We like to think of capitalism as this pure economic system where the best-run companies with the best products and services can grow revenues indefinitely, returning value to shareholders and prosperity to their employees. The reality is far messier. Markets don’t exist in a vacuum. Governments impose tariffs and regulations, issue subsidies and grants. While legislators leave their fingerprints over most industries, few are as well smudged as solar.
The Problem and Potential with Solar
Last year we wrote about America’s Solar Problem. The article’s main point was that playing politics with China (even though forced labor is a legit issue) over solar panel manufacturing hurts U.S. businesses and impedes the expansion of solar as the dominant form of electricity generation. To our point: In Q3-2022, the most recent quarter where stats are available, the amount of solar capacity installed in the United States fell 17% from a year ago, according to the quarterly SEIA/Wood Mackenzie Power & Renewables U.S. Solar Market Insight report.
Yet optimism in the solar market has never been higher in the United States since last year’s passage of the Inflation Reduction Act (IRA), which has all sorts of goodies in it for the renewable energy industry. In other words, what the U.S. government taketh in tariffs, it giveth in subsidies and other kinds of free money. For starters, the solar industry will get 10 more years of tax credits, along with a new technology-neutral tax credit that begins after 2024. It’s like seeding the mountain with green to start another gold rush. The SEIA/Wood Mackenzie report says the passage of the IRA will boost total solar deployment by 40% compared to its previous outlooks if the legislation had never passed.
Maybe that’s why we just had the hottest IPO of the young 2023 season with a U.S. provider of “intelligent, integrated solar trackers and software solutions” called Nextracker (NXT), a $4.36 billion company with annualized revenue of more than $1.7 billion. That’s a very low simple valuation ratio (market cap/annualized revenue) of just 2.6 – where our catalog average is six, and anything more than 20 is more expensive than organic cauliflower in a hipster co-op.
We finally took the plunge into investing in a pure-play solar stock last year with SolarEdge (SEDG), despite the regulatory risk and volatility because we believe solar will be the dominant form of energy. Let’s see how Nextracker stock stacks up to our current solar bet.
About Nextracker Stock
Founded in 2013, the Silicon Valley-based company had raised about $48 million before Flex (FLEX) swooped in and acquired it just two years later. In 2022, investment firm TPG, through its Rise Climate Fund, pumped $500 million into the business in anticipation of it spinning out from Flex, one of the world’s biggest electronics contract manufacturers with $26 billion in revenue last year. The IPO added another $638 million, giving the new public company a huge war chest to build on its leading market share in solar array tracking hardware and software. Flex retained more than 60% of the shares in the company, which has also been profitable on $1 billion+ revenue for at least the past three years.
But, do you see the problem? That’s right little Johnny, gross margins took a massive dump last year, dropping from 19% to 10% (more on this in a bit).
In addition, sales outside of the United States accounted for more than $550 million or 38% of revenue last year, which is way up from $294.7 million or 25% of revenue in 2021. Geographic diversification is especially a good thing given the risky regulatory landscape in the United States, though the manna from IRA heaven suddenly makes that market pretty appealing.
What Does Nextracker Do in the Solar Industry?
We first took a look at Nextracker and solar tracking technology back in 2019. But let’s do a quick recap: Its technology enables solar panels in utility-scale power plants to follow the sun’s movement across the sky and optimize plant performance. Its flagship product, the NX Horizon, is reputedly the world’s most advanced single-axis solar tracker, which enables solar modules to follow the sun throughout the day and increase energy output by up to 25%. Nextracker also sells the NX Gemini, a dual-axis tracker that can capture up to 40% more energy in regions with high diffuse irradiance. The company also offers energy storage solutions and a software platform, NX Navigator, which uses artificial intelligence and machine learning to monitor, control, and optimize solar power plant performance while lowering operational cost.
Nextracker employs what it calls a “capex-light” manufacturing model, in which most components, including steel parts, are produced by contract manufacturers just like Flex. In fact, its parent company builds solar-tracking components like self-powered controllers and network control units. This approach means that by outsourcing most of its product manufacturing, Nextracker can ship up to 40 gigawatts annually with close to no capital investment. It also means that the company must manage a pretty massive supply chain: 65 suppliers in 19 countries across five continents.
