Sunrun Inc. (RUN) Earnings Call Transcript & Summary

Okay. I think we're live so I'm going to start. All right. Thank you, everybody, for coming. I'm Mike Weinstein from Crédit Suisse, Utilities and Alternative Energy Analyst at the bank. We also have -- on the line with us today, we have Ed Fenster, Co-founder of Sunrun, along with Patrick Jobin, Senior VP of Finance. And we also have met Maheep Mandloi, my colleague over here at Crédit Suisse, who helps cover renewable energy for us. So anyway, thanks for joining us today, and I wish we could do this under more fun circumstances, but this will have to make do for now. Don't drink too much during the call, hopefully. We -- why don't we open it up for just opening remarks. Ed, you can make a few remarks, if you want, and then we can up for questions after that. And if anybody has any questions that you would like to ask, besides my own list, you can send me an e-mail to [email protected], which is also on the left side of your Zoom screen, right? I'll read your question out when you e-mail them to me. Right. Thanks. Ed?

Well, thank you. Good afternoon, presumably, to everyone who's on the call. Appreciate your making the time. As Mike mentioned, I'm the Co-Founder and Executive Chairman of Sunrun. We're quite optimistic for 2021, both professionally and personally, as hopefully, we're winding down our virtual conferences and getting back to normal life. But looking forward to chatting with you a little bit about our recent strategy and development and scale and the opportunities ahead of us.

All right. Great. So -- anyway, so I thought we'd kick it off and talk about maybe the in-house installation and sales operation that you guys have that differentiates you a lot from your competitors? I'm not sure how to -- what to make of it going forward. My instinct tells me that, as competition for dealers heats up among your competitors and among -- including yourself, that eventually in order to grow faster in this market, in order to keep growing in a market that's very underpenetrated -- only 4% of eligible rooftops have top solar, that you're going to need some kind of in-house operation, that you guys are on the right track but this is -- everybody else is going to have to copy you. Do you see -- how do you view it? Like, why did you established an in-house operation? And am I on the right -- am I thinking about this the right way? Or are there other benefits or advantages to doing it that way?

Yes. So it's a great question, Mike. So I think there are a couple of reasons that in 2014, we added an in-house operations. So for the benefit of folks on the call, for the first 7 years of the company's history, we were a channel-only business, just working through dealers. And then there were a number of things that caused us to realize we really, in many circumstances, wanted to be doing this work ourselves. Some relate to just basic business topics like growth and profitability, and some relate to just capabilities that we need to achieve the future that we want to realize. So first, from a standpoint, you're old-fashioned, but the case -- like, the amount of profit you earn as a business relates to the value-add of your business. And if all you're doing is bringing financing to the equation, then you're only ever going to earn a margin that looks like a finance company. And there are people who make good margins doing finance, but they're -- it's ROE business. It's not much better than that. Whereas, when you're in the business of doing more and harder work, finding customers, effectively installing them, owning customer relationships, that's just -- it's just fundamentally a better business with more profit opportunity. But in addition, we discovered that there were a lot of things that if we wanted to do, we really needed to control it more ourselves. Initially, it was things like, "Okay, if we're going to be selling solar in Home Depot and Costco, we really want to have a tight customer experience where we're installing it." We can have those national relationships, originate those projects nationally and install it and do a good job installing it where it's not like there's one company selling it. Home Depot's in the middle, there's someone else installing it, like, it's just -- it's a much better customer experience. And ultimately, like, the long-term success of the company results from satisfied customers who were further friends and are happy. And then second, as we think about the future of the business from here, there is going to be much more to the product offering, right? Once upon a time, it was just sort of dumb rooftop solar. Now we're adding batteries. We're supplying that capacity from the battery to utilities and grid operators and are starting to get into vehicle electrification. We've been experimenting with the sale of retail energy without taking wholesale price risk and discovering that when we offer customers a single price for their grid energy and their solar energy, we get churn rates on the grid energy side that are our tenth market. And so there's this holistic opportunity to create an energy provider. And again, controlling the customer acquisition, being able to create those customers in the areas that are most advantageous and holistically coordinate this really required vertical integration to construction. It's also the case that when we look at our cost structure for installation and compare it to others, which is relatively easy because often when we're growing very quickly, we go out into the market and we say, "Okay, what would you, local installer, charge us to install these 30 customers in San Jose?" And we get the bids back, and we compare that to what it costs to do it ourselves. By and large, particularly in places where we have a bunch of business, we're able to do it more cost effectively ourselves. So there's some actual, actual profit on the EPC side, particularly where you can be doing 1 megawatt of business within a 30-megawatt -- within a 30-mile drive time off the branch per month. That's part of where the synergies in the Vivint transaction are coming. We're going to be able to consolidate a bunch of local branches and get higher density, shorter drive times, et cetera and a higher profit as a result.

