Description

INTRODUCTION

Sunrun describes itself as “The Nation’s Leading Residential Solar, Storage and Energy Services Company”. 

A quick perusal of the accounting reveals that the only thing it is a leader in is losing money. Since 2016, has had negative 30% operating margins and not a single consecutive quarter of operating cash flow. 

Based on this, it sounds like an instant short. 

But this is VIC, not twitter, so here is why Sunrun is a terminal zero. 

DISCUSSION

Sunrun has two business lines. Solar panel leasing and solar panel installing. Both are unprofitable, and unlikely to be anytime soon.

1. Solar Panel Leasing (Customer agreements and Incentives)

Solar panel leasing is when Sunrun raises equity money from L.Ps, forms a G.P., gets a bunch of customers to sign the lease, and then finances the remainder of the initial capex by raising non-recourse debt.  Like any good lessor, Sunrun’s job is to finance its capital outlay low, lease high, and earn the spread. Sunrun claims that it can achieve over 5% returns on invested capital, which more than covers the initial capital outlay and cost of debt, thus achieving a presumably healthy margin. But it cannot even hit ROIC above 5%, let alone positive NPV.

Figure 1

There are a bunch of reasons why that 5% NPV calculation is untrustworthy, included, but not limited to:

1. A purported 30yr lifespan(which exceeds the projected maximum age of the panels)

2. Presuming 90% renewal at the end of the lease

3.  “adjustments for stock based compensation” on the cost side, where SBC has almost equaled gross profit for the past 2 years. 

4. A 0% default rate on the leases

Although we cannot find the true NPV, we can at least show that it is far lower than the 5%, simply by looking at the lease and operating revenue minus the costs(this is denoted as customer agreements and incentives revenue and costs on the income statement), and comparing it to the amount of capitalized solar panel PPE. – i.e. pre-tax, pre-interest system-level ROIC > cost of capital for positive NPV.

Over the past few years, for every $1.00 spent on capital expenditure, Sunrun has struggled to earn more than 3% of operating system-level profit (i.e. gross profit on the customer agreements and incentives), or $0.03, far short of the 5% required to even achieve positive NPV- and this is after including tax incentives, which often reach up to 80% of operating profit on those leases. 

As we note from the figure below, Sunrun’s ROIC on those solar panel leases has been sub 3% in most year’s and has only been trending down. In fact, sunrun’s costs are only likely to increase. As we know, solar panels decline in productivity(See The impact of aging of solar cells on the performance of photovoltaic panels - ScienceDirect as an example), of around 1-2% per year, and that is with increasing levels of maintenance as the panel ages- over time maintenance costs can only increase with age. 

Sunrun’s leases also mention 20-25 year performance guarantees. If Sunrun’s solar panels are unable to hit those levels, then Sunrun is on the hook for payments. Channel checks with several Sunrun leaseholders revealed that their performance guarantees were pegged from year 1/constant levels (despite the well-known effect of ageing on solar productivity), and that Sunrun will have to compensate them for lost electricity. In other words, Sunrun is doubly screwed from the cost side. Not only will they be on the hook for increasing maintenance costs, but also face additional payments for lost production. Sunrun’s highly negative reviews(Sunrun Inc. solar reviews, complaints, address & solar panels cost) , especially in comparison with another installers, also seem to indicate a company struggling with cost control and execution.  As a result, Sunrun’s annual interest costs have consistently averaged 2x that of its annual gross profit on the leases, indicating a severely broken business model. 

Figure 2

Even if you believe management’s 5% number(Figure 2) , Sunrun’s incremental cost of capital is not 5%. Sunrun’s publicly traded, recourse zero-coupon notes trade at a YTM of >8% as of last month. Sunrun’s current weighted average nonrecourse interest rate(i.e. interest rate on the debt linked to the solar leases) as of 31 Dec 2021 was 4.5%, and pegged to the trailing 3 month LIBOR. The most recent ABS sale was at 4.75%. Given the current interest rate environment, any incremental debt raised will have to be at least 6, if not 7%. For reference, the high yield index effective yield has increased from ~4.5% as of last year to 7.45% as of now. I dare say that Sunrun qualifies as “high-yield”. 

