SolarCity Is a Buy at Today's Price

When I was forced to sell shares of Power-One a few months ago in the Messed-Up Expectations portfolio (the Real-Money Stock Picking portfolio I run for The Motley Fool), that kicked me out of investing in solar energy, something I didn't exactly like. That's because I believe that alternative energy (solar, wind, and the like) will become a bigger and bigger part of the world's source for electricity and I want to take advantage of that.

I know. We've all heard that story before, clear back to the Carter administration. But, it's becoming more and more true today. From 2010 through 2012, $750 billion was invested in all forms of renewable energy. Solar capacity grew from 40 GW installed worldwide at the end of 2010 to 100 GW at the end of 2012. In 2012, the U.S. added 3.3 GW of capacity, nearly doubling its total to 7.2 GW . (Yes, that's less than 0.5% of the total we generate , but it's growing quickly.) Of that total, 288 MW -- 4% -- has been installed by a single company: SolarCity (NASDAQ: SCTY  ) .

Bringing power to the people
The company installs roof-top solar panels for residential customers as well as commercial and government customers. (Walmart Stores (NYSE: WMT  ) and homes for U.S. military are among the latter .) It then sells to the customer the power produced – at prices lower than what they would pay to the local utility -- via long-term leases, usually lasting 20 years. Doing this, it has built up a reserve of future payments due in excess of $1.4 billion .

Its financial statements are complicated and it is currently losing money on a GAAP basis. However, if you think of it as a utility, it becomes easier to understand. It raises funds from investors through partnerships and, eventually, bonds. It uses those funds to pay operating and sales expenses as well as the purchase and installation of the solar electricity systems. From the cash flows generated by the leases, it repays the investors, as well as upfront rebates, administrative costs, parts replacement, maintenance, and insurance for the systems .

With five years and counting of installations under its belt, its estimates of those costs gets better, which means it improves its knowledge of what price to charge customers as well as what interest rates it can afford to pay on its financing. Plus, as it collects electricity use data from each installation, it can use that to craft better sales pitches and help customers save elsewhere through suggestions on better appliances to install. Finally, as it grows a longer baseline of stable cash flows – something bond investors crave – it will be able to sell bonds based on those cash flows to continue expanding (just like a utility).

What's messed up?
Part of its current business plan relies upon government rebates based upon the value of the systems installed. As a weekend Barron's article pointed out (and had been previously disclosed by the company), the government is investigating the fair values claimed by the company. The company would have to make up any shortfall to its investors.

There's also the belief that solar electricity is still too expensive relative to utility-supplied electricity. However, costs of solar panels have dropped from $4 per W to below $1 per W in many areas and predictions for reaching grid parity in most major markets range from 2017 to 2020 . In several places, grid parity has already been reached , according to Deutsche Bank.

Finally, utilities increase prices at healthy rates. That alone pushes utility electricity to become more expensive than solar electricity systems installed today in just a few years , even accounting for declines in panel efficiency. One estimate says that after taking both time-of-use electricity pricing from utilities and lifetime value of solar power production into account, one-third of the U.S. population would reach grid parity within the next five years.

The uncertainty about the government rebates it's getting as well as uncertainty about when (if ever) solar power becomes competitive with utility power (with or without subsidies) is leading to uncertainty about the company's future. However, given the long-term growth of solar power and consistent declines in the costs of components, I believe the company will be able to flourish.

Valuation
Because SolarCity's not yet profitable, it's difficult to value it. However, taking what the company calls "Retained Value" (RV) – which is the present value of those future lease cash flows after removing costs to operate the solar systems and pay back investors, it is possible to estimate a value. At the end of the last quarter, the company reported RV of $662 million . At last night's market cap of $2.3 billion, it's trading at 3.5-times that.

The model assumes that SolarCity's estimates are correct for installing 270 MW of capacity this year  (which would be 72% year-over-year growth ), and halves that growth each year through 2017. It also decreases the amount of RV from estimated increases to future lease payments. These estimates try to account for a rising cost of capital (which would lower RV), as well as loss of government subsidies and potential increases in the costs of panels. From this, I get about $1.6 billion of RV at the end of 2017. If the company trades at 3-times that (a lower multiple than today), it would have a market cap of $4.8 billion, a bit more than twice last night's price.