Right. Do you think that there's a -- we were talking to Sonova earlier and they've been talking about establishing a university for new dealerships going forward. And that there's sort of an aspect of should we be franchising this business? Or should you be managing it yourself and taking on the risk of payroll yourself? And I remember before the pandemic started in 2019, there was a labor shortage issue around -- and a mistiming of when you should be hiring and you had over-hired for the winter. And those problems went away with the pandemic because the pandemic superceded it, but it -- and going forward, maybe -- have you learned any lessons from that going forward that can prevent those kinds of labor shortage issues in the future and keep this the right path instead of a -- more of a franchise approach?

Yes. So great questions. So first, if you think on a very long-term basis, probably electricians are the constraint in the industry. And that's one of the reasons why we're trying to attack the issue in 2 ways. One, build a differentiated brand on the human resource side, where we have better career opportunity, better career advancement, better training, a better place to work and live and that we invest heavily in that. And it's a place we can differentiate because we're just a much more significant complex company than a lot of people operating in the industry. And then in addition, frankly, yes, that probably does mean over time, we'll be training folks to bring them into that role. I do not think there is a shortage of people who have the entrepreneurial spirit to form dealerships. And frankly, there's enough competition on the wholesale side that a lot of the dealers end up basically putting the risks of ownership on their financiers but keeping the benefits. So one of the things, if you can run a great solar development business, you have a lot of margin opportunity to earn good margin in excess of like what a finance margin would be. But also if you're commanding fantastic payment terms and other things from your financiers, the downsides are theirs and not yours. So we've been very disciplined about that. We offer a lot of value to our dealers that our competitors don't in terms of brand, in terms of procurement, in terms of systems, in terms of the ability to help with both training of installation and sales, labor, et cetera. Like, we're in the business, we're experts at it. We can help people do better and really facilitate them. And then also when folks partner with us, obviously, we don't -- we're not in the business of like poaching employees from our partners. So that's a benefit for everyone who works in our ecosystem as well. So I feel good about that channel. I think it's an important channel for us. They'll continue to grow. But I do think when I think about, like, where I -- we really want to take the business and expand the product and have the opportunity to earn significantly more margin, like, that really is more likely to manifest in the direct channel.

You guided to about a little over $1 a watt for this year for -- or $7,500 per customer of value creation, mainly stemming from solar and some storage penetration as penetration rates start to increase. And this year is also an integration year with Vivint. How do you think about profitability beyond 2021, over the long term as you add more products and services to the offering?

Yes. So we've got a lot of tailwinds that I'm excited about on the margin side. So we've been talking at the onset of the pandemic that we expected to realize about $2,000 in savings from online sales, which result in less -- there's no drive time for the sales reps, and actually slightly higher conversion rates, interestingly, than in-person. And then second, on the permitting side, lower costs because building departments have been more receptive to our request for electronic permitting. And remote inspections via FaceTime or things like that, that just saves everybody time and effort. So that's one component of cost savings. Over the recent time period, those costs, those marginal cost savings have been offset by reduced operating leverage through the pandemic. But as we get the operating leverage back up, we should be able to see those starting to flow through. We raised the synergy target from the Vivint acquisition from $90 million to $120 million. Some of those are done already. A good chunk will probably come through over the late summer as we get the IT integrations done. And then finally, like, warehouse leasing and some of those things will come towards the tail end. But we think of the $120 million, materially all will be in the bag by the end of the calendar year. Then we've got the revenue synergies and revenue improvements. So one of the quick places, we made a lot of progress with the Vivint acquisition was rolling storage out through the Vivint sales networks. We've seen a very rapid increase in storage attachment rate to the Vivid sales force, which is fantastic. They were interested in the product, and we had it, and it's been a quick easy capture. In addition, we have said, this year, we do expect to see some constraints in the storage supply arena. Despite that, we are comfortable we'll more than double or double the storage business this year. But if we didn't have a constraint, it would be faster than that. And for that matter, if we were buying batteries, from our manufacturers at a 15% margin instead of like a 50% or whatever percent margin, maybe we'd be tripling the rate of battery installation. So as more manufacturers come online and there are more products in the battery arena, which I think is really mostly going to be a '22 story, I think you'll see some very significant cost reductions on the battery side...

Value accretion.

I'm sorry?

