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Shoals Technologies Overview
Investing in stocks is fascinating for many reasons, one of them being how Mr. Market often humbles investors. When I published a bullish stance on Shoals Technologies Group, Inc. (NASDAQ:SHLS) last November, I was convinced Shoals was well-positioned to grow in the long term and that its valuation was too attractive to ignore on the back of a 35% decline in stock price since the beginning of 2023. Mr. Market has certainly humbled me since then, with SHLS stock losing almost two-thirds of its value while the S&P 500 has surged 26%.
The lackluster performance of Shoals has come on the back of several reasons, including project delays that forced the management to slash its revenue guidance, high financing costs that continue to impact customer spending on new projects, declining margins due to rising operating costs, and legal challenges including a shareholder lawsuit which questions the company’s disclosure practices regarding warranty expenses.
After revisiting my investment thesis, I still find Shoals very attractively positioned to benefit from the revival of the solar industry. For ease of reference, I have grouped Shoals’ challenges into two broad categories.
- Operational and supply chain disruptions.
- Legal and regulatory challenges.
In the remainder of this analysis, I will dive deep into each of these challenges to determine whether Shoals can come back strongly. Based on the findings of this analysis, discussed below, I feel comfortable reiterating my bullish stance for Shoals Technologies stock.
Operational And Supply Chain Disruptions
Shoals, after enjoying blockbuster growth amid favorable industry conditions in 2022 and 2023, has faced massive growth challenges this year. The substantial decline in revenue reported in the first half of 2024 is a testament to the severity of growth obstacles faced by the company.
Exhibit 1: Shoals quarterly revenue growth
One of the major contributing factors to this deceleration in growth has been operational and market challenges that have led to project delays. According to the company management, 56% of planned installations are experiencing delays of at least 6 months, which has forced the company to push $40 million in expected revenue this year to the next year.
These project delays stem from several sources.
- Permitting issues for new projects.
- Substantial growth in grid interconnection queues.
- Supply chain disruptions have created barriers for Shoals to obtain transformers and switchgear needed for the production of EBOS solutions.
- Labor shortages.
- Elevated interest rates.
Permitting issues have been a major obstacle to Shoals and the solar equipment industry of late. An interesting study by USA Today found in February that there are approximately 116 bans or impediments imposed on utility-scale solar projects, with approximately half of those restrictions implemented within the last 12 months as local governments continue to halt the production of new renewable energy plants despite the federal government setting an ambitious target to reach a 100% clean energy goal as soon as 2035.
Looking ahead, there are some promising developments that point to better days. On August 30, the Bureau of Land Management proposed a new policy framework, updating the Western Solar Plan launched in 2012, to develop solar projects on public lands. According to this refreshed roadmap, 31 million acres of public land would be available for the development of solar projects. This is a good start given that the increasing availability of land should expedite the permitting process for new projects.
The Office of Renewable Energy Siting, established with the passing of the Accelerated Renewable Energy Growth and Community Benefit Act in New York, also aims to offer a single-permit process to complete the permitting process within a year for most projects and within 6 months for projects that request permission to develop commercial sites. This is a major step in the right direction which should be followed by other state governments to accelerate the deployment of renewable energy.
In California, the permitting process has been simplified with the California Energy Commission acting as the sole agency authorized to issue permits for projects, which is another positive development.
Although there is a lot of room – and need – for improvement, the permitting process is certainly headed in the right direction, and I expect to see some improvements in project approvals by 2025.
Resolving the interconnection queues would be a much harder challenge compared to permitting challenges. According to S&P Global data, the interconnection queue capacity reached 2.2 TW in April, almost double the size of the current grid-scale generation fleet. Approximately 94% of this total represents renewables.
Exhibit 2: Interconnection queue capacity breakout
S&P Global
The average interconnection timeline is currently 33 months, which suggests major reforms and investments are needed to address these delays. There have been some regulatory interventions, including the introduction of Order 2023 by the Federal Energy Regulatory Commission which aims to improve the interconnection process through various measures including lower-cost network upgrades.
The U.S. Department of Energy also issued a new roadmap in April, titled i2X, to reduce the average time from interconnection request to agreement to just 12 months for completed projects by 2030.
Exhibit 3: 2030 roadmap targets
These reforms, understandably, will start showing progress in the long run – not the next quarter. However, as a long-term-oriented investor, I am beginning to feel more confident about where the U.S. is headed in supporting the growth of renewables. Based on this understanding, I feel comfortable maintaining my bullish stance for Shoals as I believe some of the biggest challenges facing the company today are already showing signs of improvement.
Shoals are also focused on expanding internationally to gain exposure to markets that are better positioned to support the solar sector. This is a prudent strategy to mitigate the impact of some challenges the company is facing in the domestic market, including permitting issues and interconnection queues that limit customer spending. During the second-quarter earnings call, the company revealed that it is targeting several high-growth end markets such as Latin America, Australia, Southern Europe, Africa, and the Middle East. According to Shoals, the addressable market opportunity in these regions is 63 gigawatts, double the expectations for the domestic market.
Last June, Shoals launched a new product suite aimed at the international market, which, according to the company, is the most comprehensive product suite launched in the history of the company to target the massive opportunity globally.
There are some early signs of success with the international expansion strategy. Although international markets contribute to an insignificant percentage of revenue today, approximately 12% of the company’s order backlog consists of international sales, which is a testament to how Shoals is attracting high-value customers globally with its renewed focus on this market opportunity.
Exhibit 4: Shoals backlog and awarded orders
Finally, interest rates are poised to decline in the foreseeable future with the first Fed rate cut in this cycle expected later this month, with some economists making the case for a 50-basis point cut to boost economic activity. This should help Shoals and the solar industry, with the positive impact likely to be visible by mid-2025.
Overall, as a long-term investor, I feel comfortable with the industry positioning of Shoals as I believe most of its growth limitations will prove to be short-term headwinds.
Legal And Regulatory Challenges
Shoals are dealing with warranty remediation related to defective wire insulation and ongoing intellectual property litigation. These issues could lead to higher-than-expected litigation costs in the foreseeable future, impacting the company’s profitability. The shrink back issue, which has affected approximately 30% of wire harnesses manufactured from 2020 to 2022, led to a $9.3 million in warranty liability recognition in Q2 2023, but the company later admitted that the true value of this liability will range between $59.7 million and $184.9 million.
Miscommunication related to the severity of this liability led to a shareholder lawsuit which aims to seek compensation from the company for potentially misleading shareholders. The company, in return, has filed a complaint against Prysmian Cables demanding they accept the responsibility for these expenses, and seeking compensation from this supplier.
Shoals are also involved in a patent battle, and the International Trade Commission yesterday issued a favorable preliminary ruling which bodes well for the company.
Overall, Shoals’ litigation issues may continue to dampen investor sentiment in the short run, but in the long term, I believe these challenges will prove to be a minor roadblock to growth given that the company is well-positioned to capture a share of the booming market for electric balance of systems solutions.
Takeaway
Shoals Technologies is facing several challenges that are limiting its short-term growth potential. However, recent regulatory trends and the company’s global expansion efforts suggest these hurdles are unlikely to have a material impact on the long-term earnings growth potential of the company. With the market valuation of Shoals pulling back to more reasonable levels in the past 12 months, I am growing in confidence about the alpha-generating potential of SHLS stock.