Shoals Technologies

Shoals' first-quarter revenue of $140.6 million rose nearly 75% year on year, though adjusted EBITDA margin declined by roughly 180 basis points to 15.0%. Still, adjusted EBITDA exceeded the high end of first-quarter guidance. Shares opened higher before marginally declining intraday May 5.

Why it matters: We think the market is focused on both adjusted gross margin and underlying demand. While adjusted EBITDA was higher than management guidance, costs related to product mix, tariffs, freight costs, and labor inefficiencies came in higher than Shoals expected. Still, gross margin hit a low point during the quarter. Product mix is subject to quarter-to-quarter gyrations, and most of the mix that's driving higher revenue negatively impacts margin but still drives higher EBITDA. We expect gross margin to improve from here as the year progresses. Book to bill (orders divided by revenue) came in at 1.1 times, indicating a healthy level of demand. Fortunately, the market for utility-scale solar (grid firming and battery storage) seems healthy for now, with management reporting that it's "accelerating and not slowing."

The bottom line: We maintain our $6.50 fair value estimate for no-moat-rated Shoals. At current prices, the Very High Uncertainty-rated stock trades in 3-star territory. Backlog supports our revenue and adjusted EBITDA expectations for the year. Longer term, we await a US International Trade Commission ruling next month regarding an infringement case that's seeing positive movement. The case could impact Shoals' competitive position as it pertains to its patented way of wiring solar farms. We remind investors that we except to drop coverage of Shoals on or about May 11.

Our fair value estimate is $6.50 per share.

We forecast Shoals to achieve a low-double-digit compound annual growth rate in revenue over the next five years. This is supported by a rebound in market share within its core US utility-scale offering, as well as contributions from new product lines.

Average selling prices are forecast to modestly increase over time, driven by new products to address a larger percentage of the EBOS market. We expect gross margins to be in the mid- to high 30s long term, in line with management's commentary.

We assume EBITDA margins in the mid-20s over our forecast, below management's guidance of approximately 30%, as we expect a rising contribution of new product lines to limit EBITDA margin expansion.

We assign a no-moat rating to Shoals. While the company enjoys robust margins and returns on invested capital today, we lack enough confidence that these will persist over the long term to assign an economic moat.

Shoals is a supplier of electrical balance of system components to ground-mount solar projects. EBOS is a lesser-known segment of the solar value chain and comprises components carrying electrical current from solar panels to an inverter. Major EBOS components consist of lower-tech items such as wiring and cables, combiner boxes, fuses, and wire management solutions. EBOS represents only about 5% of a typical project’s costs but is costly to install. Installation costs can be 1.6 times the cost of components.

EBOS’ characteristics—inexpensive, high cost of failure, limited addressable market—likely limit competitors compared with solar hardware such as solar panels and inverters. In the US, Shoals is believed to be by far the largest solar EBOS provider. Its competition is much smaller in size and scale. Internationally, the market is highly fragmented and characterized by smaller companies serving local markets.

Shoals’ robust profitability today is underpinned by its system solutions, namely its big lead assembly, which was launched in 2017. The BLA introduced a new architecture for solar projects (“combine as you go”), which dramatically reduced the amount of wiring, eliminated combiner boxes, and does not require licensed electricians. This translated to significant labor cost savings—Shoals estimates greater than 40% savings—compared with conventional solutions.

Can Shoals maintain elevated levels of profitability?

Shoals has a strong record of innovation in solar EBOS, including its BLA solution in 2017. Despite its record of introducing new products, we do not view Shoals as having an intellectual property advantage. The company spends a modest amount on research and development relative to broader solar industry peers, limiting its IP advantage. Further, we have found many of the benefits espoused by Shoals, such as reduced labor costs, are also advertised by competitor solutions.

Shoals’ BLA is considered a custom system solution slightly unique to each solar project. This presents additional complexity with manufacturing, and we believe Shoals currently enjoys a manufacturing advantage over its smaller competitors by being able to manufacture high volume but also high mix. Despite the current advantage, we do not think it supports a long-term advantage, given that the manufacturing equipment is relatively inexpensive.

A critical moat question for Shoals is where there are switching costs for its customers. We see factors such as high cost of failure and low cost as potentially leading customers to ignore modest price differences between solutions. However, we think a larger factor in increasing customer stickiness is the company’s mix between selling to EPCs and developers. To date, Shoals has largely targeted EPCs to build market share quickly. We consider EPC relationships generally less sticky as EPCs are more apt to switch to lower-priced options. Conversely, we think relationships with end customers such as developers are stickier since developers can dictate equipment suppliers to a particular EPC. Shoals is beginning to target more developers as customers and, if successful, could increase the stickiness of its customer relationships.

Shoals' margins and returns on invested capital are in the top quartile of the solar industry.

Shoals' expansion into new markets, such as battery storage for data centers, expands its addressable market.

International solar markets have a chance to be sizable contributors to Shoals’ growth.

Shoals’ business is concentrated, with the vast majority all its revenue tied to US ground-mount solar market.

Shoals’ robust profitability could attract new competitors to the EBOS market, weighing on long-term margins.