Slowing down to reduce costs and focus on more profitable customers seems to be working well for residential solar installers like Vivint Solar (NYSE:VSLR) and Sunrun (NASDAQ:RUN). Costs are down, and value generated per watt has been up for both companies

In the case of Vivint Solar, a move to begin selling more solar systems is also paying off. If the trend continues the company may be a great way to play the residential solar industry. 

Row of identical homes all with solar panels on their roofs.

Image source: Getty Images.

Vivint Solar's turnaround quarter

Installations were only 47 MW in the second quarter, down from 61 MW a year ago. And retained value increased just $75 million, which isn't much considering the $1.5 billion of estimated retained value on the balance sheet.

What Vivint Solar is making progress on is its cost structure and sales strategy. Costs per watt were down to $2.88, from $2.94 a year ago, with installation costs down to $1.81 per watt from $2.12 a year ago. Falling solar panel prices were a big assist in lowering installation costs.

But that's not the biggest news for Vivint Solar.

The transition residential solar is making

I think the more important development is Vivint Solar's move to sell more of its solar systems. In the second quarter, solar energy system and product sales were $29.6 million and gross margin was 22.82%. The implication is that if Vivint Solar had sold all 47 MW it installed it could have had an operating profit of around $10 million.

Residential solar companies have long relied on leases, which rely on customers paying for energy over 20 years or more to make money. But customers now prefer to buy their solar systems, and there's no long-term history indicating what default rates will be like or how customers will behave when a solar system is 15 or 20 years old, particularly if a home is sold or the lease ends. Therefore, I think leases are higher risk than most solar companies let on. But solar sales generate margin immediately, which is one reason Vivint Solar is moving to the business model. And so far, it's going well. 

How Vivint Solar could become a great buy

On top of the solar system sales, management says there's net $690 million in retained value on the balance sheet, accounting for debt. If the company can monetize more of that value and increase the percentage of system sales increase, Vivint Solar can de-risk its business and become more profitable. If it does, the stock could be a value once again. 

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