The residential-solar industry has gone through some big changes over the past year. Large, national installers such as Vivint Solar (NYSE:VSLR) and Sunrun (NASDAQ:RUN) have lost market share to smaller, regional and local installers, and customers have moved to buying their solar systems with cash or loans, rather than leases or power purchase agreements that drove the growth of national installers.
Companies are adapting different ways to these industry changes. And the futures of Vivint Solar and Sunrun as investments could depend on how strategic decisions work out.
Adapting to loans and cash sales
Vivint Solar is adapting to the new conditions in residential solar by transitioning to more solar system sales. In the first quarter of 2017, solar system and product sales were $22.7 million, compared with just $0.7 million a year ago. And it generated 17.9% gross margin on those sales, which isn't a bad start for the company.
Cost per watt also fell to $2.98, a level that could be competitive with smaller competitors in the future. And costs are expected to be $2.95 to $3.05 per watt in the second quarter.
Doubling down on the solar lease
Across the U.S., the solar lease or power purchase agreement is slowly dying. As the cost of solar systems comes down and low-cost loans become available, it simply makes no financial sense to sign a 20-year lease. But Sunrun is doubling down on its leasing business as others push new types of financing.
In the first quarter, megawatts deployed jumped 21% to 73 MW, but solar energy system and product sales fell 12.7% to $56 million. The challenge with doubling down on leases is that you're making lofty assumptions about value creation years into the future. And with contracted project value estimated at $3.58 per watt, compared with creation costs of $3.38 per watt, there isn't much room for error in those assumption. Just increasing the discount rate to 8% (which is far more reasonable than 6%) and the default rate to 5%, the company loses $212 million of projected value versus its current assumptions.
Costs for Sunrun's internal installations were $2.94, but overall costs were $3.38 per watt. That's much higher than the costs of its competitors, which is the company's biggest problem long-term.
What is the winning strategy in residential solar?
The uphill battle both companies are facing is the loss of market share for national installers in general. Even Sunrun's growth, which was rare for the industry, didn't come without questionable assumptions of value creation, as I outlined.
From a cost side, both companies are also going to have a hard time competing with smaller installers, which don't have the same overhead costs. I think Vivint Solar has the better strategy for long-term value creation, but right now I don't think either stock is a great bet.