Module Manufacturing's Role In The Rooftop Solar Industry

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Includes: FSLR, SPWR, SUNEQ, TSLA, VSLR
by: Simple Investment Ideas

Summary

While the rooftop solar industry is still dominated by pure-play companies, upstream integration will likely become necessary for long-term survival.

The leading solar manufacturers are more than capable of integrating into the rooftop solar industry, which means that pure-play rooftop solar companies are in a battle against time.

The rooftop solar companies that successfully integrate upstream the earliest will likely be the long-term winners in the rooftop solar landscape.

On top of the incredible risks associated with solar manufacturing, the window of opportunity for upstream integration may be rapidly closing.

The rooftop solar industry has been somewhat cut off from the rest of the solar industry thus far. While the leading global solar manufacturers have integrated into several downstream markets, the rooftop solar industry has yet to see the same kind of integration into upstream manufacturing. The question of whether solar manufacturing integration will be vital for success in the rooftop solar industry is becoming more important than ever, especially with the pace of the industry's maturation. While this has yet to be answered definitively, upstream integration should theoretically be advantageous, and even necessary for the long-term survival of rooftop solar companies.

While it has been relatively easy for solar module manufacturers to integrate downstream, the same may not be true for rooftop solar companies' attempts to integrate upstream. This is largely due to the fact that the downstream solar segment is much less competitive than the upstream segment. Given that module manufacturing is arguably the most difficult aspect of the solar value chain, this is only to be expected. As a whole, rooftop solar companies are rather ill-equipped to integrate upstream, which may present enormous difficulties for pure-play rooftop solar companies moving forward.

The Inevitable Trend

Despite the tremendous difficulty of integrating upstream with no prior experience, it may be necessary for rooftop solar companies to do so nonetheless. Solar manufacturers will almost certainly start to diversify into rooftop solar in the long run, which many have already started to do (e.g. SunPower's (NASDAQ:SPWR) move into the global residential solar markets). If the leading solar manufacturers start to diversify into rooftop solar in any meaningful way, pure-play rooftop solar companies will almost certainly be unable to compete.

As such, the only way for the current pure-play rooftop solar companies to stay as the dominant players in the rooftop solar industry would be to integrate solar manufacturing. Doing this would allow these companies to capture the integration benefits of module manufacturing, putting them on an even playing field with the established solar manufacturers. In addition, these rooftop solar companies would also be able to keep their lead in the rooftop solar industry. While this is feasible in theory, very few rooftop solar companies likely have the technical/operational capabilities to integrate upstream. The rooftop solar companies that will be able to will likely gain disproportionately by pushing out the rest of the players.

The Winners and Losers

Currently, only SolarCity (SCTY) is even attempting to manufacture solar panels. This is not so surprising given how young the modern rooftop solar industry is. Despite this, the solar industry waits for no one, which means that rooftop solar pure plays may have to integrate into solar manufacturing as soon as possible. If these pure plays wait any longer, established module manufacturers will likely takeover the rooftop solar industry. As the barriers of entry for rooftop solar have not had time to mature, it may still be easy for highly-competitive, leading module manufacturers to rapidly take market share away from rooftop solar pure plays.

These leading manufacturers would be creating their modules in-house, saving an immense amount in terms of module logistic and resale costs. This means that it would only be easier for such manufacturers to take market share away from rooftop solar pure plays. While only a small percentage of rooftop solar players will be able to successfully integrate into module manufacturing, attempting to do so will likely be necessary nonetheless. So far though, rooftop solar companies may still have a few years left before successful integration becomes an absolutely necessity.

Unlike other major rooftop solar players such as Vivint Solar (NYSE:VSLR) or SunRun, SolarCity has already taken the initiative in this regard through its acquisition of Silevo. In fact, SolarCity is taking the manufacturing integration concept to a whole new level, and is constructing one of, if not the, largest solar manufacturing facilities in the world. So far, SolarCity seems to be the winner in the manufacturing integration arena, although the final result is far from certain. Despite this, SolarCity has the highest chance of manufacturing integration success out of all the current rooftop solar companies due to the company's managerial talent.

The longer other leading rooftop solar companies wait to get into manufacturing, the more painful it will be for them later on. Small rooftop solar companies, on the other hand, almost stand no chance in this regard. The smaller rooftop solar companies do not have the financial capabilities of entering module manufacturing, and cannot even withstand the relatively minor integration already occurring from leading solar companies. These small rooftop solar companies will definitely not be able to compete in an environment where the leading rooftop solar companies have integrated into solar manufacturing.

