SolarCity Is a Growth Machine But Is That Enough?

One of the challenges being a growth stocks is that even astounding growth rates often aren't enough to please investors. The bar has to continually be raised, much like what Tesla Motors (NASDAQ: TSLA) is doing by setting its production estimates each year and then surpassing it by a mile.  

SolarCity (SCTY.DL) is in that boat -- and now, even incredible growth numbers may not be enough to satisfy investors. 

Growth in residential solar communities like this one is driving SolarCity's huge market gains. 

SolarCity's earnings came with a surprise
When SolarCity released third-quarter earnings last night, there was a little surprise that it wouldn't release full earnings until next Monday, March 3, including earnings per share. The reason given was "the accounting related to recent acquisitions as well as a change in overhead allocation owing to an increase in the volume of MW deployed." This is at least a little curious since acquisitions and volume would have been known a month ago when the company announced its release date.  

There's nothing investors hate more than accounting problems, but for now I look at this as management getting the numbers right before going public.

The numbers
We don't know all the fourth-quarter numbers from SolarCity, but we do know that revenue was up 87% from a year ago to $47.3 million and operating lease revenue was up 59% to $22.4 million.

Guidance was met based on the numbers we know so far, as you can see below. Management expects 78-82 MW of solar to be installed in Q1, lower because the number of commercial projects will be lower in the quarter. 

Source: SolarCity earnings releases

What's interesting about the table above is that installations were slightly higher than expected but system sales accounted for more of the mix than anticipated. This is key because system sales margins were just 4.9% last quarter (23% in Q3 2012) and are typically much lower than the retained value margin on leases.

Installations on commercial buildings like this Wal-Mart distribution center accounted for higher system sales in Q4. Image courtesy of SolarCity.

In some markets, leases have accounted for 90% of sales as SunPower (SPWR -1.02%), SolarCity, and RGS Energy (NASDAQ: RGSE) provide $0 down leases to customers. This creates a high-margin business because they can sell equity financing, securitize payments, and make a margin on the energy provided. Last quarter, SolarCity generated about $1.90 per watt in retained value for solar leases and assuming installation costs are about $3 per watt, the retained value margin is nearly 40%. That's why management is pushing leases over sales.

But obviously customers are choosing sales more than anticipated and competitors is more willing to move into the sale or loan market. SunPower said 70% of its 48 MW of residential solar was done through cash sales. RGS Energy is similar in offering leases, loans, and cash sales, depending on the customer's situation. SolarCity stated in its conference call that it prefers leases, primarily because it's a higher margin business. 

The question long-term is whether or not SolarCity is worth the premium it's trading at if lease mix falls and system sales increase? Building solar systems and not owning them puts SolarCity and other installers in more of a construction business, competing on price rather than owning the whole value chain. Watch this mix going forward because it's key to the value SolarCity and others can generate. 

SolarCity's commercial energy storage system. Image courtesy of SolarCity.

New products continue to move into the mainstream
The next phase for SolarCity and other distributed solar companies is getting into energy storage and management. That's where SolarCity's partnership with Tesla to build storage systems for homes and commercial buildings is so important. 

It's becoming an economic necessity as well in places like Hawaii where solar power is reaching a saturation point. Being able to save power generated during the day and using it at night is the next phase of evolution and look for SolarCity to be one of the leaders in these new products. 

What to watch next week and beyond
SolarCity has gained huge market share in distributed solar by expanding its sales force and that will continue in 2014. The question is if leases well continue to be a majority of that mix or if system sales will become more prevalent. SunPower sold about 70% of the residential systems it built last quarter and RGS Energy is pushing sales as well.

A lot of the value SolarCity has built on the stock market is predicated on growing leases, not system sales, so it'll be interesting to see what the company's mix looks like going forward.