Forget what you've heard residential solar companies say about reigning in costs and prioritizing profits over growth . The growth engine is going full steam at Vivint Solar (NYSE: VSLR) and Sunrun (NASDAQ: RUN) and investors are buying into the story once again.
The move to expand is risky given the history of the residential solar industry. Companies like Vivint, Sunrun, and SolarCity were dominant until the end of 2015 but began to lose market share to smaller, more nimble, and less costly local and regional solar installers. I don't see a reason to think the economic dynamic has changed, despite their recent expansion.
New states offer opportunities for growth
In the last four months, Sunrun has announced its expansion into New Mexico, Rhode Island, Texas, Vermont, Wisconsin, Washington, D.C., Florida, and the reopening of operations in Nevada. That's a huge expansion and brings the company to 22 states, plus Washington, D.C., and likely the largest footprint of any vertically integrated residential solar company.
Vivint Solar announced its entrance into Vermont, Colorado, and the reopening of Nevada operations in June. In the first five months of the year, it announced expansion into New Hampshire, Florida, Rhode Island, and the opening of a retail channel.
These are huge expansions of the reach Vivint and Sunrun have and call into question their commitment to focusing on profitability long term.
Why expansion is a risky move
The whole reason the national sales model hasn't worked well is that it's not very efficient. Companies have to hire thousands of sales people and need more people working in corporate offices performing support roles and lining up financing and engineering for the sales staff. And then there's thousands of more installers and all of the equipment they need to put solar systems up on roofs. The result is a surge in operating expenses that have to be paid for by growing revenue or long-term value creation.
Solar companies haven't typically been able to prove to the market they can generate value long term though. Residential solar companies are rarely profitable, particularly when they're growing, and projections of long-term value creation are built on overly optimistic projections of future cash flows .
A risky expansion bet
The market certainly loves the decision by Vivint Solar and Sunrun to expand in 2017. And it's possible the decision pays off if they can profitably sell solar-power systems in new markets. But it's a risky decision to add the necessary operating costs to expand when smaller competitors are already beating you on cost and taking market share. This is an expansion plan that may not work out as planned.
10 stocks we like better than Sunrun
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor , has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Sunrun wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of June 5, 2017
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.