Another quarter is in the books for residential solar installers, and it wasn't as bad as many investors had expected. Costs were down, helped by plunging solar panel prices and declining sales costs, and many companies are making the necessary transition to solar loans.
One interesting trend that continued was Sunrun Inc (NASDAQ:RUN) posting strong value creation, despite having higher costs and no technological differentiation from competitors -- especially when compared to industry leader SolarCity Corp (NASDAQ:SCTY.DL), which has much lower costs.
How Sunrun's magic works
When Sunrun's third quarter earnings were released, investors were wowed by the numbers. Net income of $16.9 million on revenue of $112.0 million was impressive, and installations were stronger than expected.
Beyond the headlines, how Sunrun got to those numbers is a little questionable. Below is a table of the key cost, value, and financing figures reported by Sunrun and SolarCity last quarter.
Let's just ponder those numbers for a moment. Sunrun has significantly higher costs than SolarCity, but it's generating 31% more value per watt, 30% more in tax equity financing, and 6% more in financing and other early payments. If we were to use Sunrun's cost numbers and SolarCity's value generation projection, the company would barely be breaking even, and that's including very generous assumptions about discount rates and renewal value.
There are two, and only two, explanations for what's going on at Sunrun. One is that it's charging customers more for solar leases and power purchase agreements, which is shown in the higher debt financing, rebates, and prepayments for its solar systems. Sunrun's management says it focuses on customers that will be profitable, so it's conceivable this could mean higher energy production and/or pricing on a per watt basis.
The second, and far more concerning, possible explanation is that Sunrun is using a much higher value per watt when it sells tax equity financing to investors, leading to larger tax credits than competitors. No matter what the cost of a solar system, the resulting tax value should be similar for similar components, and since SolarCity and Sunrun use standard components there shouldn't be a big difference in the value of their systems for tax purposes. I could see a small difference being feasible, but the numbers above imply that Sunrun is valuing its systems 30% higher than SolarCity's for tax purposes.
The percentage of costs funded by tax equity and other financing sources should be fairly similar for both companies as well. But you can see that Sunrun is getting much more funding from tax equity and much less from creditors funding cash flows.
Tax subsidies can be a slippery slope
Keep in mind that this tax valuation number is something Congress has investigated before, and as the residential solar industry grows it could do so again. If companies overestimate the value of the solar systems they install they could be getting larger tax subsidies than they deserve, and they could be held liable for the difference. Without knowing the exact valuations being used by Sunrun, it's difficult to know if it's overestimating value -- but the comparison against the industry's leader is concerning.