The past week hasn't been good to U.S. residential solar stocks. Vivint Solar (VSLR +0.00%) and Sunrun (RUN 5.02%) both reported earnings that left a lot to be desired from an investment standpoint. The number of installations were strong, and low financing costs are helping business. Installation costs, though, continue to rise at an unsustainable level.
The low-hanging fruit in the residential solar industry has been picked already, and now installers are spending more and more to reach each incremental customer, which isn't a sustainable model long term. Dig into the numbers, and there are some very concerning trends.
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The rising cost of doing business in residential solar
The cost of buying solar panels, inverters, and other components and installing them on a homeowner's roof should fall over time as the industry gets more efficient. And broadly, installation costs have been falling for Sunrun and Vivint Solar over the past decade. But the cost of finding each customer is rising sharply.
Both companies' business models are built on growing the installed based quarter after quarter, but once the easy-to-reach customers have been signed up they have to spend more and more to find incremental growth. First let's look at how costs have trended overall in the past year by looking at creation cost (which covers installation, sales and marketing, and administration) per watt.
| Company | Q2 2018 | Q1 2019 | Q2 2019 |
|---|---|---|---|
| Vivint Solar | $3.23 | $3.46 | $3.56 |
| Sunrun | $3.12 | $3.46 | $3.33 |
Overall cost per watt. Source: Company earnings releases in Q2 2019.
You can see that both companies are experiencing rising costs overall. But dig into the numbers and we see that nearly all of the increase in cost is due to higher spending on sales and marketing, which is shown below on a per watt basis.
| Company | Q2 2018 | Q1 2019 | Q2 2019 |
|---|---|---|---|
| Vivint Solar | $0.96 | $1.16 | $1.27 |
| Sunrun | $0.69 | $0.78 | $0.80 |
Sales and marketing cost per watt. Source: Company earnings releases in Q2 2019.
There are going to be ups and downs in costs depending on the mix of states a company is selling into and things like weather, but overall rising marketing costs are concerning, and the fact that costs are rising across the industry is bad for everyone involved.
Tesla's attempt to upend the sales model has failed
The fundamental problem is that solar system sales are still labor-intensive. The most successful installers are built on door-to-door sales and talking each customer through installing solar energy. That's why the cost of sales and marketing is so high.
Tesla (TSLA 3.59%) attempted to lower costs by selling through its showrooms, and laid off its door-to-door sales force to lower costs. Earlier this year it said it was lowering its cost to consumers to just $1.99 per watt (after incentives) by selling online, and even that has failed. At its peak, Tesla (then SolarCity) installed 258 MW of solar panels in a quarter; in Q2 2019 it installed just 29 MW.
Vivint Solar and Sunrun have taken share from Tesla in part because they kept their sales model in place. But as costs rise, that model may be starting to crack.
Another model that could be working
One company holding its own in residential solar is SunPower (SPWR +0.00%), manufacturer of high-efficiency solar panels and other components. The company doesn't directly install solar panels, but rather offers hardware and services to installation partners across the U.S. and around the world. It's now second in residential market share with 70 MW installed in the second quarter, behind 103 MW for Sunrun and ahead of the 56 MW Vivint Solar installed.
Where SunPower is having success is offering high-efficiency solar panels that squeeze more power from each roof and letting local installers do the leg work on selling systems. Gross margins are currently strained at just 8% last quarter, but a new solar panel known as the A-Series, which lowers costs to nearly the level of commodity solar panels, should help the business. A residential energy storage solution is also expected this year, which will add incremental revenue and margin to the business.
SunPower's advantage is that it's offering components and services to third party installers. This lowers overhead and (in theory) makes sales channels more efficient because they're closer to the customer. If we see SunPower continue to gain market share and margins go up, this could be a winning model in comparison to Vivint Solar, Sunrun, and Tesla.
In search of a winning strategy
Residential solar companies are in a highly competitive business, and if costs are rising it'll undermine the business on multiple levels. Margins, or retained value, will be squeezed, and competitors will be able to undercut their pricing. Rising costs may be a canary in the coal mine, and investors should be cautious as costs spiral out of control.
