Sunrun Sprints Forward

Sep. 21, 2020 6:22 AM ETSunrun Inc. (RUN)VSLR20 Comments7 Likes
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Summary

  • California-based Sunrun, with the pending approval of its merger with Vivint Solar, importantly commands both scale and a 17% stake in the highly fragmented US solar installation market.
  • While understandably skidding in the COVID-19-impacted 2nd quarter, forced backlogs, the pulling forward of operational program alliances and low borrowing costs should drive growth in second half and beyond.
  • US energy consumption sourced from renewable sources is about 10%, with forward growth projections doubling over the next two decades.

California-based Sunrun (NASDAQ:RUN) hit full market stride after skidding badly in the heat of the COVID-19 pandemic this past March. Sunrun announced an all-stock purchase of Vivint Solar (VSLR) in the first week in July, which sent both stocks skyward. Sunrun (green-red line) currently posts a market cap of roughly $7 billion. Since the July announcement, the stock is up over 200%, dramatically parting ways with both its 200-day trading average (blue line) and the S&P 500 (black line) since mid-May. For its part, Vivint Solar (orange line) boasts a little more than half Sunrun’s market cap at about $4 billion, posting a similar upward thrust (see Figure 1, below). The merger creates a combined 17% share in the US solar installation market, leaving SolarCity/Tesla (TSLA) with a distant 5% share on data through the end of 2019. Somewhat surprisingly, last week the Department of Justice formally bowed out of any move to block the merger on possible anti-trust grounds, clearing the way for a vote of the shareholders on the merger in the next several weeks. Final approval of the merger is expected in early October. Once the two companies are merged, Vivint shareholders will own 36% of the fully diluted outstanding shares of the merged company.

Figure 1: Sunrun and Vivint Solar against the S&P 500

As with most mergers, management highlights the synergies to be gained, the reduction of standing operational costs and rosy forecasts of growth, and the Sunrun-Vivint merger is not different on the score. Management sees savings of about $90 million in merging the joint operations of the two companies, which increases the customer base of the merged company to half a million. The increase adds an estimated $8,000 in net present value per customer through the end of the year. Merged grid services, that is, solar promotional programs through utility companies like Southern California Edison, and Orange/Rockland county subsidiaries of Consolidated Edison here in New York, could add dramatically to that forward growth paradigm.

To date, the company has already inked ten grid services contracts through the end of the 2nd quarter, worth about $50 million over the lifespan of the resulting contracts. Another potent area of growth is through community choice aggregation (CCA). CCAs enhance the purchasing power of local governments by bringing a collection of towns together to shop for and negotiate long-term contracts for the delivery of energy to its residents and businesses from disparate energy sources, including renewable providers. Opt-in/opt-out CCA agreements could deliver renewable energy and/or credits for an entire town - delivered through the transmission and distribution services of a local utility provider. Grid services tie into thousands of local energy consumers, potentially providing a motherlode of potential adopters of renewable energy products at a fraction of the across-the-table sales tools of old.

Through the end of 2019, renewable energy production in the US came to 11.6 trillion BTUs. Consumption of renewable energy came to 11.5 trillion BTUs over the same period. Residential consumption came to 825 trillion BTUs. Total energy production from all sources came to 101.1 trillion BTUs, while total consumption came to 100.2 trillion BTUs for the period. That breaks down to just over 10% of US energy consumption is currently coming from renewable sourcing. Forward projections have renewable energy consumption doubling over the next twenty years. The Vivint Solar purchase provides scale in a highly fragmented solar installation market.

Further cost reductions come from the development of proof-of-concept programs for renewable energy, which have now been completed in 10% of Sunrun’s geographic markets. These programs tie solar energy production with battery storage capabilities, sketching out the beginnings of virtual power centers at the local level. Batteries provide energy capacity on cloudy days or a vehicle for returning excess energy back to the grid. Almost every US state has introduced time-of-use tariffs as a way of controlling the cost of energy during peak daytime hours users. The flip side of that equation means electricity could become more expensive in the evening hours, more likely to hit residential rather than commercial users. Battery storage allows the sale of generated electricity when it is most profitable to sell. Accordingly, solar-plus-storage systems tend to score higher cost efficiency measures than solar-only systems.

