Description

I am recommending a short position in Shoals Technologies Group (SHLS)

Shoals is a US-based supplier of innovative Electrical Balance of Systems (EBOS) components for utility scale solar projects. Their Big Lead Assembly (BLA) product, which was introduced in 2017, was a game-changer; it allows for reduced material usage and labor hours relative to traditional “homerun” wiring configurations for large ground mount solar projects. Their innovative BLA product has allowed them to gain market share well in excess of 50% of US utility-scale solar MWs installed. To date, SHLS has derived “substantially all” of their revenue from the US market. They also have nascent initiatives in EV charging, and plans to expand internationally.  SHLS came public in an IPO in January 2021.

SHLS, however, is a victim of its own success: it’s priced for perfection on likely unachievable 2023-2024 estimates. Key points of the short thesis presented here:

• SHLS likely shipped 15GW+ of EBOS in 2022 into a US utility market that’s sized at 10GW in 2022 (per solar market forecasters Wood Mackenzie)

• Full management turnover since 2021 IPO

• Since the IPO, insiders have sold a whopping 74% of today’s entire share count!

• Current and coming competition for a company that currently has huge majority market share in US utility solar looks like trouble

• The Inflation Reduction Act, though positive for solar overall, should provide no special benefit to SHLS

• Limited to no traction in new initiatives in international expansion or EVs, so company is entirely exposed to US solar

• Company carries extremely high margins for a relatively simple electrical wiring product – they’re already at the high end of target GM range

• SHLS is valued at 16x Sales, 59x EBITDA, and 94x EPS on 2022 numbers; because I think they’ll miss 2023 substantially, I don’t know what the forward multiples look like, but they’re too high

INTRO: What SHLS does and why they’ve been successful

Old (Homerun) System:

SHLS BLA system:

Versus the legacy standard, SHLS BLA system selling points:

• Reduces amount of wiring needed

• Reduced labor needed

• Reduces mistakes in the field 

• Can be installed by non-electricians

In short, though it’s a relatively simple product, it’s been a game-changer since its introduction in 2017.

SHLS appears to have significantly over-shipped end demand during 2022

When SHLS issued initial 2022 revenue guidance of $300M-$350M in March 2022, Wood Mackenzie forecast 15GW of 2022 US utility solar buildouts at that time. By December 2022, that Wood Mackenzie estimate had declined to just over 10GW, but SHLS has been able to maintain their outlook within the original range (it revised to lower half in May - $300M-$325M). Achieving their 2022 revenue guidance implies that SHLS likely shipped 15GW+, up from 11GW in 2021.

Cowen (SHLS bull) explains that SHLS did ship to projects ahead of the pace of project completions in 2022; they apparently see this as fine:

“The Wood Mackenzie forecast is interconnected projects and not actually projects under active construction, thus shipments of modules, trackers, and related eBOS equipment from the likes of Shoals is well ahead of this trend line”

Note that this trend of SHLS shipping well ahead of Wood Mackenzie-measured interconnections was apparently not particularly notable previously, as SHLS compares their shipment results to Wood Mackenzie same period utility scale volume data for the purposes of calculating market share in 2021 and prior periods:

Source: SHLS Q322 presentation (November 2022)

If SHLS were to use the same market share methodology as in their chart above, their 2022 market share would be approximately 150%! I certainly expect a methodology change from SHLS, or just dropping this market share table altogether. 

Even if we look ahead at the latest Wood Mackenzie forward forecast for almost 19GW of utility scale in 2023, the estimated 15GW-16GW that SHLS shipped in 2022 would indicate SHLS shipments are already bumping up near the limits of market size. 

15 page Wood Mackenzie Q422 report can be obtained here: https://www.woodmac.com/news/opinion/the-us-solar-industry-waits/#form

MANAGEMENT TURNOVER

SHLS prospects going forward, particularly around new growth initiatives, could be substantially hampered by significant (total) turnover in senior leadership:

• Founder and key innovator/visionary Dean Solon “had resigned from his position as an employee and from our board of directors” as of February 2022 – SHLS filing

• CEO Jason Whitaker’s departure was announced in Q422, for health reasons

• CFO from the IPO (Philip Garton) left in Q222

INSIDER SELLING: Risk has been thoroughly offloaded onto public (bag)holders 

Insiders aren’t waiting around to see how this all plays out: 

• Majority holder pre-IPO Oaktree sold their entire stake (82M shares, 51% of company) purchased only 4 years earlier, and did so in the IPO, and shortly thereafter 

• Founder Dean Solon, after his most recent stock sale in December 2022, has now sold 59% of his pre-IPO holdings

• Outgoing CEO Jason Whitaker sold 75% of his pre-IPO holdings in 2021-2022

In total, 4 key pre-IPO insiders (majority holder Oaktree, Founder, CEO, CFO) have sold an astonishing 74% of the total current S/O just in the period since the 2021 IPO!

Interestingly, these sales are all in addition to a massive debt-financed $356M special dividend that was paid out to holders 2 months prior to the IPO in November 2020! This massive payout also explains why the public company, despite strong profitability and minimal CapEx needs, now carries net debt of over $250M, or over 3x EBITDA.

I’ve seldom seen such a rapid and thorough off-loading of exposure from insiders to public holders in such a short amount of time. Needless to say, nobody in the know seems to want to see where this goes.

COMPETITION

Tegus interviews with solar developers & a former executive are not encouraging for SHLS!

