the lead in international expansion while ENPH has only more recently expanded its focus outside the US.

Solar Edge v Enphase

	SolarEdge	Enphase
Pricing / Margins	SolarEdge systems (inverter and optimizer) are priced anywhere from $1k to $3K which is a small portion of the entire system cost which includes system design and installation and panel costs.	Enphase inverters are typically priced below $200.  Enphase’s storage system the Encharge 3 is priced between $6,000 and $8,000, and the Encharge 10 between $18,000 and $20,000 with a full system installation.
	(Provided as reference. Not directly comparable)
Efficiency (% of light converted to electricity)	Two components: the central inverter, which rates a 99% efficiency, and the power optimizer, which lists 99.5% efficiency. This puts the overall efficiency at 99.25%.	Enphase IQ 7 series converts at 97% efficiency. The new devices are 19% lighter and 17% smaller than the previous generation.
	Point to SEDG
Battery Backup (to store unused solar power)	StorEdge DC-coupled backup solution automatically provides homeowners with backup power during grid failures. The solution is based on a StorEdge single phase inverter which manages solar production, consumption, storage and backup power, and is compatible with high voltage LG Chem RESU batteries. LG batteries have proven themselves as one of, if not the, best solution on the market.	Enphase offers a proprietary battery: the Enphase Ensemble. Vertical integration is attractive; however, this battery system is more expensive than SEDG offering (and other industry solutions) with much less power output and storage capabilities. You can use batteries from other manufacturers, but options are limited as the battery must be AC-coupled.
	Point to SEDG
Scalability	Limited to the rating of the central inverter which limits the number of solar panels	A new solar panel can be added with each compatible microinverter.
		Point to ENPH
Backward compatibility	New microinverters can be installed to existing systems.	New IQ series models are not backward compatible with older versions of Enphase inverter technology. All new inverters are required to upgrade existing solar arrays.
	Point to SEDG
Application	Power optimizers are designed to help the systems perform better in partial shade.	Microinverters are superior in handling complicated rooftop layouts, but microinverters are known to overheat since they are installed on the roof.
	Toss-up
Warranty	Power Optimizer: 25 yearsCentral Inverter: 12 yearsMonitoring Systems: 12 years	Power Optimizer: 25 yearsCentral Inverter: N/AMonitoring Systems: None
	Even. However, SEDG offers warranties on more items which exposes it to more potential liabilities.

Reliability Comparison

Both companies have had reliability issues over time. For Enphase, several product iterations have allowed them to work out the reliability issues in their system and installers have reported fewer in-field replacements and dead-on-arrival units with their Enphase IQ 7 product lineup. In the fall of 2021, ENPH began shipping the IQ8. The IQ8 can form a microgrid during a power outage using sunlight, providing backup power even without a battery.  Enphase inverters come with a full 25-year warranty and so solving these issues was critical improving overall product margins, reducing potential balance sheet liabilities, and gaining market momentum through customer satisfaction. 

The essence of the SolarEdge reliability strategy is a physics-based multi-level method of failure point identification combined with a software-based monitoring platform. More recently (2019/2020), SEDG has received increased warranty claims due to faulty inverters and optimizers. The company is working to address these issues. Our research indicates that solar panel installers and repairers have not cooled on the company as the repairs offer a steady revenue stream for repairers.  

Comparison Summary

Enphase offers a state-of the art solution but with higher up-front costs to the consumer.  SolarEdge is offered at a lower price point and allows consumers to save more due to their higher efficiencies. SolarEdge’s real differentiator comes from its comprehensive suite of products. SEDG customers have access to integrated home solutions including electric vehicle charging, consumption monitoring, and smart energy devices. New homeowners want the option to expand their system beyond solar panels. Management reported in Q4 2021 that customers were ordering storage systems at a 50%+ attach rate.

We actually view both companies as potentially attractive.  The ENPH valuation is challenging, but their growth in the US is special. And they are looking to expand their product portfolio and global presence. In Q4 2021, ENPH completed the acquisition of ClipperCreek which offers electric vehicle (EV) charging solutions for residential and commercial customers in the U.S. Ultimately, we see consolidation in the global market for inverters and we believe either company can be long term winners and capital compounders.

