Sunrun: Four Reasons I’m Neutral For Now (NASDAQ:RUN)

Introduction

Sunrun (NASDAQ:RUN) is a provider of Solar Panels, Batteries, and Solar Systems primarily targeting residential customers. The company has seen its share price trade in the teens before a big move upward in 2021 as a result of speculative money coming into exciting, but highly unprofitable, names. Since then, however, the stock price, along with the entire residential solar sector, has underperformed. Here are four reasons I believe RUN may continue to underperform and is worth avoiding.

Reason #1: Profits and Cash Flow

Sunrun’s business model currently consumes massive amounts of cash as a result of funding solar panel purchases and installation themselves and offering customers financing or leasing options.

Sunrun has technically earned positive net income in the past, but cash from operations has always been negative, and free cash flow is substantially worse as the company requires massive capital expenditures. Sunrun’s negative FCF is in the billions of dollars annually. It’s difficult to grow a business that is so CAPEX intensive, as the business will continue to require more and more capital as it gets bigger.

That said, this may ultimately prove to be a moat in the long run, as it will make it tremendously difficult for new entrants to compete. Given Sunrun’s position as the current market leader, the opportunity to build this moat remains.

Reason #2: Higher Rates For Longer and NEM 3.0 in California

High interest rates directly impact Sunrun’s subscription-based lease-like model, whereby homeowners finance or lease their solar systems over a period of 20-25 years. Higher interest rates simply make it more expensive for homeowners to lease or finance solar panels.

Inflation has stayed moderately above 3%, leading the fed to hold rates rather than pursue cuts for now.

Many economists were predicting multiple rate cuts in 2024, but now that we’re halfway through the year, it appears we may not get any.

This makes it substantially more expensive for homeowners to finance solar panels, leading to a reduction in sales for Sunrun and its competitors.

Furthermore, the new NEM 3.0 policy in California changes how solar is sold back to the grid (known as “export rates”). Under the old policy, Solar owners could sell back their excess electricity to the grid at the retail rate they’d pay. The new rules only allow solar owners to sell electricity back at wholesale rates, and/or changes the billing structure to reduce financing payments on the panels rather than reducing their utility bill. Investors can read more about this here.

Ultimately, NEM 3.0 makes it less beneficial to install solar-only systems. However, NEM 3.0 may actually increase the benefits of pairing solar with battery storage. The effects of this policy on Sunrun are yet to be determined, as it may encourage more battery sales, but simultaneously reduce solar sales.

Reason #3: High Debt and High Valuation

Sunrun has $11B of debt and just $3B of equity. This substantial debt position cost Sunrun over $250M of interest expense last quarter, which is a run rate now exceeding $1 billion of interest expense going forward.

Given the relatively small amount of equity, it could be difficult for Sunrun to address their debt problem. Even if Sunrun diluted equity holders substantially, it still would not be nearly enough to offset their debt position.

Sunrun compares unfavorably in capital structure compared to competitors like SunPower (SPWR), which has only about $300M of debt and $600M of equity, but more favourable relative to competitors like Sunnova (NOVA) which has about $700M of equity and a whopping $7.5B of debt.

Sunrun trades at the highest P/S multiple relative to its closest peers. One could perhaps justify this by suggesting that Sunrun is the leader, and therefore deserves the highest multiple. It should also be noted, however, that multiples on these solar companies are difficult to compare given different levels of gross margins and significantly different capital structures.

Reason #4: Politics

They say never to mix politics with investing. However, at risk of venturing into dangerous territory, investors in Sunrun should at least pay some attention to potential policies that could impact the future of Solar in the near to intermediate term.

The recent presidential debate saw what most would describe as an underwhelming performance by current President Biden. This has resulted in Trump’s victory odds increasing. Given Trump’s position of being less supportive of renewables and more supportive of traditional energy, the Solar industry could see some less favorable policies, especially relative to oil & gas, should we get another Trump administration. That said, some Solar policies do benefit red states. It remains to be seen what the ultimate impact of another Trump Presidency would mean for this industry.

Recapping 24Q1 Report and The Upside Case

The first quarter of 2024 saw Sunrun’s customer additions decline by about 24,000, down 26% year over year. This illustrates a clear slowdown in the residential solar market. However, some of this was offset by subscriber value increasing by about 15% YoY. Total customers increased by 15% YoY, and now sits at just under 1 million. Overall, the KPIs here had mixed results.

This all resulted in revenue declining in the quarter from $590M in 23Q1 to $458M this year. Decent cost controls also brought operating expenses down such that the operating loss came in at $183M compared to $228M in Q1 of last year.

The company reiterated guidance of $200-500 million of annualized cash generation by Q4 of this year. I am currently skeptical of this figure. However, if the company can indeed achieve this, then perhaps the equity does start to look cheap at a market cap of $2.4B (5-12 times guidance cash generation). If you believe they can achieve and sustain this guidance, then it seems likely the stock may have a chance at turning around in 2025.

Conclusion

Sunrun is the leader in the residential solar panel industry and has led the market with innovations in their business model, allowing customers to install solar systems without paying the entire up front cost. However, this model makes Sunrun capital intensive. Higher interest rates have also had an impact on Sunrun as their products become more expensive for customers as a result of higher interest rates. Sunrun has considerable debt. Finally, future US administrations could have an impact the success of the Solar industry.