Sunrun Inc. (RUN -2.43%) has become the biggest residential solar installer in the U.S., overtaking former leaders in the industry. But that doesn't mean the company is home free in solar. Competitors continue to fight for market share, and there are some headwinds all solar installers are facing. What investors will want to look at is whether or not the risk outweighs the potential upside.
Competition is coming
The truth is that Sunrun has benefited from broad solar industry trends to take market share over the past two years. Tesla (TSLA 12.06%) has de-emphasized and shrunk its solar business over the past two years, leaving space for Sunrun to grow. And Vivint Solar (VSLR) was weakened after its failed sale to SunEdison, a debacle it's still recovering from. Sunrun filled the gap both companies left behind.
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However, the competitive environment Sunrun is facing at the end of 2018 might not be as friendly as the past few years. From a product standpoint, SunPower (SPWR -1.02%) just got a lot stronger in the residential solar market after it was granted an exemption from solar tariffs for its high-efficiency solar panels. This will siphon off some of the high-end portions of the solar market, which are also some of the highest margin customers.
Vivint Solar is also in a much stronger position than it's been in over the last two years, and is looking to grow. It expanded in Florida and Illinois this year, and other states will soon be added to the mix. With its solid financial footing and a flexible sales model that includes both lease and loan financing, Vivint will be a company to watch closely.
And don't overlook competitors increasingly moving to a loan or cash sale model, rather than the lease model that Sunrun is sticking with right now. The cost of loans has come down far enough that it's often cheaper to finance a solar system purchase than lease a system for 20-30 years. This will take installations from Sunrun, and potentially force the company to fight based on price, which will squeeze margins. None of this will be good.
The Fed is a headwind
The other macro fear I have for Sunrun is interest rates. Instead of putting the interest rate risk on customers or banks, as a solar loan or cash purchase would do, Sunrun finances solar projects itself. If interest rates go up, as they have all year, so will the cost of doing business.
One of the big takeaways from SolarCity's collapse pre-Tesla acquisition was that once SolarCity's financing costs started rising it wasn't long before the company had financial trouble. Installers need a constant flow of cash, and rising rates can shut the cash off quickly.
The upside for Sunrun
According to GTM Research, the residential solar market shrunk 15% in 2017 as headwinds like fewer incentives and the threat of tariffs hit installers. But installations have flattened out, and are expected to grow slightly as states like California and Florida open up more solar incentives.
That tailwind could be great for Sunrun, which can leverage its large market share to grow in each solar market. That doesn't mean there aren't challenges from competition or financial markets, which I outlined above -- but if the entire residential solar industry is growing, it's good for solar installers.
Why I'm not a buyer yet
What I'm most worried about is Sunrun's financing model and what could happen if customers shift to cash or loan sales in the future. If customers shift to buying solar systems, Sunrun's origination costs -- which are about 10% higher than those of competitors like Vivint Solar -- could become a problem.
Sunrun has $1.72 billion of contracted earning assets on the balance sheet, but that's offset by $1.48 billion of debt obligations, leaving just $240 million of contracted value according to management's projections. That's not a lot of balance sheet value for a company with a $1.4 billion market cap, and with my questions about Sunrun's business model long-term I plan to stay out of the stock altogether.
