Reflections: Solar innovations and the path to a greener future

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Not making mistakes suggests we are not bold enough to seek and hold multiple upside companies. Not learning from them suggests an arrogance in intellectual certainty. Embracing a continuous improvement and adaptability culture will enable us to navigate the ever-changing market landscape better and deliver performance for our clients.

In 2007, we invested in two solar companies, First Solar and Qcells, which were poor investments. We believed in the shift to renewable energy, especially solar, but underestimated the market’s tolerance for ongoing losses in exchange for market share. We were also far too tolerant of a culture we distrusted. This experience led us to refine our process by thinking more deeply about questions two through five of our 10-question research framework, which centres on what happens over 10 years and beyond, differentiation of business culture and adaptability.

While it might be easiest never to look back and ignore the solar sector, it would almost certainly put us at risk of erring too far toward perceived safety and missing potential outliers.

So here we are again. More embattled yet hopefully more enlightened. We have purchased Enphase, a solar microinverter company.  

Enphase, founded in 2006, produces microinverters that transform direct current (DC) energy produced by rooftop solar panels into the alternating current (AC) energy consumed in homes and small businesses. The visionary co-founders, Raghu Belur and Martin Fornage, are still actively involved in the business.  

The potential for long-term growth in the solar industry is undeniable. Despite solar energy accounting for only 2 per cent of the global energy mix in 2022, its demand is expected to increase as the need to reduce carbon emissions becomes more urgent. Enphase’s systems have already prevented 45 million tons of CO2 emissions, similar to Greece’s yearly emissions.

Over the next decade, Enphase could be instrumental in helping to avoid 2–3 billion tons of CO2 emissions by replacing fossil fuel generation. This is roughly equal to the emissions from 700 coal plants operating for a year.

Renewable energy is crucial for reducing emissions. We see an acceleration of adoption with the falling cost of solar energy, which has dropped 33 per cent for every doubling of shipped volume in the past decade. In 2023, it is expected that over 50 per cent of all new electricity capacity in the US will come from solar energy. 

Enphase creates products that act as the control centre for solar-powered homes. Their microinverters, batteries, and software work together to manage solar energy generation, storage, and consumption, similar to how a brain controls a body’s functions. Microinverters convert solar energy into usable electricity, batteries store extra energy, and the software optimises the system’s performance and efficiency.

This business model differs from our past solar industry investments, where high volume growth didn’t lead to sales or profit growth due to intense price competition leading to a commodity-style market. 

In contrast, Enphase is an oligopolist benefiting from increased adoption resulting from deflation. They offer a premium and highly regarded product combined with strong software DNA that utilities and others in the value chain lack. Furthermore, there are significant barriers to entry in terms of technology and installer preference.

Our recent research has involved exploring the entire solar value chain to identify potential opportunities. In this process, we looked into SolarEdge, an Israeli inverter company that, along with Enphase, holds 95 per cent of the US inverter market.

Although both Enphase and SolarEdge are inverter companies, they have unique advantages. The main difference lies in the end-user experience and the software offering. Since hardware alone is not enough for a competitive edge, smaller installers depend on Enphase for software, giving it a significant advantage over competitors like SolarEdge.

We looked at Chinese companies Sungrow and LONGi and our current holding, Tesla. Initially, we were positive about Sungrow’s potential but had concerns about its business culture. Sungrow did not sign the Solar Industry Forced Labour Prevention Pledge, unlike 340 other companies. 

LONGi is a company that produces solar wafers and cells. It resembles our previous solar investments, offering a commodity product without a long-lasting competitive edge.

Tesla’s solar business is a minor component of its overall operations and not currently its primary focus. Our established relationship with Tesla gives us a deeper understanding of the long-term prospects for companies in this sector.

Enphase’s share price has recently faced weakness due to concerns about excess inventory and short-term demand related to interest rate cycles. However, these concerns overshadow the 5–10-year potential. We anticipate increased support for solar adoption and Enphase leading the solar energy revolution one home at a time.

Past performance is not a guide to future results. Changes in the investment strategies, contributions or withdrawals may materially alter the performance and results of the portfolio.

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This communication was produced and approved in December 2023 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

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