Sunrun Inc. (RUN, Financial) was founded in 2007 and has grown to become the largest residential solar company in the U.S. with a market share of about 18%, making clean energy more accessible to those without the option of commercial clean energy.
In the first part of this two-part series, which can be found here, I discussed Sunrun’s product offerings, business model and financial structure in order to assess the current state of the business’ operations. The key takeaways were that Sunrun mainly makes its money by leasing solar panels to customers, and that it is currently far from profitability, as its cost of goods sold, operating expenses and investments in other companies are higher than its revenue.
In this discussion, I will go over the market opportunity available, Sunrun’s supply chain structure and the headwinds the company faces or could encounter in the future.
Market opportunity
First, let’s take a look at the market opportunity that Sunrun forecasts for itself. Sunrun sees the addressable residential solar market as incredibly underpenetrated; according to its third-quarter 2022 earnings report, only 4% of addressable homes in the U.S. have solar. The U.S. residential electricity market is worth approximately $194 billion per year, so any expansion in this market share could rake in huge profits. The company estimates that, with a 15% compound annual growth rate for the next decade, it could achieve 17% penetration of addressable U.S. households.
Sunrun also claims that households with electric vehicles consume approximately double the electricity of households without EVs. This is likely due only in part to the energy consumption of the EVs themselves. Right now, those who adopt EVs still tend to skew toward the wealthy, and greater wealth usually correlates to higher energy consumption. As the world’s electricity demands continue to increase, so will the market opportunity for residential electricity and thus solar.
According to Sunrun, its residential solar panels will be a less costly way to meet energy needs overall compared to “bulky centralized infrastructure.” Personally, I disagree with this argument. For starters, competitor First Solar (FSLR, Financial), which mainly deals in utility-scale solar energy systems, is in much better financial shape than Sunrun and is actually profitable. Another consideration is that the country cannot just abandon centralized energy infrastructure if we want it to continue functioning. If we go the decentralized route, then it would need to be an “all in” kind of thing.
However, the energy grid in the U.S. is outdated, and from an individual’s perspective, another incentive to get rooftop solar panels is to be secure in the knowledge that even if the energy grid does falter or collapse, your individual household at least will still have a source of electricity. This by itself could be a huge hidden source of value if the U.S. continues failing to invest sufficiently in the electric grid.
Even so, in the absence of further incentives, many customers will likely opt to wait for utility-scale renewable energy to reach their area so that they do not have to put in the additional work to learn about solar panels. A powerful incentive would be if utility companies put the cost burden of system upgrades on consumers, hiking prices to an unsustainable level, in which case more people would want to get rooftop solar panels to save on energy costs.
Supply chain
No matter how good the market opportunity is, a company cannot survive without its supply chain. Securing the necessary materials and components at favorable prices is essential to success, as is making more money from goods than what you paid to acquire, distribute and manage them.
Sunrun primarily partners with Korean tech conglomerate LG Corp. (XKRX:003550, Financial) and China-based LONGi, the largest solar panel manufacturer in the world, to source its solar panels, and it gets its batteries from Tesla (TSLA, Financial). It has also formed a promising partnership with Ford (F, Financial) to provide an at-home charging station for the F-150 Lighting, which I discussed in part one. This could potentially lead to partnerships with other EV makers.
Sunrun does fall on the higher end of the spectrum in terms of its full solar array sales, but its main product is its leasing program with as little as $0 down (though not all customers will be able to meet the qualifications for $0 down).
When we get to the marketing and human capital part of Sunrun’s supply chain is when the real cracks begin to appear. Sunrun employs many people, not only to install solar panels but also to provide maintenance and, most notably, sell to new customers. In fact, with selling, general and administration expenses at half of revenue, we can see the company is really pushing efforts to expand its customer base.
Growing customers is great for the company, but the fact that it needs to spend so much on selling its products is worrying. Upon reviewing the anecdotes of former Sunrun sales representatives, it appears even the sales representatives themselves recognize that Sunrun is far more expensive than local competitors. Former sales representatives said they felt bad when they made a sale when customers could have gotten a much lower price.
We are again brought back to the $0 down monthly lease. Customers who have the monthly lease typically report that it is cheaper than their utility bill would be, as long as the array meets enough of the home’s energy needs. Positive reviews seem to more be coming from larger households that consume higher amounts of electricity.
There is a key assumption in Sunrun’s financial modeling that investors need to keep an eye on. Sunrun assumes that customers will typically renew their leases upon expiration (or the new owner will renew if a customer sells their house and transfers the lease). If they do not renew, Sunrun must remove the solar panels and restore the roof to its original condition at no additional cost to the customer, which is a huge expense.
Sunrun’s bears claim that, given advancements in solar panel technology, customers are incentivized to cancel Sunrun upon the expiration of their lease and switch to a competitor, much like customers might switch between AT&T (T, Financial) and Spectrum internet each time their promotional discount runs out. The biggest problem I see with this argument is that Sunrun and its competitors are not required to give customers the latest tech just because they made the switch. They will still try to get the maximum number of years out of their systems, replacing only when repair is not feasible.
Depending on how many customers renew and how many cancel, Sunrun may have to allocate more resources than expected to its supply chain in the form of retrieving, assessing and relocating solar panels and accompanying technology. The company will move and reinstall solar arrays at an additional cost to the customer if they want to take their solar panels with them when they move house.
Other headwinds
We have already gone over most of Sunrun’s key headwinds, but to recap, the company is unprofitable and likely will be for many years to come, it spends an exorbitant amount of money on marketing that smaller local competitors do not have to contend with, its full system sales are too overpriced to be competitive (potentially to push the leasing option) and potential customers often do not want to bother with the additional time investment to learn about solar.
Right now, the company benefits from its massive investments in sales because it has been able to rapidly scale up and get its name out there. However, if rooftop solar panels do end up becoming more popular due to rising utility costs, competition will also have the opportunity to grow, and local (cheaper) competitors will likely strengthen as well due to increased interest within their service areas.
Then, there is the unpredictability of government incentives to consider. The U.S. government does provide tax credits for rooftop solar arrays, but they tend to very broadly from year to year based on changes in policy and the customer’s unique financial situation. The oil and gas industry has been heavily subsidized by the government since its inception, and the renewable energy industry is also making some strides in this regard, especially on the utility scale. When it comes to rooftop solar panels, local incentives can be what makes the difference for a customer, but usually only if you install locally sourced panels, which favors local companies.
Last but not least, solar panels need many raw materials to be produced at scale, and if any of those materials are disrupted due to shortages, it could greatly increase the price of solar panels and decrease market penetration. This problem is not unique to Sunrun, but it still must be considered.
Takeaway
Overall, I think Sunrun has too many profitability issues to ignore. Its cost of goods sold and SG&A expenses alone are enough to give me pause, let alone the many headwinds the rooftop solar industry faces as compared to the utility-scale solar industry.
Sunrun’s lease offering is a great idea in concept, but I do not think the energy situation in the U.S. has reached the point where mass adoption of it would be feasible. It is cheaper for some customers when compared to paying a utility bill, but it is not cheaper for everyone, and those that are interested in solar panels typically are more interested in purchasing the system outright, a market in which Sunrun is not competitive in the slightest.
