SolarEdge Technologies, Inc. (SEDG) Earnings Call Transcript & Summary

Thank you all for joining. My name is Mark Strouse. I cover alternative energy and services within the U.S. here at JPMorgan. Very happy to have SolarEdge Technologies, Lior Danziger, Investor Relations.

Thank you very much.

So SolarEdge, overweight-rated stock for us. It has been for a long time. So thanks to you and the team for making us look smarter than we probably are. Stocks had a good run since we picked up coverage with 5, 6 years ago. Just getting going. Can you just give us kind of a brief overview of SolarEdge for the uninitiated.

Sure. So first, thank you for having us. And my name is Lior. I'm VP, FP&A and IR for SolarEdge. SolarEdge was founded in 2006 and we started doing manufacturing in 2010. We're currently the largest inverter company in the world in terms of revenues. We have installations in 130 countries. We're doing an MLPE solution. We entered the store space, the e-mobility space, and I'll be happy to elaborate more.

Maybe just starting with your markets. So obviously, a lot of focus on European energy right now. Just remind everybody in the room what percentage of your revenue comes from Europe. And then you've talked about acceleration in Europe even before the RePower EU plan came out. What is driving that? And kind of talk about the trends?

So what we've been witnessing in the last couple of years is increased portion of our European revenues as part of the whole. And right now, it's roughly about 45% of our business. And you're right, we've seen accelerated demand in Europe and we've been observing that and discussing about that before the RePower Euro plan was announced, before the Ukraine and Russia event started. And I think it's driven mostly by heightened electricity prices. In some markets in Europe, it's 50% more. And that drives the payback period in some markets still as low as 4 years to solar installations and that drives a lot of demand. So on top of that, we have the other events. We have the RePower Euro plan, but it's an incentive plan. It's not a binding one, not a combining one. It can serve as another vector, but we think it's not governments that generate demand, it's economics. And right now, we're seeing that in Europe.

That being said, I mean, RePower EU, since the announcement, have you seen any kind of acceleration in the market in your business?

Well, I think it's hard to associate directly to the plan itself, but we are seeing accelerated demand in Europe almost in each and every country and each and every segment. We're operating both in residential and in commercial and the demand is extremely strong. It's somewhat hard to associate purely to the plan itself, but very strong demand.

So I mean, there is this trend of RePower EU and everything else, like you mentioned, but kind of accelerating the longer term plans for the region, like the Fit for 55 plan was like 2030, right? So it's kind of pulling forward some of that. How do investors kind of think about -- like you said, you've got resi business, you've got a C&I business. There's different construction cycles for each of your businesses. What do you see is potentially accelerating now versus something that might be a bit longer-dated for RePower EU or anything else that might come out?

So by definition, commercial transactions tend to be longer. You're usually involved in the design. It's a longer sales cycle. So this might take longer. We are seeing very strong demand in residential space in Europe, also driven by the high electricity prices, self-consumption trends that we're seeing in some of the markets there, but we're also seeing those on commercial side as well. Corporations in Europe also have to face high electricity prices. They also want to offset that. They also want to go green, show their ESG initiatives as well. But usually, on commercial side, it takes slightly longer, I would say.

Europe has relatively higher attach rates for energy storage than what we are used to here in the U.S. Can you just kind of talk about the relative mix between the 2? What you see as attach rates for your business of energy storage in certain countries in Europe? And what the value to SolarEdge is from that as far as an incremental uplift per customer per homeowner?

So we're seeing very strong demand for batteries. I think it's no secret. In many of the markets, we're already delivering batteries to 10 different countries in Europe and of course to the U.S. And when you think about the value that it brings to us, we should remember the price of the battery is 4x or 5x the price of being better. So in that sense, the uplift just for one battery attached is meaningful and we are seeing increased rate of batteries attached. So in some of the markets, homeowners would like to attach more than one battery. It's very hard to try and determine the attach rate. I think a good proxy, for example, would be our storage inverter sales in the U.S. that it's probably a high runner product right now. And even if you don't have a battery available that you can attach to it, you're only buying this inverter if you plan to attach a battery. So -- and this is already beyond the 40% of the inverter sales in the U.S. So that's a good proxy.

So that's a good segue just into your overall battery business. Can you just kind of provide an update -- well, actually, I mean, for those that are uninitiated, maybe kind of we hear batteries and we think that you're competing with Samsung or LG Chem or whoever. What exactly is SolarEdge bringing to the table with batteries?