Note that 45% of the $662 million of RV comes from assuming all of its customers will sign up for another 10-year lease after the current lease expires . Cut that down to 1/3 of its customers doing so, and the 2017 projected market cap drops to $3.8 billion .

The return from last night's price to either of those projected prices in 2017 is significantly higher than the market's long-term average. Therefore, I'm going to be buying SolarCity for my MUE port as soon as possible.

I'd be happy to share my valuation model or discuss the company and solar energy prospects on the MUE discussion board. Hope to see you there!

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Read/Post Comments (17) | Recommend This Article (27)

Comments from our Foolish Readers

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  • Report this Comment On September 04, 2013, at 7:26 PM, ronwiserinvestor wrote:

    SolarCity's current business model is heavily dependent upon state and utility rebates which are drying up across the country. They are also dependent on the 30% federal tax credit that expires in 2016.

    $0 down solar loans that allow the homeowner to own their system while keeping all of the incentives instead of forfeiting them to the leasing company offer a greater return on investment are now penetrating the market.

    SolarCity in its basic form is a solar installer that charges a much higher price for their service than many other solar installers. Now that these competing installers are armed with $0 down loans and much lower pricing, I simply don't see very many solar leasing and PPA companies surviving.

  • Report this Comment On September 05, 2013, at 7:28 AM, goatea wrote:

    Have you actually spoken with these other solar companies, ronwiserinvestor? I have. They're are a ton of fly by night companies who are completely illegitimate and relying on the 30% tax credit (that actually expires in 2017). Also, I don't think it's accurate to claim that Solar City charges more. My experience has shown the opposite.

    I have Solar City and chose them because they were the most established. I didn't want a company I knew nothing about bolting solar panels to my roof.

    As far as forfeiting my federal incentives to a leasing company. Have you tried to navigate and actually get paid by a federal leasing program? I have and am still waiting for my check. I was more than happy to give this responsibility to Solar City.

    As far as valuation goes, I think it's very important to mention RV. However, the article doesn't mention the fact that SCTY has a goal of 1,000,000 solar rooftops. At an average of $14,000 per lease term and a current market cap of $2.6 billion, that makes their P/E pretty damn good.

  • Report this Comment On September 05, 2013, at 9:16 AM, TMFGebinr wrote:

    I just posted the valuation model I used along with a detailed explanation of how I built it and what I was thinking. http://boards.fool.com/hi-swcaraway-sure-thing-please-forgiv...

    I'd be happy to discuss this company, competition, reliance upon federal subsidies, the drop in those to 10% in 2017, and other relevant topics at that link.

    Cheers,

    Jim

  • Report this Comment On September 05, 2013, at 2:53 PM, ronwiserinvestor wrote:

    goatea: You either work for SolarCity, have invested in SolarCity or you don't have a clue what you're talking about. I've worked in both the wholesale/retail side of the solar PV industry for over 15 years. About a decade longer than SolarCity.

    My statement is 100% accurate. SolarCity does charge far more for their systems than many other companies. I review and beat SolarCity quotes on a regular basis. The SolarCity quote that I have in my hand at this moment quotes a 7.3 kW system at over $24,500 after incentives. Our price after incentives for the same quality and performance system is $14,473. I don't know about you but the last time I checked, $10,000 was a considerable amount of money.

    And your statement about the "ton of fly by night companies" is ludicrous. There are thousands of reputable solar companies across the U.S., many with NAPCEP certification that provide excellent service.

    And as for you claim of being paid by a "federal leasing program"? There is no such thing as a federal leasing program when it comes to solar, which probably explains why you're still "waiting for a check", It's a federal tax credit and it only takes a simple one page application which is submitted with your tax return. In all the years that I've been in the solar business, not a single one of our customers has ever complained of not receiving their credit. Nice try!

    And to be exact, the 30% federal ITC expires at midnight December 31st 2016.

  • Report this Comment On September 05, 2013, at 3:43 PM, goatea wrote:

    I do not work for the company. I just like them.