Furthermore, note that according to management’s own estimations, a 200bps increase in rates is enough to completely wipe out Sunrun’s NPV. As in the figure 3 below, a 2% increase of the discount rate from 5% to 7%(however unrealistic), dropping gross earning value(the NPV of the subscriptions before costs) by ~ 20%, which reduces the NPV to breakeven. 

Figure 3

In other words, Sunrun’s solar leases simply aren’t profitable, and whatever meager revenue from the leases is far exceeded by the interest payments on the initial capital outlay. And even if we do accept the outlandish management figures, rising rates present a real risk to profits. 

2. Solar Panel Installing

Sunrun also “earns” money via solar panel installations and distribution, averaging ~20% gross margins, which is in line with other distributors and installers. More disturbingly though, it has only does so by spending an exorbitant amount on sales and marketing. 

For the past 4 years, Sunrun’s Sales and Marketing expenses have been ~3x that of their solar panel installation and distribution gross margins. In other words, terribly unprofitable.

Remember that this is a crappy installation business- there’s no way to beat out the competition in this highly commoditized market.

UNIT ECONOMICS AND MODELLING

We can also think about Sunrun’s 2 segments as 1 large process of selling, financing, installing, and leasing combined. After some calculations based on the public model, we get (on a per year basis, based on the last 2-3 years), for each new KW installed:

Capital expenditure of : $1500-2000 /KW

Leasing gross profit of: ~$30/KW per year 

Interest rate(~5% per annum) of: $75 - $100/KW per annum(assumes wholly funded with debt- unrealistic, but just treat it as a toy model)

Installation profit of ~$200 per KW installed

Sales and Marketing of ~$700 per KW installed

In other words, there is no way for them to make money - Sunrun isn’t even trying. Note that this is before G&A, corporate level taxes etc. 

PATH AND CATALYSTS

So why now? The stock is down ~50% from highs, but I think that the troubles are just starting. 

1. Increasingly expensive growth – topline is harder to hit.

1. JV’s are getting more expensive. Financing cost on each incremental lease goes up, and at the same time debt advance rate goes down(debt advance decreases by 4% for every 1% increase in interest rates.). Assuming a 90% debt funded financing, any 1% increase in rates increases the required equity exposure by 40% based on Sunrun’s own slides. 

2. L.P.s become more skeptical, perhaps demanding better terms, or more sales and marketing. Sunrun probably has to inject proportionally more cash before(as compared to L.P.s). L.P.s also probably find better substitutes in other credit opportunities with rising rates over the next year or so. 

2. Increasing inherent cash burn – harder to keep surviving

1. Biggest cost for installations and maintenance is labor and panels. Neither seem to be going down any time soon. Gross margins on leases continue to deflate

2. If RUN has to inject more equity to continue growing with increasingly skeptical LPs and Financiers, it exposes itself to increased cash burn from the unprofitable leases.

3. Not a true link, but RUN just burnt 200m last year on SBC. What happens when the stock price gets cut in half? Will workers not insist that they get paid in cash or more stock instead? Already seen this happen in tech land. 

4. Also small but possible signs of cash problems. Accounts payable spiking by $100m over the quarter for instance.  

3. Debt schedule. -Increasingly onerous

1. RUN has to repay ~$190m of debt in 2022, $600m in 2023, $700m in 2024. They have 1.7B of current assets, 1B of current liabilities, so positive by 800m. Also has 80m of unused borrowing capacity. But they also burn cash. They burnt ~$380m in operating cash flow before working capital last year. Also, assuming they install an extra ~400MW at minimum of capacity( based on Q1 earnings transcript) = >1B of capex using last year’s numbers as a proxy. In other words, they have ~880m of liquidity right now, ~800m of debt due in 18 months, and have to find partners and help burn another 1B of capex. Have no clue how they can make it past 2024.

4. Insider action – you think they know anything we don’t? 

1. Everyone is selling(See below), CFO just left. 

RISKS

1. People keep giving them money. I don’t get it, but management claims that they had another 400MW in commitments, which is what they said in Q2 2021, which is on a larger install base. Have to see how this evolves over the next quarter or so. 

