Monday buy of SolarEdge Technologies in my Jubak Picks portfolio

I’ve been looking for a way out of this investing puzzle for a while and I think I’ve finally found one. SolarEdge Technologies (SEDG). I’m adding these shares to my Jubak Picks Portfolio on Monday. And I’ll be buying call options on these shares in my Volatility Portfolio on Monday as well as part of my strategy “Profiting from the Earnings Boom” that I be posting on Monday as well on the JubakAM.Com subscription site (and only on that site.)

Here’s the puzzle that I’ve been wrestling with.

The macro trend has been running strongly in favor of solar energy. Last year global solar capacity grew by 50%. That was enough to push growth in solar capacity above growth in coal and gas capacity. In 2017 the global economy added 126 gigawatts of solar and wind capacity and 86 gigawatt of coal and gas capacity. The cost of generating electricity from solar cells has continued to fall until now, according to the International Energy Agency, contract prices for solar and wind power are comparable or lower to generation costs for newly built gas and coal-fired power plants in markets that include China, India, Mexico, and Chile. Even in the United States where the combination of increases in tariffs on imports of solar cells and the Trump administration’s preference for coal, the market remains the second fastest growing market for wind and solar after China. Outside the United States the growth in solar actually seems to be accelerating. China, for example, hit its 2020 targets for electricity generated from solar three years early.

But… and for an investor it’s a huge but… very few solar companies are making any money. Thanks to huge over investment and cheap loans China’s solar cell producers are struggling with massive overcapacity in the sector. In the last year China’s Trina Solar has gone private, essentially deciding to hide from the financial markets while it continued to sell its cells into the Chinese market in order to help the government meet its goals for the sector–despite higher prices for solar cells in other markets. JA Solar has received a revised bid from its chairman to take the company private at a valuation of about $362 million. (Seems low considering the company had $2.6 billion in sales in the last year–but it’s not low if those sales aren’t profitable.)

Back in the United States installers of solar panels are looking at tariffs on imports of Chinese solar cells that will raise their costs. Leading the parade of worry is Solar City, which Tesla (TSLA) bought for $2.6 billion back in 2016. (The company was founded by cousins of Tesla founder and CEO Elon Musk.) The company expanded its sales rapidly on a river of cheap financing. But that debt of Solar City–now at $2.9 billion–has forced retrenchment at the company (the termination of its door to door sales program, for example) because a big chunk of the company’s “solar bonds” come due this year. (Most of Solar City’s debt is non-recourse meaning that Solar City and not Tesla is on the hook for repayment.)

So why is SolarEdge an exception, in my opinion, to the “profits problem” that characterizes the solar sector?

Largely because SolarEdge isn’t a commodity solar producer going up against the cheap cash of Chinese solar companies. And it isn’t an installer facing the expenses of building out a sales force, the uncertainty of U.S. tariff policy, and the shifting attitudes of the U.S.government.

SolarEdge Technologies makes a wide range of power inverters. Inverters are what makes it possible for solar cells to send the electricity they produce into the power system. The company makes inverter systems that are either embedded directly into each photovoltaic module or that are added to photovoltaic modules by installers. The systems consist of a DC optimizer, an inverter, and a cloud-based monitoring system that enables these pieces to act as a single system. By tracking what’s called the maximum power point of each module in real time the SolarEdge system can increaser the energy output from each photovoltaic module and also keep the module’s voltage output constant under changing circumstances. The company also sells DC to AC inverters with digital controls and cloud-based monitoring software that allows users to see data at the module, string, inverter and system levels.

Founded in Israel (where the company is headquartered) in 2008, the company began shipping products in 2010 and as of the end of 2016 had shipped 15.4 million in power optimizers and 633,000 inverters. Sales grew to $607 million in 2017 from $240 million. Net income increased to $103 million from $25 million. Standard and Poor’s projects that sales will climb 43% in 2018 and gross margin will move higher to 37% in 2018 and 2019 from 34% in 2017. In the fourth quarter of 2017 about 60% of sales came from North America and 40% from the rest of the world. The company’s forecast is that by 2019 33% of sales will come from North America, 33% from Europe, and 33% from Asia. (As part of that forecast, SolarEdge forecast a compound annual growth rate of 22% through 2020.)

Obviously, there are dangers to the stock–and I’ve put the shares in my 12-18 month Jubak Picks Portfolio rather than in my five-year 50 Stocks Portfolio because I would not put this position on auto pilot. One danger is that the tariff and other policies of the Trump administration will slow growth in the solar sector in the United States. Industry figures say that U.S. solar installers and their Chinese suppliers stockpiled components in the United States ahead of the tariffs so price increases and supply problems shouldn’t be issues until 2019. A second danger, of course, is that the Chinese solar companies will develop competing products. In the fourth quarter SolarEdge told analysts on its conference call that it had seen products from Chinese producers but that their systems had limited functionality and limited communications ability.  The software-heavy nature of SolarEdge’s products gives the company some protection from Chinese competition since Internet-based communications software systems aren’t the historic strength of the Chinese solar sector. And further balancing the dangers of Chinese competition SolarEdge continues to make inroads in the Japanese (signing a deal with Japan’s Omron at the end of 2017) and Indian markets.

SolarEdge reports first quarter earnings on May 9. I think there’s a very good chance that the company will surprise again–which is why I’m adding call options to my Volatility Portfolio to capture that earnings surprise effect.