So I would say we have a strategy about storage that is 2-fold. One, we actually have a collaboration with Samsung. So we're procuring currently the battery cells from Samsung and we get about 250 megawatt hour of battery cells every quarter and we assemble those to a battery pack which is the end product that you put out there, including all the electronics and mechanics and the BMS, the battery management system. So this is what we're doing right now. This is the capacity that we're utilizing right now. And by the end of this quarter, we will fully ramp up our assembly capacity and be able to assemble 250 megawatt hour of battery packs. In parallel what we're doing is, we also finished the construction of Sella 2.This is our own manufacturing facility of battery cells in Korea. It has a capacity of 2 gigawatt hour annually. So that's double the agreement with Samsung. And right now, we're ramping it up. We did a nice ceremony a couple of weeks ago. We're right now doing these wet rounds and test trials and generating the first batches of battery cells for qualification and test. And we will finish this process by the end of the year. And then we'll have this flexibility. We have the agreement with Samsung. We would like -- we would probably be happy to see this collaboration continues. It enables us with a good flexibility of putting battery packs, both from externally-sourced battery cells as well as our own manufactured ones. And then we can also bridge whatever gaps we might have on the way.

So by year-end, 3 gigawatt hours of capacity. How do we think about that evolving over time? And what are the benefits of doing it yourself versus partnering?

So first, when we do our own manufactured cells, it's going to be a better cost structure than externally sourcing them. But I think what we try to do is we try to be as flexible as possible because I think we still don't really know the demand for batteries in the solar space. The market is so much constrained on batteries that we're still waiting to see what will be the real demand in the solar space. And then our strategy is to be well hedged. So if the demand in the solar space is as high as many of us think, we have the ability to expand Sella 2 into 3 and 4 gigawatt hour in terms of the infrastructure and the facility. It's already built to accommodate that. And then we will have the third-party agreement that we will be happy to continue the collaboration with Samsung. We might find other viable players as long as we can, I would say, keep this flexibility without compromising on quality then that could be a good potential for collaboration.

Can you talk about the impact of the Ukraine war and Chinese lockdowns on your battery business from a raw material pricing perspective and from a battery availability perspective?

So we've seen metal prices going up. And usually, what you see in those type of agreements is that the price of the battery cell is usually attached to some metal index, and this is our case as well. But these inflationary pressures is something that we roll forward in terms of the price. In terms of China, we haven't seen too much of an impact. We don't have a direct footprint in those provinces and areas. What we are seeing is some [ slowliness ] coming from few vendors that do have their footprint over there, but it's something that we manage, we navigate. We talk to them very frequently about COVID and lockdowns and expectancies and that's how we navigate it.

So you're able to fully pass on the increased costs to the customers?

Yes.

There is -- I kind of think about solar plus storage being what solar only was maybe 7, 8, 10 years ago, meaning that there are some markets that are still coming into their own as far as economics. So I guess, you're implying that there is enough demand in the strong solar plus storage markets to overcome any potential weakness that you're seeing in the markets that are more on the fringe you should think about it?

Yes, I believe.

Can you talk about your thoughts on battery chemistry NMC versus LFP, others? And kind of in your capacity targets that you're talking about, how should we think about that mix potentially evolving of chemistries?

So right now we're utilizing NMC. The battery cells that we get from Samsung are NMC-based. Sella 2 factory that we constructed is also going to start with NMC chemistry. We have very strong knowledge and expertise coming from Kokam that has been doing the NMC for years and we will leverage that. So right now, in the foreseeable future, we will probably go with NMC. We are continuously evaluating the different chemistries and we are evaluating LFP as well. But right now, we will probably in the first few generations utilize the NMC.

I should have said this at the outset. If anybody has any questions, please feel free to raise your hand, we'll get you a mic. So can you just talk about -- I mean, so we've talked about batteries. Can you talk about just generally supply chain challenges you might be having on the inverter business, shipping, anything else?

So I think it's no secret that most of the challenges we're seeing this day are around the supply chain. This is where management spends most of its time and trying to navigate that. I think we've been somewhat successful in doing that. There is semiconductor chips issue. There is components issue. You're put in a war on everything you need to get. And this is where we are and this is what we're trying to do. Talking about logistics then, we are seeing some stabilization in shipping costs. It's still at a very high level, but stabilizing. Hopefully, the next direction of the curve will be to go down. But all in all, I would say that this is where challenges are focused these days. Demand is extremely healthy. And we're mostly busy on navigating through the supply chain.

So within the U.S., maybe a moot point, but just kind of the -- what was the impact from the AD/CVD investigation? Did that impact C&I more than resi? And kind of what has changed, if anything, since a couple of weeks ago when Biden announced the 2 year window?

So it is usually the case that the larger installations are the one taking the heat. And in that sense, we haven't seen an impact on our C&I business thus far and we haven't been that present in the utility segment to see any heat there. So I think right now, there's no real impact on our business, not on residential, not on C&I. And I think in many ways that was also lifted, that concern for the next couple of years.

What about your Mexican manufacturing facility? Can you just kind of brief investors on why you're doing that, where you are in that progress and then kind of what the benefit to the financials might be over the coming few quarters?

