The solar industry is having a rough go of it early in 2018, hurt by the implementation of tariffs on solar panel imports and rising borrowing costs in the U.S. As the third biggest rooftop solar installer in the country, Vivint Solar Inc (NYSE:VSLR) isn't immune to the macro trends hitting the industry.
Recently released first-quarter 2018 results show deterioration in some key metrics that should concern investors. Here's what I'm keeping my eye on right now.
Installations are falling and costs are rising
Installations fell 11.8% in the first quarter to 40.4 megawatts (MW) as higher costs hit the industry and Vivint Solar put less emphasis on growth to focus on markets where rooftop solar has better economics due to better solar insolation or higher competing electricity costs. That may be a good strategy for now, but you can only shrink your addressable market for so long to help margins if costs are continually rising.
There's on silver bullet to bring down costs either. The cost of installation rose $0.20 sequentially to $3.15 per watt on higher costs across the board. Installation costs were up $0.08 sequentially, and non-installation costs were $1.22 per watt, the highest level since the company came public in 2014. Tariffs are part of the rise in costs, but it's clear that the cost of installing solar is going up across the board. Competitor Sunrun's costs also rose $0.21 per watt to $3.51 in the first quarter, so Vivint Solar's challenges aren't isolated, but they're a bad trend for Vivint Solar long-term.
The entire thesis of the solar industry has been that costs are coming down, increasing the addressable market and driving growth of the entire industry. Vivint Solar is saying costs are going up and it's going to shrink its business as a result. That's going to help margins short-term, but it may not last if competitors lower their prices and if costs continue to rise Vivint Solar may need to keep cutting its addressable market to maintain margins. Ultimately, rising costs and a smaller addressable market is the opposite direction from where solar companies should be headed.
Loan and cash sales are dropping
A big surprise is that Vivint Solar's volume of solar system sales, versus leases or power purchase agreements (PPAs), took a step back in the first quarter. System sales were just 7.2 MW, down from 11.7 MW in Q4 2017. Meanwhile, lease/PPA installations rose slightly to 33.2 MW.
Selling solar systems allows Vivint Solar to book gross margin immediately and offload the financing of projects to the homeowner or bank. Increasing lease/PPA sales will increase the company's financing needs, and it may not be a good time to do that.
Financing is getting more expensive
There have long been two pieces of financing solar systems for Vivint Solar to deal with, and both are getting tougher for the company. The first is tax equity financing, which sells the tax credit solar systems receive, accelerated depreciation, and a small amount of cash flows to an investor. Companies buying tax equity then use these credits to lower their own taxes. The tax reform bill passed in December 2017 has lowered corporate tax rates, reducing the need for tax equity from companies like Vivint Solar. That makes financing projects a little more expensive.
Maybe more notable is the rise in interest rates, which makes financing any remaining cash flows from solar installations more expensive. You can see that rates have risen about 50 basis points since the beginning of the year, and that'll reduce what Vivint Solar can finance in the future.
Small changes in financing can be a big deal for a company like Vivint Solar. Management uses a rate of 6% (the discount rate) to calculate its current retained value of $1.296 billion. But if the discount rate goes up to 8% -- because interest rates rise or investors see residential solar assets as higher risk than they did previously -- the value is just $1.103 billion. Rising interest rates and weak tax equity demand will be big headwinds for the company long term.
Trying to turn the ship around
Management knows there are challenges facing Vivint Solar and is making some changes to turn the business around. They're changing the compensation structure for sales people to focusing on profitable markets and adding third-party dealers to the network. The intention is to increase sales in the most profitable markets and give up sales where margins are low. However, it could take a few more quarters for the strategy to help financial results.
For investors, there's still value on the balance sheet with an estimated $6.78 per share in net retained value. Even if the installation business is breakeven long term, there should be upside to investors with shares trading at just over $4 per share.