    I appreciate your expertise and you know more about solar. However, you've worked in solar long enough to see that your methods haven't worked, so i wouldn't tout that as a plus. There should be solar on every rooftop in every sunny city in this country, so I'd be embarrassed if I worked in that industry for that long. But that's just me.

    I misspoke about my rebate, sorry. It's for my EV charger installation. In Los Angeles our local utility provides a rebate for EV chargers. I've been waiting for months for this. The point is, I'd rather have someone else do the paperwork and I'd pay a premium for it.

    My statement that there are 'tons of fly by night companies' is based on my personal experience (as a customer, not a solar industry professional). I should have made that more clear. I did call and meet with many providers who's methods did not stack up for me. Some were very shady indeed.

    As far as you offering cheap alternatives. Do you guarantee the panels/ inverter for 20 years? Do you do all the paperwork? I think most people will go with Solar City because it's a one stop shop. If you can offer this to people, then more power to you. I think with a relatively new trend, people will navigate towards the simple, clear option even if it means paying a bit more.

  • Report this Comment On September 05, 2013, at 5:26 PM, ronwiserinvestor wrote:

    goatea, we do not offer cheap alternatives. We offer higher value alternatives. Our solar modules come with a 25 year warranty that is backed by a 25 year, third party, warranty insurance policy from one of the largest re-insurance companies in the U.S. SolarCity's modules are not covered by any third party warranty insurance company that I'm aware of.

    Besides you're paying so much more when you consider all of the leasing payments plus the tax credit and rebates that you're giving away, that it is actually the homeowner who is paying for any maintenance and repairs during the term of the lease not the leasing company.

    Yes, we do process all of the paperwork, including the rebate and utility connection agreements, as well as system design, and lifetime technical support at no additional cost and have been doing so since 1999 when California's original "Buydown Program" started, before it became known as the CSI program.

    We too as well as many others are a one "stop shop". The difference is, we offer pricing that is nearly half the cost of a SolarCity purchase and nearly 1/3 the cost when compared to a typical $0 down lease. The best part is that we offer $0 down loans instead of renting, which results in keeping all of the incentives and system ownership for a much greater return on investment than any lease or PPA.

    The primary reason that the leasing companies are leading the pack at this time is because they have momentum and a lot of cash to spread their marketing. They got their start back in 2008 when no other viable financing option was available. Even though the consumer had to forfeit the tax credit and any cash rebate and even agree to an annual payment escalator, the allure of $0 down solar was too great for many to resist.

    Today, it's an entirely different market. Today pricing has dropped by 75% since 2008, and you no longer have to giveaway the 30% tax credit or any rebate in order to get $0 down financing. It's a whole different ballgame. One that the solar leasing and PPA companies are no longer competitive in.

  • Report this Comment On September 05, 2013, at 6:31 PM, goatea wrote:

    no, Solar City provides their own warrantee, they come out and fix anything wrong with the system during the lease period.

    You say you provide a third party warrantee through a re-insurance company. What's a 're-insurance' company? I'm not sure what that means. Do I get to choose who comes out and works on my roof? Is it like an appliance warrantee company that charges large deductibles? I fear that your model is like a PC, and I would like a Mac.

    One thing I didn't mention is guaranteed production by Solar City. They guarantee a minimum production of the unit and will pay you the balance if it falls below this minimum. Do you offer that?

    I guess the market will decide who wins on this one. All I know is that Solar City has started a large move into residential solar in this country. Common people who could care less about the environment suddenly care about solar, because it's easy and cheaper than their existing rates. I think this has more to do with Solar City than what your company was doing back in 1999. I still maintain that any arguments of past business prowess in solar are nullified because what was done in the past was not very effective at getting solar on as many roofs as possible.

    Either way, I'd like to hear more about your company. What's the name?

  • Report this Comment On September 05, 2013, at 11:05 PM, Bujutsu wrote:

    All I need to know about Solar City is...

    ...Elon Musk.

    I would not bet against him.

    He has a knack for being very successful in whatever wild idea he chooses to pursue (online paymet, spaceships, electric cars...).

    Regards,

    Bujutsu

  • Report this Comment On September 13, 2013, at 2:50 PM, Mega wrote:

    Ex tax credits, SCTY's expected return on investment is below their cost of capital. There's no margin of safety here.