2. Biden tariffs. Biden has indicated freezing further tariffs on solar panels. Unclear if this makes an impact(earlier section 201 had no impact on the company). 

3. Sunrun claims that they have been able to ramp up prices and profitability. I am not sure if I buy this, considering that their financial statements have only gotten worse, and management is unable to show how their “new” unit economics present themselves in the cash flow statements. All incremental analysis of the cash flow statements looks worse.

FINAL WORD.

This isn’t perfect. There’s relatively high short interest of 15%. They may or may not be able to keep funding themselves. Trades in line with solar, and maybe rising energy costs will make them seem more attractive. 

But they have to pay back the debt in some shape or form, rates are rising by at least 100bps, the company cannot seem to make profit in any shape or form, and they will run out of cash next year-or at least one of the JVs will. OCF has been negative for the past 5 years- not just net income, but operating cash flow after hideous amounts of SBC!

As importantly, I think Sunrun has a ridiculously low liquidation value, if it all. Even HOOD and DKNG have their user base. CVNA has its inventory. But all Sunrun has is a bunch of interests in solar lease VIEs, none of which can earn their cost of capital. They are going to burn a TON of cash, and none of what the spend will be of use.

Additional note: I had presumed a LIBOR of 2% by Dec 2022. Looks like it may end up being 3% based on the forward curve. If that happens, RUN is extra screwed. 

Catalyst

PATH AND CATALYSTS

So why now? The stock is down ~50% from highs, but I think that the troubles are just starting. 

1. Increasingly expensive growth – topline is harder to hit.

a. JV’s are getting more expensive. Financing cost on each incremental lease goes up, and at the same time debt advance rate goes down(debt advance decreases by 4% for every 1% increase in interest rates.). Assuming a 90% debt funded financing, any 1% increase in rates increases the required equity exposure by 40% based on Sunrun’s own slides. 

b. L.P.s become more skeptical, perhaps demanding better terms, or more sales and marketing. Sunrun probably has to inject proportionally more cash before(as compared to L.P.s). L.P.s also probably find better substitutes in other credit opportunities with rising rates over the next year or so. 

c.

2. Increasing inherent cash burn – harder to keep surviving

a. Biggest cost for installations and maintenance is labor and panels. Neither seem to be going down any time soon. Gross margins on leases continue to deflate

b. If RUN has to inject more equity to continue growing with increasingly skeptical LPs and Financiers, it exposes itself to increased cash burn from the unprofitable leases.

c. Not a true link, but RUN just burnt 200m last year on SBC. What happens when the stock price gets cut in half? Will workers not insist that they get paid in cash or more stock instead? Already seen this happen in tech land. 

d. Also small but possible signs of cash problems. Accounts payable spiking by $100m over the quarter for instance.  

3. Debt schedule. -Increasingly onerous

a. RUN has to repay ~$190m of debt in 2022, $600m in 2023, $700m in 2024. They have 1.7B of current assets, 1B of current liabilities, so positive by 800m. Also has 80m of unused borrowing capacity. But they also burn cash. They burnt ~$380m in operating cash flow before working capital last year. Also, assuming they install an extra ~400MW at minimum of capacity( based on Q1 earnings transcript) = >1B of capex using last year’s numbers as a proxy. In other words, they have ~880m of liquidity right now, ~800m of debt due in 18 months, and have to find partners and help burn another 1B of capex. Have no clue how they can make it past 2024.

4. Insider action – you think they know anything we don’t? 

a. Everyone is selling(See below), CFO just left. 

RISKS

1. People keep giving them money. I don’t get it, but management claims that they had another 400MW in commitments, which is what they said in Q2 2021, which is on a larger install base. Have to see how this evolves over the next quarter or so. 

2. Biden tariffs. Biden has indicated freezing further tariffs on solar panels. Unclear if this makes an impact(earlier section 201 had no impact on the company). 

3. Sunrun claims that they have been able to ramp up prices and profitability. I am not sure if I buy this, considering that their financial statements have only gotten worse, and management is unable to show how their “new” unit economics present themselves in the cash flow statements. All incremental analysis of the cash flow statements looks worse.