Solar installer Sunrun (NASDAQ:RUN) had a stellar 2018, with its share price jumping 84.6%. That was a dramatically better performance than competitor Vivint Solar (NYSE:VSLR) or the broader S&P 500 -- both fell by about 6% last year.
Sunrun's shares have continued on their tear this year -- they're up more than 80%. That actually lags Vivint's better-than-100% gain so far in 2019, but overall, that's a lot of share price growth in 17 months. But after a couple of underwhelming earnings reports, it's natural to wonder whether the stock is now overvalued. So let's dig into Sunrun's prospects and see whether it's still a buy.
Some scary numbers
Sunrun's share price rally makes sense when you look at the company's recent revenue growth. Over the past three years, its revenue has increased by 100.8%. It has also increased its enterprise value by 170.8%. But that's where the good numbers end.
Over that same period, Sunrun's total long term debt has also skyrocketed by 123.7% to $1.8 billion. Meanwhile, it only has $245.6 million in cash on its books. And while revenue has steadily increased, its net income nosedived by 132% over the past year. That has wrought havoc on the company's valuation metrics. Its higher share price combined with its lower earnings give it a P/E ratio of 61.1. Compare that to Vivint's P/E of 2.5.
But if Sunrun's numbers are this bad, isn't it a miracle the share price has continued to go up and up? Here's what's going on, and why these numbers may not be as scary as they seem.
Leasing the future
Many people who want to install residential solar power systems don't have the money to pay up front for them. So Sunrun happily leases those systems to them, fronts the cost of the installation, and then collects payments over the life of the lease, usually 20 years. But in many cases, Sunrun must finance those upfront costs by taking on debt itself. That's a major reason its debt levels have risen so much: The company is doing more and more installations. In fact, in the most recently reported quarter, Q4 2018, the company broke its record for deployments, selling 115 megawatts of solar power systems to 14,700 new customers.
Those deployments stay on Sunrun's books as assets -- because technically, Sunrun owns the systems and is just leasing them to customers. That's why the company's enterprise value has been increasing: The more deployments Sunrun makes, the more assets it has. However, management is valuing the potential renewal value of those leased systems rather highly.
Renewals would occur when customers reach the end of their 20-year solar leases, and then choose to renew the leases on their existing equipment. This would obviously be great for Sunrun, as it would be able to lock in additional revenue without needing to front the cost of an installation. According to a recent Sunrun investor presentation, the company's "renewal assets" of $963 million are more than twice the value of its $441 million in assets under contract.
That optimism may not be justifiable.
A whole new world
Here's the thing: We have no idea whether customers will want to renew their leases on 20-year-old solar power systems. The industry is new enough that there just isn't enough data available. What could instead happen is that Sunrun will get stuck with a whole lot of useless, outdated solar panels on the roofs of former customers.
According to Sunrun, the cost of installed solar panels has declined by 64% since 2010, and the cost of system batteries has declined by 85% over the same time frame. The company projects that panel costs will fall by a further 61% over the next 10 years, and system battery costs will decline by 49% over that time.
In other words, by 2030, when a solar system installed in 2010 hits the end of its lease, a new set of installed solar panels is expected to cost 86% less than it did in 2010. A new battery system will cost 92.3% less than it did in 2010. So will Sunrun customers renew their leases ... or opt to get new, much cheaper, more efficient systems?
Further, as the costs of residential solar power systems decline, customers may opt to just buy those systems outright rather than leasing. California, in fact, is mandating that solar panels be part of all new construction in the state by 2020. That could open a floodgate of new installations, to Sunrun's benefit...or it could lead homebuilders to try to package the solar panels into the construction as part of the sale rather than a separate lease.
If that happens, Sunrun will find itself in the unpleasant position of competing against numerous other middleman installers of third-party solar components -- and also Tesla, which recently told The New York Times that it would be cutting its solar panel prices in a bid to boost its flagging solar sales.
Stay on the sidelines
The economics of solar keep getting better for consumers as solar panels and system components continue to get cheaper. Unfortunately, that hasn't been great news for the solar industry. In particular, it may cause problems for Sunrun's lease model and lease renewal projections. Plus, there's the big question of how Tesla' s renewed focus on solar installation might impact the market.
While an upcoming solar installation boom in California seems promising, Sunrun stock still has quite a few risks right now, and the shares aren't exactly cheap after their recent run-up. Investors should probably give this stock a pass until the future of the residential solar market becomes clearer.