So I actually think that maybe ramping up Mexico is maybe the most important milestone for us in 2022 to execute on. And there are many good benefits that will come once we will fully ramp up that facility. So first, the idea is that by the end of this year, we would like to serve the entire U.S. residential demand from that Mexico facility. When we gave Q2 guidance, we said, 20% of the residential demand will already be addressed through that facility. And then you should assume a gradual and I would say linear ramp-up until the end of the year, bringing us to 100%. Now in terms of the benefits, so now, first, you have another site that is non-tariff that is serving the U.S. market. We had products coming into the U.S. from China that were [ bearing tariffs ]. So that is one clear gain that you get. But I think the more important one is that you're getting closer to the market that you serve now instead of having our products coming in from China or Vietnam or Hungary or Israel on boats for 4, 5, 6 weeks, they're going to be delivered to the U.S. on trucks in a few days. So you have shorter lead routes and you have less expensive shipment costs. And you gain all of these benefits on the other sites as well because we're clearing the capacity from them to the Mexico facility. So now the Asian sites can serve markets and the European one will serve newer markets as well and you gain those benefits on those sites pretty much the same. And then I think what we mentioned is, we have something like 480 basis points that we feel like we think we can offset once we're fully ramping up the Mexico facility.

480 basis points to your gross margin?

Roughly, yes.

To overall gross margins, sorry, or just the U.S. resi business?

No, to the solar gross margin and once fully ramped up. So it's a gradual process getting there.

You touched on this a little earlier, but can you just talk about your initiatives within utility scale, which for those that aren't familiar, utility scale is roughly half or so of the global solar market. So if you can get into this market at a very big expansion of your TAM, maybe walk us through the history? I mean, why start in resi and work your way up to utility scale? Kind of where are we now from an economic cost benefit analysis within that market?

So this was the trajectory, as you mentioned. We started in residential and we created a name for ourselves as a premium residential player. And then we stretched, extended the architecture into commercial. And I think we're very fortunate to have an architecture that is scalable so we can actually take our solutions and not only address one segment, but actually address all the segments in the solar space. And we think we can come with a good value proposition to the utility segment as well. We already have a handful of projects in the utility segment, not too many of them, but a few of them. And these are actually been deployed using our large commercial inverters. So even before rolling out our tailor-made or specific utility product, we're already seeing demand coming just by using our large commercial inverters. So that's a very good sign. And what we're doing is we're trying to learn from those projects that we're currently running and worked very closely with the assets developers to understand what they need, how they need it and then to build the right value proposition for them. When you're talking about utility scale, it's a lot about sensitivity to cost and price. So as long as you are able to show a very clear ROI, even though you were a premium player and you're charging more, then you have a very good chance of winning the project if you can show that over the lifetime of the system you're generating a better ROI.

I think when I explained your company to investors for the first time, it's easy to understand resi because you're solving a lot of known issues on a home with shading and leaves falling on your panels, things like that. What are the applications that are important to utility scale?

So well, it's difficult to justify, for example, the same premium for shading when you're talking about an open field. But if you were a utility asset owner or a developer, then you're very sensitive, for example, to O&M cost because you have a run -- you have to run a large field. Usually, these are currently managed by central inverters, these huge containers. We're going to make those distributed fields. So the ability to recover any downtime is much better. The ability to actually run the site without external technicians, et cetera, is also getting better. And on top of all of that, you are gaining those benefits of harvesting more energy optimization, probably not to the same extent as residential simply because of the structure, but it is a very good value proposition and we are seeing more and more utility developers finding good value in that.

Can you kind of talk about just generally who those developers are? Like where they are? I mean, are you focused on proving this out in a certain geography now? And kind of talk about what the pipeline looks like? When we might expect to see more of a material contribution from this business to your financials?

So as I mentioned, right now, we have a handful of projects. Most of them are actually located in what we like to call ROW, Rest of the World. So outside the U.S. and Europe. We mentioned a very big one in Taiwan, about 77 megawatts of installation. And again, this is coming from commercial inverters and this is a huge size of a site. So right now, we're executing those and working on learning experience so we can stretch that and extend to European markets and the U.S. market as well.

How do we...

And by the way, in 2022, you won't see any material numbers. And if we are successful, then maybe in 2023.

A follow-up to that is, 2022 is a backlog year in revenue in 2023 or 2023 is a backlog year in 2024 as revenue?

So I would say that for utility we will not see meaningful revenues before 2023.

Let's say, what is the impact from utility scale on your financials? I generally think of utility scale being more competitive, like you said, more -- much more focused on cost ROI. Should we think about it as kind of lower margins but higher EBITDA or even gross profit dollars or I mean, what's the message there?

