2023-08-15 00:41:24 ET
Summary
- Low-interest policies and subsidies have nurtured renewable energy companies with unsustainable business models, including Sunrun.
- Sunrun's business model revolves around residential solar energy solutions, but its heavy operating expenses and sinking gross profit margins raise concerns about the viability of its business model.
- The company's sustained and increasingly negative cash flows in addition to shareholder dilution are further weighing the stock down.
- Recent macro events, such as rapid interest rate increases and potential decreases in utility rates, pose challenges for Sunrun's debt-dependent growth strategy.
The low-interest policy of the Federal Reserve yielded many unintended outcomes and potentially nurtured numerous businesses with unsustainable business models. This is in addition to the fact that investments in climate change have been driven by subsidies and tax credits further fueling the growth in renewable energy companies with unviable business models.
My focus recently shifted to Sunrun's annual report and latest earnings, which reinforced my belief that recent events are not favorable to the company. Below we will briefly examine their operations and break down their financials to further examine how the current environment makes this company a Strong Sell.
Business Model
Sunrun ( RUN ) operates with a business model centered around providing residential solar energy solutions. As a leading player in the solar industry, Sunrun offers homeowners the opportunity to transition to clean and renewable energy sources. The core elements of Sunrun's business model include:
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Solar Panel Installation: Sunrun designs, installs, and maintains solar energy systems on residential properties. These systems consist of solar panels placed on rooftops, converting sunlight into electricity.
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Leasing and Power Purchase Agreements (PPAs): Sunrun offers homeowners the option to lease solar systems or enter into power purchase agreements (PPAs). Under these arrangements, homeowners can enjoy the benefits of solar energy without the upfront costs of purchasing and installing the equipment.
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Solar Ownership: In addition to leasing and PPAs, Sunrun also provides homeowners the option to buy and own solar energy systems outright. This allows homeowners to take full advantage of the financial benefits and energy savings associated with solar power.
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Energy Storage Solutions: Sunrun offers energy storage solutions such as batteries that store excess solar energy generated during the day. This stored energy can be used during peak demand times or when solar generation is insufficient.
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Monitoring and Maintenance: Sunrun provides ongoing monitoring and maintenance services for the solar systems it installs. This ensures that the systems are operating efficiently and generating the expected energy savings.
All these operations result in the following revenue mix. For fiscal 2022, Customer agreements and incentives contributed to 42% of the revenues, and Solar energy systems and product sales contributed to the rest.
Revenue mix for 2022 (Annual Report 2022)
This business has been operational for quite some time and most bullish arguments focus on their customer growth and growth in net sales. But the cost of net sales and additional operational costs gives us the first hint that this business model is unviable. Costs of customer agreements and incentives are 96% of the revenues brought on by this segment and solar energy systems and product sales are not much different (88%). When you include additional expenses, we see that expenses exceed sales by 28%
Cost mix for 2022 (Annual Report 2022)
The company does mention that the cost of customer agreements in 2022 also includes costs carried over from systems placed in 2021. But when we look at their history of operating margins, it is clear that their heavy operating expenses are not a recent phenomenon. This is in addition to the fact that their gross profit margins have also been sinking.
The business has been operational for close to 15 years and the normal expected trajectory is that as the company matures, it starts getting a better grip on its costs. The fact that we see this going in another direction questions the viability of their business model.
Latest events
We have had quite a turn of macro events in the last few years. From a low-interest rate environment, we have had the fastest pace of interest rate increases in history. The market again expects the Fed to pivot but no one is sure of the timeline. There is a view that higher for longer is something that could be very much expected. This makes it very tricky for businesses such as Sunrun which depend on a lot of debt and external financing to grow. Looking at its LTM, the company has been able to grow its top line and is able to show positive net income mainly due to an increase in minority interest which offsets its expenses.
Income statement snapshot (Seeking Alpha)
But Net Interest expenses have almost doubled during the comparable time periods. The company also acknowledged this in its latest earnings release and highlighted its approach to address it as it has also been affecting its cash generation capabilities.
Sunrun has increased pricing and adjusted go-to-market approaches multiple times throughout 2022 and into 2023 to respond to inflation and higher interest rates. High utility rate inflation across the United States has provided us the headroom to increase pricing while still delivering a strong customer value proposition...
Recent rapid interest rate increases, inflationary pressures, and working capital needs have prevented recent meaningful Cash Generation. Since the start of 2022, the increases in the cost of capital reduced realizable proceeds on new installations by more than $1 billion. We responded with higher pricing, which was possible given escalating utility rates and operating efficiency improvements...
The increased cost of borrowing money has lowered the initial funds that Sunrun can get from the value of its installed systems. This decline has been happening since the start of 2022. However, this reduction has been balanced out mainly by higher prices and a greater 30% Investment Tax Credit. But as we saw from the interest expenses, this is far from sufficient.
From their statements, I have highlighted "high/escalating utility rates" as their primary enabler for Sunrun to counter the increase in interest expenses. Here is the problem. What about a scenario where interest rates go higher or continue to remain high but utility rates start going down and customers start reacting to increased prices from Sunrun? This could possibly be a double whammy for the company. There are indications that the first part of this scenario (interest rates have remained high but utility rates go down) already happening .
Certain analysts predict that the decrease in natural gas and coal prices, which collectively fuel around 60% of U.S. electricity production, will gradually influence consumer electricity costs. It's typical for consumer rates to adjust to fuel costs with a delay of six to nine months. This delay happens because utilities often safeguard themselves from price changes by purchasing resources in advance. A recent announcement from the Connecticut Public Utilities Regulatory Authority is providing further support for this fact -
On average, electricity rates starting July 1 will decrease by about 22% for typical Eversource residential customers and about 11% for typical UI residential customers using an average of 700 kilowatt-hours (kWh) of electricity a month
Other negatives
1. The company has had increasingly negative internal cashflows and there are no indications to see this improving in the future. In my opinion, it is quite hard to see a situation where this can be sustainable
2. In addition to debt fueling the company's growth ambitions, the company has been increasingly looking at shareholders to fund its growth (Close to a 100% increase in shares outstanding). Again hard to see this being sustainable
3. Valuing this company is especially hard when the company has a low net income, negative EBITDA, and negative cash flows. We could look at its EV/Sales which presently has a value of 6x. Within the sector, this is overvalued. But since it has such a unique business model we could just compare it to another company operating in a similar fashion (In my opinion, companies in this business suffer from some of the same problems as Sunrun. I have covered the problems with Sunnova here ).
Rounding Up
I believe Sunrun is a Strong Sell. In my opinion, the company's business model is inherently unsustainable. This is clearly evidenced by their operations. The company could take steps to turn this around but this means significant effort and time, both of which the company does not seem to have. It faces headwinds in terms of interest rates and decreasing electricity prices which do not provide it with the conditions it needs to make an impact on its business. The stock market realizes this to a big degree when you see the stock price which is down more than 80% from its highs. Are there risks to this thesis? Certainly. Part of the business model rests on government subsidies and a big increase in this would definitely be to the company's advantage. We could also see a quick return to the low-interest rate environment which could again play into the hands of the company. But unless I see these developments, I will not be revisiting my thesis.
For further details see:
Sunrun: Sprinting Away From This Business Model