It sounds like there'll be more value accretion if supply constraints relax.

Exactly, because right now, there's just a very significant profit pool capture in the stage that is the productization of lithium ion batteries for residential installation. And there's more competition there that actually flows through. Then we'll have continued increases in operating leverage compared to our peers. We obviously already have radically less G&A expense per customer. We expect to be able to continue to outperform there. And then some of these other initiatives that we're working on, electric vehicle charging, ultimately, vehicle to grid, starting to experiment with a single product that includes grid energy, these are all things that we'll be layering on over a 2- to 4-year period that should be enhancing to margin per customer as well.

Right. Do you -- how much longer does it take to get batteries -- to get a system installed when it includes storage versus no storage at all? And is that -- is the extra length of time a problem for your salespeople in trying to close deals?

That's a great question. And certainly, it varies because when you initially launch storage in a market, your installation crews are less familiar with it because we're the category leader, the building department's probably haven't seen it before. And so you might end up with more change orders and more education. And so you've got this initial period within every crew and every local permitting jurisdiction, where it's a little kludgy at first and then gets better. It is, however, even in the best, most advanced markets, a little bit slower and requires more man hours to install a storage system that could be just because it's more work or it could be like Southern California Edison, inexplicably, it takes them like 2 months to approve a newer main electric panel. The CPUC is livid about that because like how are we ever going to electrify transportation or heat if you tell people they have to wait 2 months to get a new hot water heater. It's going to be electric, right? So I think that kind of stuff will work through the funnel because it's just too important not to fix. So there certainly are places where salespeople are a little bit more apprehensive to sell storage, right, because of these considerations, obviously, it's #1 in our strategy agenda on the op side to make it as streamless and excellent as possible an experience. But it will take a little bit to get over that hurdle, and there will be longer lead times, and that's just kind of a fact of life as you roll out a new product. But I think it's very clear to us in 5 years, maybe 80% of our new installations are going to have storage. We just have to get good at it. And it's been a major priority. We've been years ahead of our competitors, I think, in figuring it out. We're definitely ahead of people today and expect to continue to do that as we roll out storage to more and more markets.

Right. That's funny. You live in California, and I don't know if you watched Bill Maher, but he -- every episode now, he complaints about how long it's taking. You need to clear his interconnection request.

Yes, I don't know. It's funny. Actually, our L.A. branch manager reached out to him and is trying to fix this problem for him. So maybe we -- I'm hopeful we'll succeed at that. But yes, his pain is real. I mean, it's the permitting. It's just like a self-inflicted wound, particularly in California, that Germany and Australia don't have. And we're working aggressively to root it out.

Yes, speaking of permitting costs. Cost of a solar system in the United States residential side is almost 2x the cost of Germany and Australia. And the Europeans are far more streamlined when it comes to permitting. We have so many more jurisdictions here and a lot more hurdles to jump through. How can cost be brought down here? How can we eliminate that friction for the whole industry?

Yes. So great question. So there are 3 components to the higher cost in the United States: tariffs, electric code and permitting. We have way more tariffs, both on batteries and solar panels. I'm optimistic those will phase out over time, that the Biden administration is not going to double down on those efforts. So hopefully, that just works its way through the system. On the electric code, frankly, there have been some companies in the U.S. like SolarEdge and Enphase that lobby for gold-plated electric standards that don't exist in other countries that makes the inverters a little bit more expensive here. But that's a smaller component. The juicier, most significant area is permitting as we talked about. And one of the things we are excited about is that the Biden administration does seem to recognize this and is already looking like they're going to be moving some funds towards soft cost production. I think we have been working -- we, Sunrun, have been working and with SolarAPP for years now in trying to get streamlined, standardized, online permitting in as many AHJs as possible. AHJs being counties who do building inspection. And so we now have a hit list for the industry of all installations by county, which are the counties that are doing the most business and, like, how do we get these streamlined policies operationalized in those counties, whether it's, like, through the building department or the mayor, the other politicians. And we've got policy dollars against that. The Biden administration, I think, is going to put policy dollars against that. And so I'm optimistic we'll start to make progress on that over the course of the year. And that, I think, is that -- literally, if we're successful at that, could save almost $1 a watt in cost by itself.

Is -- and SolarAPP, is that the app that's being developed by the DoE, Department of Energy?

Yes, exactly. They're certainly funding and helping with it. But yes, it's designed to be a standardized online permitting system. Local counties tend to use like 3 or 4 different software packages for permitting. And part of what is happening now with SolarAPP is building the APIs for those various different pieces of software and rolling them out so that we can get more and more of it adopted. So the core technology to do the e-permitting is nearing completion. And so now it is the IT integration with the systems that these billing departments generally use, that's kind of the next step.

