You might think that all solar companies are essentially the same, installing solar systems on rooftops or open fields where there's an abundance of sunlight. But the reality is that how solar companies do business varies widely across the industry, and knowing how a company is positioned and where the industry is headed can mean the difference between making a profitable investment and a losing one.
Recent news that Vivint Solar (NYSE:VSLR), the second largest residential solar company in the U.S., is pulling out of Nevada after just two weeks shows one of the risks solar companies face. If you've got sales and installation teams on the ground you've got to keep them busy, and if you don't it can be a costly mistake.
Solar panels, financing, and the cost of "owning the trucks"
There are essentially three components to a residential solar installation. There's the equipment -- panels, inverters, racking, wiring, etc. -- that goes on the roof, there's financing for the project, and there's a sales and installation team that works in the field to put equipment and financing to work.
Some companies are vertically integrating up and down that supply chain, like SolarCity (NASDAQ:SCTY), which controls financing, sales, and installation, and has acquired solar panel and racking companies. Vivint Solar is vertically integrated with financing, sales, and installation, but doesn't make solar equipment. SunPower (NASDAQ:SPWR) makes solar panels and designs other equipment and provides financing for projects, but it generally doesn't do the sales or installation directly. These three companies show different models, which can all work in the solar industry.
One debate I've had over and over is whether or not owning the sales and installation teams, also known as "owning the trucks", is wise for solar companies today. While the residential market can be attractive when installations are going gangbusters, if there's a lull in business and you have thousands, or tens of thousands, of workers to pay each month it can erase years of strong operations very quickly.
Companies like SunPower and Sunrun have viewed this as a risk they don't want to take, and essentially pay a fee to third party companies that sell and install systems, providing financing and other services, like high efficiency solar panels in the case of SunPower.
For a long time it appeared that "owning the trucks" was actually the best strategy, but Vivint Solar's news in Nevada could show what a risky strategy it is.
Why Vivint Solar is abandoning Nevada
The story of Nevada is the story of a great potential solar market with entrenched powers that have been very successful staving off the solar industry. NV Energy, which is owned by Warren Buffett's Berkshire Hathaway, has proposed extremely onerous rate structures, including basic service charges, demand charges, and energy charges. The change in structure would essentially kill the residential solar industry where it stands.
Before regulators could decide whether to allow or oppose NV Energy's plan they wanted to study the options. So, it allowed net metering to continue with a cap of 235 MW, put in place in May. Solar installers thought that would get them into 2016, when they hoped regulators would allow more net metering, but NV Energy says it's approaching the cap, which could bring the industry to a halt.
This is no small market for the solar industry either. According to GTM Research's first quarter 2015 Solar Market Insights Report, Nevada installed more residential solar in Q1 than it did in all of 2014, and in total it was the second largest solar market in the country at 97 MW (behind California at 718 MW).
For Vivint Solar, it wasn't even worth keeping its new outpost in Nevada open, and SolarCity could run into similar challenges. If the residential solar industry in Nevada collapses, SolarCity would be out millions in operating costs because workers won't have anything to do.
"Owning the trucks" may allow for lower costs and even faster growth in residential solar, but it also comes with risks.
Don't underestimate diversification
One of the major risks U.S. solar companies face today is the reliance on a small number of markets, namely California, where 55% of the solar installations in Q1 2015 occurred.
As we see in Nevada, policy changes can impact a business almost overnight and make a formerly attractive market an unprofitable one. That's why diversification and contracting with sales and installation companies may prove to be a better strategy long-term. It won't be as good when the industry is booming, but it won't require massive layoffs and losses when there are disruptions in the market.
Sometimes the risks in the solar industry are deeper beneath the surface than you think. We may now be seeing the risks involved in building massive sales and installation teams.
Travis Hoium owns shares of SunPower. Travis owns, and the Motley Fool owns and recommends, Berkshire Hathaway. The Motley Fool owns and recommends SolarCity. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.