Many stocks involved in the clean energy transition — either renewable power generation, or the transition to electric vehicles (EVs) — have been absolutely hammered lately. In fact, during this rapid rise in interest rates, even the highest-quality leaders in the space have seen precipitous drops in their share prices.
Case in point: Over the past week, both silicon carbide chip leader ON Semiconductor (ON 3.51%) and solar microinverter company Enphase Energy (ENPH -3.58%) plunged after issuing dire guidance for the current quarter.
But assuming the EV market and residential solar market have years of growth ahead, these declines could be opportunities to pick up shares of industry leaders on the cheap for the long run.
However, of these two heavyweights, only one looks like a buy on the dip today.
Why these two companies are so important to electrification
Enphase is one of the only players in the solar inverter market for residential and small-scale commercial solar deployments. The inverter is the device that converts direct current produced by solar panels into alternating current for use in a house. This market is less commoditized than the panel market, making it profitable and attractive.
Enphase has fashioned itself as an innovator, and is a pioneer in what is known as a microinverter. A microinverter attaches to each panel on a rack of solar panels. This is in contrast to string inverters, in which all panels send electricity to a single conversion source.
Microinverters are safer and don’t have a single point of failure, and they tend to be more efficient. So microinverters tend to garner a premium over string inverters, and Enphase has higher margins than its rivals.
ON is a current leader in the silicon carbide (SiC) market. SiC is a material that’s more difficult to produce than straight silicon, but has higher conductivity under high temperatures and rugged conditions, and is thought to be crucial to the electrification and EV transition. The SiC market seems destined for hypergrowth in the years ahead, as long as EVs keep increasing penetration, and newer models use more SiC chips.
ON is one of a half-dozen or so semiconductor companies gunning for this market, but it appears to be executing better than others. Already, ON is generating significant SiC revenue growth and design wins, while others are still working out the kinks of fabrication plants manufacturing this new, difficult-to-produce technology.
Soft guidance sends these stocks dramatically lower
Over the past week, each stock was hammered on lukewarm results and even worse guidance.
Enphase reported just over $551 million in revenue, which missed estimates by over $15 million and was down 13.2% year over year (YOY). Adjusted (non-GAAP) earnings per share (EPS) came in at $1.02, slightly higher than estimates, thanks to cost controls. However, Enphase guided for a big down quarter next quarter, guiding for only $300 million to $350 million in revenue.
Meanwhile, ON Semiconductor actually beat analyst estimates in the recently reported third quarter. Revenue of $2.18 billion was down slightly YOY, but came in ahead of expectations, as did the company’s adjusted EPS of $1.39.
ON also guided for a soft fourth quarter, for about $2 billion in revenue and adjusted EPS of $1.16 at the midpoint, below expectations.
So what exactly is going on here? Both companies’ slowdowns can likely be attributed, at least in large part, to rapidly rising interest rates. Many residential customers finance or lease their solar energy systems, as it’s a large-ticket purchase. Therefore, higher interest rates are increasing the cost of systems in relation to grid power. In addition, the European market is slowing down, after a surge in 2022 following the Russian invasion of Ukraine and concerns over energy prices and security.
Solar energy systems are large-ticket purchases, and so are EVs. EVs tend to save owners on gasoline purchases, but they also tend to be more expensive, even with tax credits. Therefore, higher rates on car loans are also cooling down the growth of the EV market. During ON’s conference call, management noted that a large part of the Q4 guide-down came from a large European EV maker, which is trying to work down inventory after over-producing EVs.
The better buy right now
Is this dip an opportunity to scoop up these stocks on the cheap? It appears that is likely true for one, but perhaps not both.
Enphase did note that the company’s Q4 guidance contemplates under-shipping end demand by about $150 million, as distributors of solar energy systems look to lower their inventory. But that leaves more “true” end demand around $450 million to $500 million, still below last quarter’s figures.
Enphase is also feeling negative operating leverage, as lower revenue severely hurts profits. Even at a $500 million revenue level, that would probably put the company’s profits at around $100 million per quarter, or even lower. At a $10.3 billion market cap, that would mean a normalized earnings multiple of, say 26 or so.
If the solar market eventually recovers strongly, that could make this stock a buy. But that’s somewhat difficult to figure out. While solar penetration is low, it’s unclear how much penetration at-home solar will eventually get. And with California and some European countries now limiting the amount of electricity one can sell back to the grid, regulations add another wildcard.
There’s also the issue that Enphase generates the vast majority of revenue from microinverters, with very little recurring service income. The company does sell software to solar installers, but that’s a relatively small portion of revenue. So investors should view Enphase as a cyclical growth company, not necessarily a recurring-revenue name.
With revenue to remain depressed for at least the next two quarters, one could very easily see Enphase stock take another leg down.
ON looks like a value
While residential solar has a more unpredictable outlook, the number of cars produced in any given year is fairly constant, at around 70 million units, with some up years and some down years.
Meanwhile, EVs are still growing as a percentage of cars produced, even if the pace has slowed. In the U.S., EVs accounted for just 8.6% of new car sales in the first half of 2023, with 26% penetration in China, and 12.1% penetration in Europe last year.
On the earnings call with analysts, CEO Hassane El-Khoury noted that EV demand is continuing to grow, just not by as much as initially thought. That seems like a much healthier and milder problem than the more unpredictable solar market.
ON trades at a much more palatable 12.8 price-to-earnings (P/E) ratio, which de-risks buying here somewhat. In addition, ON’s P/E ratio may be inflated a bit. The company has deliberately exited some low-margin consumer businesses, intentionally depressing revenue growth but structurally lifting margins. But those exits should be done by the end of the year.
The company is also dealing with higher-than-expected costs in the East Fishkill fab it bought in January of this year. But over time, management said it should be able to improve operations and get costs under control there.
Despite the slowdown in EV adoption, El-Khoury expects healthy growth for silicon carbide, which grew a stunning 70% quarter over quarter. And El-Khoury expects ON to grow its SiC revenue at twice the rate of the SiC market next year.
As ON’s structural transformation ends, its East Fishkill costs come under control, and silicon carbide makes up a larger part of the business, growth should eventually inflect upwards.
Combined with a lower valuation, ON’s potential revenue reacceleration next year should put it on your buy list today, especially over the more expensive and less-predictable Enphase.