Got you. The...

One question, if I may.

Go ahead. Yes.

Ed, just on the SolarAPP. So we -- last year, we did see a lot of counties or AHJs adopting the SolarAPP, just given the constraints around filing permits in-person. That accelerated some of that adoption. Now are you seeing that continue? Or has it slowed down? Or do you expect those dollars from the Biden administration or other states kind of help that accelerate that going forward?

Yes, I'm hopeful we can accelerate it. I mean it's clearly been working. I'm not aware of any instances where there have been any safety issues that have arisen from online permitting or remote inspection. And I think that's recognized by AHJs, and I don't know that anyone wants to make their jobs and lives more complicated than they need to be. So it's been, I think, a really nice forcing function to get the initial wave of adoption done. So I hope that that will continue to roll forward and that hopefully, we'll get DoE allocating more money behind the process of actually getting and paying for AHJs to operationalize SolarAPP over the coming years. We'll get, therefore, more people on an accelerated time line.

Yes, the Biden administration has talked about doubling the growth rate of residential solar for the next 10 years or at least doubling -- or at least doubling the amount of solar, right? Doubling -- its a target of 8 million rooftops, which is about double the growth rate. So we've been trying to think of ways they could do that. I mean this -- the Department of Energy's streamlining process sounds like at least one way to do that or one way to help. But I mean, do you see any other initiatives coming down the pike that might actually achieve 8 million rooftops by 2030, for instance?

Yes. So I think like the ability -- like our holy grail, it's like how do we have a system up and running 3 days after we talk to the customer? Like that's the real goal of the company, right? And so online permitting is one of those areas. Interconnection is another. I mentioned, for instance, like just to pick on Southern California Edison for a second. Every time you electrify something in your home, it requires space in your main electric panel. That could be storage. It could be an electric vehicle. It could be a hot water heater. And it literally takes them 2 months to approve that now, right? And that's just a major barrier to adoption. That should be something a customer can do by their self in a day with a licensed electrician. And so things like that, I would add to the category as well. Because if we're going to decarbonize electricity and also get fuel usage, transit, oil, gas, fuel usage to electric, like everyone's electric panels are going to have to expand. And so that just has to be usage, like that's another area. They have talked about, obviously, extending or making the tax credit more generous, even maybe more generous than that, if prevailing wage or something like that is used. Storage stand-alone tax credit support, like, these are all kind of things under discussion that I think could be helpful to expediting the growth rate.

Got you. Got you. When do you expect grid services to contribute meaningfully to subscriber value accretion? How big is this potential opportunity going forward? When do we really start to see it truly flow into that NPV per customer?

Yes. So it's starting to flow in already. And just to kind of orient people on how these contracts work. Often if we sign a grid services contract, it might mean that revenue begins in 2 or 3 years and then is contracted for 5 or 6 years or 10 years after that. And so in terms of it generating actual revenue in the P&L, like it's anemic at the moment, but when it comes to the project value of a customer, which would include the contracted PV stream of the grid services arrangement, like that's relatively near term as we grow our grid services business. So currently today, we've said the grid services business is available to about 1 in 10 new customers who we originate, but we have a pipeline and negotiations underway where we think we could grow that to 50% in maybe an 18-month time frame. And so as we get those, that sort of opportunity for the home is passed, eligible homes passed number up, and then we start installing those systems, you'll start to see that in project value immediately. So that, I think, will start to happen and be noticeable in the next 18-month period.

When we talk about financing and refinancing expectations for this year, what should we be looking for in terms of the next round? And also, when it comes to thinking about green bonds, are you -- is that in the near future that you expect green bonds to maybe start supplanting the -- at least the high-yield portion of the ABS issuances or...

Yes. Yes. So great question. We haven't really done many ABS high-yield issuances. And that's really -- because I feel like the ABS market is an excellent fit for investment-grade issuances, but it's not necessarily -- it could be, but it's not always the best for, like, sub-investment grade. Historically, how we at Sunrun capitalize the business was with the sub-subordinated notes that were like kind of 8% to 10% in cost. If you look at where high-yield trade is today, obviously, it's like half that, right? So I think there is a real opportunity to reduce the cost of our subordinated debt. It will come with slightly less proceeds upfront, but potentially radically more levered cash flow over time. And we're undertaking some discussions currently, thinking through where in the capital structure would we do that. Would it be rated? If it's rated, what rating? And it's going to take a couple of quarters to really figure that out. But I'm optimistic that there are enough paths to victory that we ought to see a pretty significant reduction in the subordinated debt cost start to roll through this year. In addition, on the senior side, we have a number of financing and refinancing opportunities that are coming to fruition this year, and there's a good refinancing pipeline for this year and next year. So I'm sure we'll start to see some of that coming through soon as well.