  • Report this Comment On September 13, 2013, at 2:53 PM, Mega wrote:

    It's ironic that this supposed free market hero - Elon Musk, the 21st century industrialist, the real life Tony Stark - owes an enormous amount of his recent success to tax credits and government subsidized loans.

  • Report this Comment On September 14, 2013, at 12:40 AM, Tuxster12345 wrote:

    Retained value?! What kind of company created cocck and bull metric is that? No wonder so many people

    think investing in the stock market is a fool's game!

    Yeah, this company says, we're not profitable on a GAAP basis, oh but let me tell you about our RETAINED VALUED!

    LOL!

    What a joke!

  • Report this Comment On September 14, 2013, at 9:48 PM, sciencedave wrote:

    What industries get big Government subsidies at taxpayers expense? let me count: auto industry, airline industry, nuclear industry, oil industry. I could go on. Why not solar, wind etc? Level the playing field.

  • Report this Comment On September 16, 2013, at 12:00 AM, SkepikI wrote:

    ^ because in INVESTING, if you rely heavily on overt subsidies and tax credits, your business goes away if the overt subsidies and tax credits go away. Profits are the rocket fuel that drives valuations to the upper limits of an enterprise, ala Apple, Cisco, Intel, and maybe one day oh, DDD.

    Live by the subsidy, die by the subsidy and this happened in the past to wind in the 80's and yes solar in the 90's.

    If they get off the drip and are self fueled (ha) on profits, they stand a long term chance. Stay on the drip and long term...well, RIP

  • Report this Comment On September 16, 2013, at 7:47 PM, tdotsports1 wrote:

    Any thoughts on picking SPWR instead?

  • Report this Comment On September 18, 2013, at 9:58 AM, damilkman wrote:

    Regarding letting the market decide, I have to move three states over before I can purchase their services. The other problem is due to states having artificially high power costs which is not the case in the midwest. My dad was all excited about looking into installing a solar panel on his car port to save him money. I asked him what is electrical bills were and he admitted they were never in excess of 50 dollars a month. Now this might not be realistic for everyone as my parents are thrifty. So if a system cannot come in under 6000 dollars for ten years he is losing money even assuming he turns everything off at sundown.

  • Report this Comment On September 18, 2013, at 10:36 AM, Johny205 wrote:

    Goatea, I'm guessing that ronwisers company is not as well know as Solar City is because they are not a huge public traded company. Goldman Sachs just gave $500 million in credit to Solar City in one deal alone, so it's pretty hard for a small company to get as many customers as a company like Solar City. Now if Warren Buffet had an IPO for ronwisers company and invested a ton of capital into it, I would imagine that perhaps they would give Solar City a run for their money. Warren Buffet is an even bigger name than Elon Musk and would probably be very succesful just because Buffet backed it.

  • Report this Comment On February 28, 2014, at 9:35 PM, justmythoughts wrote:

    All,

    One thought I have is this. I was approached today by a Solarcity rep at Home Depot ( very nice girl and was happy to meet her.. enough said..). Where is the money coming from? How does this work? With a bit of research well it came to light.. Us taxpayers. Solarcity gets a 500 million dollar loan from Goldman Sachs the Feds bailed them out a the tune of 5 Biilion plus and then passes on the money " to some unknown entities" like AIG and other contriibuters? what party? Good question .. follow the bill.. then follow the money.. I will let you do the homework on that one..

    The stock and its company is relying on the current state of Goverment and their "invovlement" subsidies or shall we say tax incentives.This is a tax that is carried over to the citizen. Yes we- you are paying for them "

    Last I knew Al Gore was not a major a enviormental expert however he received a Nobel prize? Go figure? Now it seems going green is the best thing since slice bread. Many are getting rich for sure but from my eye level it is not the guy or gal working their ass off to pay for said house-roof to put their very nicely "paid for or leased" read the fine print.. solar panels on.

    My summary of all of this is that if it seems to good to be true it usually is because somebody has to pay for it. Sadly to me again its the hard working taxpayer..

    Just my 2 cents,,,

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