Nextracker: Competitive Pressures Should Compress Margins Over Time (NASDAQ:NXT)

Justin Paget Introduction Nextracker (NASDAQ:NXT) is the world’s largest manufacturer of solar tracking technology. Over the last few years, Nextracker’s sales and profitability have been soaring with rapid revenue growth and record margins. While most analysts are bullish on the company, I see several issues related to the company’s margin profile, particularly with respect to competitive pressures. In my view, competitive pressures will force the company to slash prices and pass on cost savings, an assumption that hasn’t been factored into most analysts’ targets and estimates. In this article, I’ll discuss the issues I see with Nextracker’s business model, the industry at large, and my thoughts on valuation to explain why I’m bearish on the company’s outlook. Company Overview Nextracker is the largest global manufacturer of intelligent tracker systems for utility-scale solar projects. Tracker systems improve efficiency and energy yields by intelligently directing solar panels in the most efficient proximity to the sun, thus improving the economics of a project. The additional upfront capital spending to install a tracking system, often 10%-15% of the total project cost, is made up for in the long run by enhancing energy yields. Similarly, Nextracker’s value proposition is that its products, while at a marginal pricing premium to its competitors, offers the best energy yield enhancement and ultimately the lowest levelized cost of electricity among its peers. Nextracker’s growth strategy is to expand internationally (growing positions in the Middle East and India) to further build market share. Background When looking at the historical financial performance of Nextracker, the company has delivered CAGRs of 21% and 37% in revenue and EBITDA, respectively, driven by strong industry tailwinds in the solar tracking market (source: S&P Capital IQ). According to one source, the global solar tracker market was valued at $7.88 billion in 2023 and is projected to grow to $25.24 billion by 2032. Given the global solar tracker market value, Nextracker’s implied global market share is roughly 29%, with its U.S. market share at 41%. Author, based on data from S&P Capital IQ Competitive Environment So, if Nextracker is a market leader and is poised to grow with the industry’s growth rate, what gives? One of the biggest issues I see with the industry is the competitive environment, which should increase R&D costs and reduce gross margins, as the company (and industry as a whole) cuts prices in order to compete. On the company’s latest Q4’24 conference call, management’s tone was increasingly cautious on the competitive environment compared to previous calls, noting a reduction in both system costs and pricing. With panel pricing down, the trackers that Nextracker sells are representing a larger percentage of total hardware costs in an industry which is dealing with higher financing costs. Nextracker expects more pricing pressure in the future. Together with its competitor Array, they control a 70% market share in the U.S. (Nextracker has 45% market share), according to Morningstar. But tracker systems are a relatively new technology with just a few players. While Nextracker has over 500 issued and pending patents, R&D makes up less than 2% of sales and as new entrants enter the market as the cost to develop and manufacture trackers increases, Nextracker’s pricing should suffer which should lead to margin erosion. Margin Compression When looking at analyst estimates for gross margins, some normalization is expected with gross margins for FY’25 and FY’26 at 27.9% and 28.0%, respectively, according to Bloomberg. I view consensus estimates as being high for two reasons. Firstly, while management hasn’t broken out the backlog in terms of the geographic and customer mix, based on previous commentary on earnings calls, U.S. business is higher margin, which is what partially drove margin expansion as the company took on more U.S. customers this year. Given Nextracker’s focus on growing in international markets, it’s likely that more of the backlog is tilted to international customers, compared to U.S. customers in the current revenue mix. Secondly, the combination of rising prices with easing supply chain inflation that Nextracker has experienced unlikely to persist into the future. Based on commentary from competitor Array’s Q4’24 earnings call, ~10% price reductions are already occurring as customers expect that as the tracker companies benefit from lower commodity costs (e.g. hype deflationary steel market), they should pass those cost savings to them. Nextracker will need to share these lower costs with customers in the next few years in order to remain competitive and maintain its leading market share position. As an aside, $121mm of Nextracker’s $813mm gross profit was related to the manufacturing tax credit, which isn’t likely to persist into next year. Valuation To value Nextracker, I assumed a WACC of 10.06% based on the U.S. 5 Year Treasury yield, which includes a cost of debt based on its Term Loan A credit and a cost of equity based on the implied market risk premium and industry beta of 1.25. My assumption shares consensus view on revenue of 14.6% and 12.2% in FY’25 and FY’26, respectively, where revenue is at the mid-point of guidance given on the most recent company conference call. Where my analysis differs, however, is on their margins. For gross margins, I assume FY’25’s margin will be the same as FY’24, excluding the one-time impact from manufacturing tax credits. Thereafter, I assume NXT loses 150bps of margin the following year, settling in the mid-20s by the end of the decade, as NXT competes more aggressively on price and as cost savings are passed on to customers. Based on my assumptions, I derive a share price of $28.82, implying about 46.9% downside from the current price. While my target price is far off the current price, I don’t believe my assumptions are aggressive. For one thing, the growth rates are still in line with industry growth rates and margin normalization in the mid-20s seems like a reasonable bet. Author, based on data from S&P Capital IQ As for the upside risks to my bearish target price, one possibility to justify the current market price is to assume a more aggressive adoption of solar tracker technology and solar energy becoming a more viable source of renewable energy. Another is that Nextracker could continue to expand its market share beyond the 40% range. This seems like a more reasonable assumption compared to the former, because of Nextracker’s market position, name recognition, and wider geographic coverage. With mid-teens market growth, increasing tracker penetration rates, innovative company-specific technology expanding addressable markets, Nextracker could be considered a buy if you have more optimistic and aggressive assumptions on these growth rates compared to my estimates. Conclusion No question about it: Nextracker is a clear leader in the solar tracking industry, with better margins and higher market share. However, I think Nextracker’s valuation fully reflects most of the positives, all while most analysts haven’t underwritten the strong possibility that margins deteriorate from here. With more entrants entering the market, it will be hard to maintain a strong market share when the company doesn’t invest that much into R&D to improve its product offerings. At the very least, I believe Nextracker will be forced to pass on cost savings to its customers and keep prices low in order to compete with other market participants. For these reasons, I’ll be avoiding shares of Nextracker and will keep a ‘sell’ rating for now.