The small rooftop solar companies are already losing share at an extremely rapid rate, which is a pattern that should only get accelerate with the onset of the rooftop solar industry's upstream integration. This essentially means that the long-term winners in the rooftop solar industry will have even larger market shares in the rooftop solar industry, as the smaller rooftop solar companies still make up for around half of total market share. If leading rooftop solar companies can survive upstream integration, they should gain enormously.

SolarCity is the only leading pure-play rooftop solar company currently involved in solar module manufacturing. As is depicted in the picture below (taken approximately 2 months ago), the construction process of the company's massive manufacturing facility is well underway.

Source: buffalonews

Opportune Moment For Upstream Integration

While the current solar landscape is one defined by its segmentation, the trend of consolidation across the solar value chain is clear. Although it has not yet gotten to the point where solar manufacturers are integrating into rooftop solar en masse, the trend is clearly pointing in this direction. Given the likely oncoming module supply shortage, it may be an opportune moment for rooftop solar companies to start integrating into manufacturing, although this window of opportunity is rapidly closing.

As the solar industry has historically moved in boom-bust cycles, there are clear signs of a boom cycle coming, which is only natural given that the industry just suffered one of the worst solar PV bust cycles in history. As such, business cycles usually last a few years, and as building out manufacturing capacity also takes a few years, an argument could be made that it is already too late to enter into manufacturing with the intention of feeling the positive effects of a boom cycle.

SolarCity, on the other hand, may have entered the market at the right time, as its manufacturing facility should be nearly complete by the year's end. This should make it easier for SolarCity to successfully integrate into manufacturing, as margins for module manufacturers are higher during boom cycles, therefore leaving more room for margin of error. Although it will be much harder for pure-play rooftop solar companies to integrate during a bust cycle (where manufacturer margins oftentimes hit the low-single digits), the vast majority of rooftop solar companies may have to do so anyway in order to survive the inevitable trend of industry-wide consolidation.

Extreme Challenges For The Rooftop Solar Industry

Pure-play rooftop solar companies still face many obstacles regardless of these companies' timings in upstream integration. Even if such companies integrate at exactly the right moments, this still does not guarantee success by any means. In fact, many have been skeptical about SolarCity's ability to produce cost-comparable modules even in the case of a supply shortage. Of course, such concerns are very real and just highlight the challenges facing the pure-play rooftop solar companies.

If SolarCity will have a hard time successfully integrating upstream, this speaks volumes about the difficulties that other, much less competent rooftop solar companies face. SolarCity has already proven itself to be extremely competent in an innovation and operational sense, largely due to its unparalleled management team. On the other hand, other leading pure-play rooftop solar companies have largely achieved success through imitating SolarCity's business model. Although this is to be expected given SolarCity's initial lead in the industry, this means that other pure-play rooftop solar companies such as Vivint Solar may face much higher risks in their integration attempts.

Conclusion

There is no doubt that the rooftop solar industry is nowhere near mature, which means that much more consolidation and integration is likely to occur. The long-term solar landscape will likely be of one where the leading solar companies are integrated across the entire solar value chain, from manufacturing, downstream utility-scale/distributed solar, and even to energy management. This leaves very little room for pure plays, of which the rooftop solar industry currently houses a disproportionate amount of such companies. While the barriers of entry are certainly rising in the rooftop solar industry, they are still not yet high enough to keep out the highly competitive leading solar manufacturers (and may never be).

It must be remembered that the current leading solar manufacturers are some of the most competitive companies in the world. These manufacturers are the handful of solar companies out of literally hundreds that have been able to survive the brutal period of module overcapacity in the past few years. Such companies, e.g. First Solar (NASDAQ:FSLR), SunPower, SunEdison (SUNE), etc., are likely more than capable of penetrating the rooftop solar market in the rooftop industry's current state. This implies that the current leading rooftop solar companies will absolutely need to integrate upstream in the near-term future.

So far, only SolarCity, and Vivint Solar to a lesser degree, seem capable of doing so. As such, these two companies have much more upside compared to the rest of the rooftop solar industry. Despite this, success in upstream integration is still far from guaranteed. While it would be a safer bet to invest in the leading solar manufacturers such as the ones just mentioned, the leading rooftop solar companies offer more potential reward, albeit at higher risks. Either way, both these types of solar companies have tremendous amounts of upside.

Disclosure: The author is long SCTY.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.