Of course, the aftermath of the 2018 California fires ushered in a totally new paradigm with the announcement of planned blackouts to prevent fires that trace back to climate change and malfunctioning utility equipment. The California market for solar-plus-storage systems is expected to grow six-fold though 2025, a statistic gathered prior to the current firestorms ravaging not only California, but Oregon as well as Washington State. More than 40% of Sunrun’s client base through the end of 2019 is in California.

Storage battery capacity, however, remains limited given current storage battery technology. The typical daily household use of energy is about 30kWh. The equally typical storage battery unit has a capacity of about 10kWh, of which about 9kWh is actually usable. When temperatures hit freezing or below, usable battery capacity falls by about half. With this example, three stackable batteries would provide enough storage capacity for just about 24 hours of energy during the warm summer months and about half of that figure when temperatures are at or below freezing. Given the scale of power outages in fire-torn California, Oregon and Washington State, an extra 24 hours of stored power may fast become more of a value proposition to an increasing number of homeowners in fire-prone areas of these states, despite the average $8k to $12K price tag for a single battery pack. The California Self-Generation Incentive Program offers rebates on renewable energy purchases to low-income households and communities in fire-prone areas of the state. Longer-duration battery capacity is still in the future.

One further consideration: the 25-year lifespan of a typical PV system means battery packs will likely be replaced at least once, perhaps twice. As with electric cars, technology advances in batteries come in the form of range. For storage batteries, capacity will no doubt increase with time.

Renewable energy companies that generate free cash flow and have strong balance sheets hold a clear comparative advantage over financially weak competitors in a highly fragmented market - if for no other reason than rewarding the former greater access to the capital needed to finance growth. Sunrun provides investors with a steady, smooth, utility-like level of recurring cash flow predictability and resulting earnings profile. While its customer base has the option of buying the company’s solar equipment outright and services as needed, most of Sunrun’s client base lease both equipment and services in long-term, 25-year contracts. This high-quality cash flow predictability, coupled with historically low borrowing costs in the greater market - at least through 2023, according to recent Federal Reserve estimates - provides a strong tailwind for both company project funding and growth over the time frame.

In the 2nd quarter, the company installed 78 megawatts of solar capacity - a big climb-down from the 2,085 megawatts installed in the 1st quarter. The decline speaks worlds to the disruptive nature of COVID-19 on business operations and installations during the period. Unsurprisingly, the pandemic slowdown created a sizable backlog of projects that will hit its balance sheet in the second half of the year. COVID-19 also forced new restrictions on the conduct of business and operating procedures that are now in place. More importantly, the pandemic abruptly pulled forward the aforementioned marketplace alliances, such as promotional programs with CCAs, utility companies and other novel client outreach endeavors that, under different circumstances, would have taken much longer to implement. The formula is surprisingly simple and straightforward: Sunrun offers up discounts on equipment and installations. In return, CCAs and utilities send promotional emails and other literature to their respective customer bases. The offset comes from greater penetration of these markets, efficiencies gained through lower acquisition costs, lower costs to clients and greater revenue generated by increased volumes of sales.

Barring a second wave of COVID-19 in the fall and winter months, coupled with a medical solution to the pandemic in early 2021, pent-up demand for goods and services across the greater economy is a reasonable expectation for the merged company’s overall growth equation through the end of the year and likely beyond. The second half of the year projects out $8,000 net present value per client installation from an augmented client base, creating added cost savings for clients and value for shareholders - all the while building an energy internet for the future.

This article was written by

Douglas Adams profile picture
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Douglas Adams specializes in macro-economic research and turning theory into practical portfolio applications for clients over the past seventeen years. Mr. Adams recently formed Charybdis Investments International based in High Falls, New York where he is the managing director of a fee-only investment advisory practice with clients throughout the United States. As an author, Mr. Adams has commented widely on a diverse array of topics from Brexit to monetary policy to forex to labor productivity and wage growth. He holds an undergraduate degree from the University of California, a master’s degree from the University of Washington and an MBA in finance from Syracuse University.
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Disclosure: I am/we are long RUN, VSLR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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