Financials and Valuation

We originally acquired our shares in SEDG in September 2019. At that time, shares traded at 30 TTM P/E, 20x Fwd. P/E, 3x P/S, and 23x P/FCF.  Even at that point, we believed the stock traded at a premium, but the premium was warranted given the tremendous opportunity set ahead of the company.

We expect SolarEdge to grow in excess of 20% for the next several years and we see opportunities in multiple new markets, with expanded product offerings, which our projections don’t fully account for.  The SEDGE management team is keenly focused on profitability, generating cash from operations and maintaining a strong balance sheet.  This focus is key given the competitiveness of the industry and the financial stability needed to support a 25-year warranty on their products. 

A current financial snapshot of the company along with our internal projections:

SolarEdge continues to spend heavily on R&D as it considers growth opportunities beyond solar:

• Growing demand for storage solutions in Europe, Australia, South Africa and the United States.
• Selected as supplier for electric powertrain units and batteries for Fiat E-Ducato (Stellantis).
• Investigating adjacent markets, like power storage, electric vehicles, and uninterruptible power supplies.
• Storage and inverter modules for large scale Utilities projects.

Even as multiples have expanded since our first investment, shares trade in line with peers and their premium remains warranted given their relative growth, margins and addressable market.

Solar Inverters

Storage solutions

Risks

The biggest risk for SEDG is they are disconnected from the end consumer.  Their business model relies on solar panel installers to integrate their products into their systems. These solar panel installers also interface directly with the solar customer base. This model can be fickle.

Other potential risks

• Re-entry of Chinese Competitors – Huawei exited the US solar market in 2019 due to escalating trade tensions under the Trump administration.  With tensions potentially easing, they could reverse course.  Huawei is always a formidable competitor (ref: Nortel, et al)
• Unfavorable Tax Laws – The combined failures of the Build Back Better Act (which included $555 billion in proposed federal clean energy subsidies) and California’s Net metering policy put a damper on the sector.  However, publicly disclosed pushback against the BBB bill was largely related to policies unrelated to climate change. It is possible that the tax credits and incentives within the bill most beneficial to SEDG could become law through separate legislation. And solar installers have already devised solutions to the (currently paused) potential net metering policy which would install solar and storage systems disconnected from the meter and thus not subject to the metering policy. Finally, SEDG is rapidly expanding internationally which will continue to diversify their customer base and mute US based tax law risk.
• Frenemies Risk – Tesla, which has long relied on SEDG and ENPH inverters for its home EV solutions. Tesla launched their own inverter in early 2021.
• Supply Chain Disruptions – Supply chain issues are always a potential threat to manufacturers, but these challenges are heightened in the current environment and on the tail of the Covid pandemic. SEDG experienced some supply chain issues related to Covid (Vietnam manufacturing facility) but has worked through these issues and have effectively rebuilt their supply chain. Utility scale projects are proceeding, and solar panel installers have been able to pass along price increases to consumers and demand remains strong.

Conclusion

The global solar market is evolving rapidly with new entrants entering the market each year and incumbents evolving as they learn from their experience. We continue to view SEDG as the attractive market leader that solar panel manufacturers trust as a reliable brand in the space. Our view is that, despite relatively high valuation and increasing competition, we want to hold our investment for the long term and observe how management adapts and evolves.  At the same time, we have witnessed the progress ENPH has made in the market, and we are investigating the company as an option or even the possibility of owning both companies. The market is growing quickly and, ultimately, we see consolidation in the global market for inverters. We believe either company can be long term winners and capital compounders.

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[1] Publicly disclosed pushback against the bill was largely related to policies unrelated to climate change. And thus, it is possible that the tax credits and incentives within the bill most beneficial to SEDG could become law through separate legislation.

[2] Bloomberg estimates.

[3] However, ENPH’s Q4 2021 earnings report highlighted significant growth in Europe.