Got you. We only have another 1 or 2 minutes left. I thought I'd -- why don't we talk about the PV5 calculation that you now use for calculation of retained value and renewal value. Interest rate sensitivity came up as a pretty big issue for the sector in terms of stock valuations over the last couple of weeks. How sensitive is -- how sensitive are your calculations to that discount rate to the cost of capital that you're actually choosing to use for your presentations?

Yes. So higher base rates just short of like interest rates going up 5 points overnight. Shorter base rate, base rates increasing kind of even if they have been this year, isn't really that big a deal to the company. And let me explain why that's the case. And we have to look at kind of 2 baskets, the existing book and new originations as well. So first, most of our debt cost is spread, it's not base rate, right? So one of the things we've been very successful at in the company's history is lowering the spread. That is to say how much over the treasury rate is our cost of capital. And one of the advantages of the pandemic to us has been our collections actually improved during the pandemic, like our delinquencies in every basket, in almost all periods improved. And so that's going to be really helpful in sort of re-rating the base case for the industry, which should allow us to get lower spreads and higher LTVs. And the opportunity there is more significant, frankly, than an increase in a base rate, right? So probably the weighted average cost of capital today is around 4.25%. And the base rate maybe moved from 70 basis points to like 1.4% or something like that. There's easily that opportunity in spread. I was just talking about hundreds of basis points of opportunity on the subordinated debt side alone, and the senior spreads are coming in, too. So I continue to think we should be able to -- particularly with the collections tailwind that we got during COVID, continue to get the spreads down to offset the increasing base rate. On the existing book of business, you can see this in our financials. We have billions in swaps that go up for 18 years. So on a good chunk of our credit facilities, even if we refinance them we've locked in low base rates, so those are here to stay. And then finally, if you think about the new customer origination side, our real competition is the utility. And in the markets where we operate in, 70% of the cost of electric energy is the amortizing cost of the utility times the cost of capital. And if interest rates go up, utility ROEs amazingly go up. So our real competitor is going to raise rates, and so we can raise rates behind them, right? So it's not so much a constraint on the new origination side, particularly where you get a kind of orderly increase over time.

Right. I mean, do you see maybe other higher commodity costs, in general? Other higher energy costs, oil and gas as well, providing some tailwinds to the industry?

Yes, for sure. I mean, obviously, higher gas cost means higher wholesale electric costs. It makes electrification look more exciting. All of it is a general tailwind. So I would be really surprised if we're going to see any constraints that concern us as a result of these sorts of changes in interest rates.

This one is just at the left field, just thinking about it. I mean do you ever see a new threat ever emerging from Elon Musk, Tesla, SolarCity? I mean is it ever going to come back in some kind of force that has to be reckoned with?

I mean, obviously, Elon and Tesla are a force of nature, for sure, right? And you never understimate them.

You guys need the battery.

It's a good practice not to underestimate them. That said, there are a few things that make me feel comfortable about the situation. First is a lot of their efforts have been on the product side. And in order to do anything profitably in energy, the scale is enormous. You couldn't possibly manufacture and deploy a solar product if you don't have thousands of people installing it. Like, the minimum efficient scale of a PV plant alone is probably like half the size of the U.S. residential business. Just like the scale of these things have to operate at is just profound to be profitable. And they're working on an interesting strategy, right, where they're saying, look, we're going to look at online self-service, lower-cost-type installations. That's a product we've had lots of discussions and topics about -- discussions within Sunrun. If it's one that proves successful for them, it would be an easy one for us to offer as well. So we're sort of watching it with curiosity to see how it would go. I think probably at some point in the future, you'll see a lot more online activity in this industry. I think the million-dollar question is at what point is the mass market customer knowledgeable enough about solar and experienced enough that kind of self-service is a good approach. And so I was curious to have that data point and watch. So obviously, I feel really good about our position in the market right now. And obviously, we purchase Tesla Powerwalls, which we think are a great product and use in our business and continue to watch the situation. But again, feel very comfortable about our prospects.

Great. All right. We're going to wrap it up here. Thank you very much for your time today. And hopefully, we'll see you again at Vail next year and hopefully, before that. Hopefully, way before that. So anyway, stay healthy, stay well. See you guys later.

Okay. Thanks for having us.