So it is the case that as you move from residential to commercial to utility, these are characterized with lower gross margins, but the scale is much bigger. So if the transaction is much bigger at the time, you mentioned it yourself, it's huge. So in that sense, we think that every gross margin dilution will be more than compensated in terms of the bottom line contribution. And then, as you mentioned, you find yourself with, I would say, larger operational profitability, higher operational profitability on a much higher revenue base. So in that sense, whatever we're losing on the gross margin basis, we will compensate in the bottom line contribution.

So one of the biggest questions that I've gotten since we launched coverage 6, 7 years ago was, is it really just around competition. You've got patents. You've asserted those against competitors over time. And I think most people would agree that's kind of why you get the gross margins that you get. Just give us an update on competition though. I mean, are you seeing any influx of Chinese competitors in certain markets in Europe or anywhere else?

The answer is yes in Europe. I think the phenomenon you see right now in Europe is that you've actually seen the European string inverters losing market share probably to both sides. So you have on one side, the Chinese string inverters that are getting better on quality and getting very close to the quality of the European string inverters. And then you might just go for the cheaper one, quality is very close. But on the other hand, if you're a homeowner in Europe and you want to one day connect your EV, your battery or EV charger, you're going to need an MLP solution. So we think we're gaining market share in Europe. And given what I said about the Chinese players, I think that both of us are doing that on the expense of the European ones.

One of the advantages that you and your peer Enphase have in the U.S. market is electrical standards that require kind of remote or rapid shutdown. Is there anything like that kind of in the works in any of your other international countries?

Not really. So this is a very special dynamic regulation that is specific to the U.S., and it created this duopoly that you mentioned. By the way, it's also in commercial in the U.S., but we haven't seen any similar regulation in Europe or in other geographies. So in that sense, I think that's what creates fierce competition in those markets.

At the same time, you say you're gaining share even without those regulations. So yes, that is encouraging. I get a lot of questions from investors on the equity raise from earlier this year. What can you say? What are the proceeds?

So I think what we wanted to do here is we wanted to make sure that we're ready. When we were talking to investors and giving our commentary every quarter, we mentioned already a few months ago that we're seeing historical levels of demand. Especially in C&I, we mentioned we have a backlog of 180% of 2021 shipments. And when you see this, you want to make sure we're ready. And we wanted to make sure that in terms of financial soundness we're there and we will be able to capitalize on whatever opportunity that we're seeing. And translating that to use of proceeds, it could be working capital considerations that we have, it could be M&As that we're now seeing maybe in better valuations than it was 3 months ago, it could be expansions that we will do. And if we think that we have exhausted all, I would say, ways to create good value to our shareholders, then we might have that discussion of what payout we need to go for. But right now, we're not there.

Getting a lot of questions. Give me one second. A lot of questions from investors on just macro conditions, fears of recession. You said you went public in, what, 2014, if I remember right. We have...

'15.

'15, okay. We haven't been through a recession or a major recession anyway since you've been public. What are you expecting? Maybe can you talk about kind of -- I know it's on a much smaller scale at the time, but what the experience, what the learnings were from 2008, 2009?

So it's a good question. I think it's going to be interesting to follow and see. In many ways, it's still economic to install solar despite everything that is going on. So when you have electricity prices rising 50%, you still might want to go and install a solar system despite everything that is going on. So in that sense, we will have to wait and see. Right now, we haven't seen any pushback, slowliness in demand, anything of that type. We're actually very fortunate to see extremely healthy demand in all of the markets and segments that we're operating in. So right now, this is the case.

Just on the same line, the question on payback for residentials and if you can distinguish between European and U.S. residents. What is the likelihood payback that will stop demand? I mean, we're seeing a lot of changes in M3 in California, ITC may or may not be extended up or down. So is 10 years kind of the limit where investor or residents will not do it anymore? Is it 7 years? Where do you see demand starting to fall apart?

So first, just to give you a sense, with everything that is going on in Europe, for example, with electricity prices, we have seen markets where the payback period is as low as 4 years now. You're right that in some of the U.S. markets, and it's not the case. It's hard for me to say the clear number that will stop demand. I'm not sure. There is one in California, for example, if you think about NIM, if you think about those type of things, probably the case that it will become a self-consumption market with higher attach rates of storage, self-consumption devices. This is what we've seen happening in Germany, for example. So I think that would be a natural evolution in that sense for a market like California.

What are your thoughts just within the U.S. market as far as the likelihood of an ITC extension or some kind of a build back better getting passed?

So first, we don't model those. We don't think, again, that governments generate demand, we think economic does. And in that sense, maybe it will be another vector that fuels that, but it's already a very healthy and accelerated demand that we're seeing. So it can be additional tailwind.

Any other questions? Great. Okay. Well, we can wrap up. Thank you all very much, Lior. Thank you so much.

Thank you. My pleasure.