Its strategic plan to operate in the United States amid the ongoing kerfuffle with China sounds pretty solid: Nextracker sources raw material from U.S. steel mills regionally, which is transferred directly to its manufacturing suppliers. The company currently has 10 of these fabricators, representing a total of 25 GW or 63% of total annual capacity. Nextracker claims it has shipped about 70 GW worth of its solar tracker systems through September 2002, so it sounds like it has plenty of contracted capacity to meet demand, including for “$2.1 billion in executed contracts, purchase orders, and volume commitment agreements for projects” that’s in the pipeline.
Global Market for Solar Tracking Technology
Those numbers are good enough to make Nextracker the leader in the global solar tracking market since 2015, currently with a 30% share.
Here is some more market fodder from Wood Mackenzie, also known as WoodMac, a 100-year-old global research that specializes in areas like energy and renewables, so presumably it knows what’s what: Solar trackers are the reportedly the fastest-growing utility-scale mounting system across the world, with the percentage of ground-mounted solar installations utilizing trackers growing from 23% in 2015 to a projected 49% in 2022 globally. The percentage was actually more than 80% in 2022 in mature markets such as the United States and Australia.
In addition, Wood Mackenzie estimated a $4.6 billion market for trackers in 2022, the third consecutive year in which the annual market value of trackers exceeded that of fixed-tilt systems for the ground-mounted market. The cumulative addressable market between 2020 and 2030 is about $71 billion, representing about 682 GW of solar capacity installed over that time period.
Should You Buy Nextracker Stock?
There is some appeal to Nextracker stock, particularly amid the bruising bear market we’ve been in for about a year now. But we’re risk-averse investors, so we always focus on red flags. Here are some of the ones we’ve found so far:
- Gross profit decreased by $85 million or 37% in fiscal year 2022, primarily due to a doubling in logistics costs, especially around freight and container shortages. That meant gross margin dropped down to just 10.1% in 2022 compared to 19.4% the year before.
- There is some customer concentration. Its largest customer, SOLV Envergy, accounted for 13.5% of total revenues. Right now it’s hard to say if there is additional risk here based on the data from the 300-page+ prospectus.
- Nextracker only recently spun out of Flex, so we suspect that the $80 million in costs reported for sales and general administrative expenses (SGA) and R&D may balloon upward as the true costs of operating a standalone company come into focus. Supposedly, the accountants already tried to account for this, but it’s hard to fathom that SGA and R&D only represent about 5.5% of total revenues.
- As far as we know, there are no recurring revenues. Nextracker licenses TrueCapture, its flagship software, on a separate basis.
- A $4.6 billion solar tracking market in 2022 does not sound that impressive, and a $71 billion cumulative opportunity over the decade amounts to just $7.1 billion per year. The ceiling doesn’t seem very high here.
Finally, there’s the question of competition. At the top of the list is a company called Array Technologies (ARRY), which we covered back in 2020 after it IPO’d. At the time, we were not too impressed with the company. In 2019, about 87% of its revenues came from the United States. Array also had serious customer concentration, with its five largest customers accounting for about half of all revenues, with the biggest representing 17.2% of total revenues.
However, based on Q3-2022 results of $515 million, the company is looking at annualized revenue of more than $2 billion with a market cap just north of $3.3 billion. Quarterly revenue growth is strong and Array even turned a profit in Q3-2022. Maybe it is making good on its international expansion plans and adding new customers. Prospective investors should revisit Array Technologies for a head-to-head comparison with Nextracker for which is the best solar tracking tech stock. (Incidentally, the two companies settled a five-year-long lawsuit last year where the latter admitted that maybe it should not have hired a former Array Technologies employee who had signed a non-compete clause.) One similarity you’ll find is that Array also has their gross margins being squeezed – from 23% in 2019 to 10% in 2021. This implies that tracker hardware is a commodity business, and one effective way to change the directions of those gross margins is by adding some software-as-a-service.
Conclusion
We’ve opted to invest in SolarEdge because it’s one of the largest solar companies out there with decent gross margins, nice consistent growth, and market leadership in a key hardware component for solar installations. It’s also an extremely volatile stock, which means we might have the opportunity to add more shares below our cost basis in the future. Solar tracking seems to be a less profitable solar niche with a capped total addressable market and one we’ll be passing on for now. Those who see Nextracker as a compelling investment should give some time for the dust to settle following their IPO.
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