Some key takeaways from the interviews:

• There’s already low-cost Chinese competition that’s just as good (per a large developer); one multi-GW developer has already switched away from SHLS completely to that competitor, based on price

• There’s no shortage of potential future competitors: 

  • Solar trackers like Nextracker or Array could compete

  • More low-cost Asian competition will come along, in addition to the Chinese competitor turned up here (Voltage)

  • First Solar could bundle

• Founder Dean Solon’s departure is a BIG deal – he’s THE product innovator

• Failure in both EVs and international are predicted

Interview with Strata Clean Energy

Multi-GW developer that has switched away from SHLS completely in favor of Voltage, a just-as-good, cheaper Chinese competitor

Interview with Velo Solar

Interview with former SHLS Executive:

“And so Dean Solon leaving, he was the legitimate only like product innovator that they had. I mean, every design came out of his head and anybody that tells you differently is just abjectly lying to you and him not being there anymore, if you look at like what they spend on both biz dev and research or product research, product innovation, whatever, it's very little. And so where is the next kind of great innovation going to come from.”

INFLATION REDUCTION ACT (IRA)

Because the IRA has significantly boosted market sentiment around solar, it’s worth touching on that and its impact on SHLS. 

While the IRA should undoubtedly be positive for solar overall, and all players within it, by driving increased volumes (should be reflected in latest Wood Mackenzie estimates), I don’t believe it will provide any particular benefit to SHLS beyond the overall market. A key provision of the IRA is that it provides for a 30% Investment Tax Credit (ITC), but if the project qualifies as using American components, that number goes up to 40%. Clearly getting a full (extra) 10% of the total project cost paid for by Uncle Sam is a powerful incentive for solar project developers to qualify as an American materials project. As SHLS is an American supplier, this should be a boon for them, right? In my opinion, NO. Here’s why: to qualify as an American project, a developer must use 40% US materials in 2023, with that percentage rising over time up to 55% by 2026. SHLS’s ASP has been right around $0.02/W out of total materials costs of ~$0.54/W for a utility scale project (per SHLS slides, see below). So SHLS has less than 4% of material costs of a project. In other words, it’s not much of a needle-mover either way in attaining the 40%-55% American material provision. It’s far more important that developers focus on sourcing the higher value components from the US: modules, trackers, inverters, and even the non-SHLS EBOS are all larger than SHLS % of materials. In hitting the 40%-55%, SHLS at <4% doesn’t get a developer much towards the 40%-55%. Quite literally, all other materials/components go much further towards meeting the goal. Note in the slide below from SHLS that 40% of total project costs are non-materials costs, so those must be excluded entirely in thinking about what constitutes 100% of materials costs, and SHLS piece within that. 

IRA’s Buy American provisions:

https://crsreports.congress.gov/product/pdf/IN/IN11983#:~:text=This%20percentage%20would%20be%2040,steps%20to%2055%25%20after%202026

Cowen commenting on this dynamic: “Trackers and modules are the two most likely pieces of equipment to increase the ITC to 40% from 30%, given they hold the most weight in increasing domestic content. Steel supply would need to come from the U.S. in lieu of China, Turkey, Thailand, India and other countries.”

NEW INITIATIVES

EVs: I’ll be brief here because numerically we have essentially nothing to go on.

The company claims first EV sales as of Q421 and “full market launch” in Q222. That said, the company has never disclosed an EV revenue number, or a backlog number. They’ve also never publicly announced ANY EV deals. Put together, I’d be surprised if EV-related sales were even 1% of total. It’s just not relevant, in my opinion. 

As a former exec at SHLS put it (on EVs):

“So the company will continue to ship cash all the time in terms of making the same stuff that they've made. But there is no engineering talent to make anything new. Every EV attempt that they've had has been an absolute abject failure disaster.”

On international expansion?

Here’s what SHLS says:

And here’s what a former SHLS exec said on a Tegus call around international expansion (from Tegus call above):

“Like you're essentially already at 70% of the U.S. capacity. That means that you can really only go international. And the problem with that for Shoals is they don't play well in the space. They make everything in the U.S. and it's hard to ship it everywhere else.

A lot of the countries that utilize the most utility-scale solar, I hate to say this, but use akin to slave labor. So your sales pitch of we can lower your labor cost when you're paying someone $0.20 a day doesn't really matter. And so even though it is a better, cheaper, more efficient solution, it's very hard for them to crack into international markets.”

NUMBERS

Given what I’ve laid out thus far, I’d hope you can see how aggressive (absurd?) analysts’ 2023-2024 Revenue estimates look:

SHLS carries impressive margins for what’s essentially electrical wiring:

SHLS: “backlog represents signed purchase orders or contractual minimum purchase commitments with take-or-pay provisions and awarded orders are orders we are in the process of documenting a contract but for which a contract has not yet been signed”

SHLS IP POSITION

SHLS’s IP position does not sound particularly strong to me:

“We believe that many elements of our manufacturing processes involve proprietary know-how, technology or data that are not covered by patents or patent applications, including technical processes, test equipment designs, algorithms and procedures.”

CONCLUSION

While I do not have estimates for what I believe SHLS will do in 2023-2024, I believe they’ll do SIGNIFICANTLY less Revenue than analysts are modeling. SHLS carries a full $5B Enterprise Value on ~$300M of 40% GM revenue, which is patently absurd, in my opinion. I believe that in their core solar business, both market share and margins have only one way to go: down. I believe SHLS oddly over-shipped in 2022; I expect them to pay up for that with a significant shortfall in 2023 relative to aggressive analyst estimates. And finally, I believe the market seems blissfully ignorant that there’s already real competition, and more to come in the future. 

Insiders have sold essentially the entire company onto the public; I humbly suggest that you should follow their lead with a short position.

Catalyst

• Lowering of 2023-2024 numbers, resulting in a significant downward multiple revision on lowered numbers