Holes Forming in SolarCity's Massive Valuation

Finally, SolarCity's (NASDAQ: SCTY  ) fourth-quarter 2014 numbers are out and by the look of the market's reaction, investors aren't terribly happy. Quarterly revenue was $47.3 million, loss from operations rose from $32.3 million a year ago to $55.3 million, and non-GAAP loss per share was $0.46.

But the bigger focus today is on the expected first-quarter loss of $0.70 to $0.80 per share, which is well below the $0.53 analysts expected the company to lose. We're also getting some hints that customers are shifting to cash sales, which don't generate the same value for SolarCity. So, let's dive into the trends we're seeing and what investors should be looking for going forward.

A solar installation on a Wal-Mart distribution center, completed by SolarCity. Commercial installations like this one accounted for a higher percentage of revenue than normal in the fourth quarter. Image courtesy of SolarCity. 

Cash sales are picking up
Not every solar installer looks at their sales channels the same way and that's one of the major differentiators among competitors SolarCity, SunPower (NASDAQ: SPWR  ) , and RGS Energy (NASDAQ: RGSE  ) . SolarCity has explicitly stated that it wants to own leased systems and actually ran a negative 4% gross margin last quarter on systems that it sold for cash.

SolarCity workers installing a rooftop system. Image courtesy of SolarCity.

SunPower and RGS Energy, on the other hand, offer leases, loans, and cash sales to customers and don't care which one they choose. SunPower sold about 70% of its residential systems for cash last quarter (although it doesn't break out margins) and RGS Energy generated a 21% gross margin from system sales and selling leases to third-party owners.

Since SolarCity is focused on leases and runs a loss on system sales, it would be concerning to see sales pick up and lease mix drop. But that's exactly what we've seen recently.

One way to see the shift is in solar system sales trends versus MW installed. System sales were higher than expected in the fourth quarter, which set off alarm bells for me in late February, and guidance for Q1 2014 reinforced the trend. You can see that even though installations will fall quarter over quarter, system sales will remain about flat, meaning they're expected to be a higher percentage of the mix.

 

Q2 2013

Q3 2013

Q4 2013

Q1 2014

MW Installed

53 MW

78 MW

103 MW

78-82 MW

New Energy Contracts

9,040

12,386

10,763

n/a

Solar System Sales

$35.0 million

$23.8 million

$24.9 million

$23-$27 million

Source: SolarCity earnings releases.

This can also be seen in retained value added each quarter versus MW booked. When SolarCity books a customer to a lease it adds the projected retained value of future cash flows to its reported retained value calculation. Conversely, a cash sale doesn't have a retained value number because it immediately hits the income statement.

So, it's interesting that retained value added in Q4 was down sequentially even though MW booked was up, indicating that booked cash sales are a higher percentage of the company's sales mix.

 

Q2 2013

Q3 2013

Q4 2013 

MW Booked

69 MW

91 MW

101 MW

Total Retained Value Added

$95 million

$184 million

$145 million *

Contracted Retained Value Added

$59 million

$132 million

$104 million *

Source: SolarCity earnings releases. Note: Q4 2014 retained value figures have pulled out $60 million in value for the completed securitization deal, per management's comments.

These numbers don't guarantee that cash sales will be a growing part of SolarCity's mix long term but it's definitely something to keep an eye on. 

Why this is a big deal to SolarCity
Selling more systems for cash isn't inherently bad and won't result in weak installation figures, but it could dramatically change the amount of value SolarCity generates for shareholders. In the most recent quarter, management said it projected $1.90 per watt in retained value for the quarter, which implies a nearly 40% retained value margin if we assume installations cost around $3 per watt.

The moves into securitization and solar financing products for individuals could also hold less value if more systems are sold. After all, $60 million in additional value was generated from the just one securitization deal completed last year.

Residential solar community with SunPower panels. Image courtesy of SunPower.

What's good for homeowners?
The question is which way the market will move long term? I think cash or loan sales will become ever more common in the future, particularly as costs fall. If a consumer buys a system, he can keep the tax benefits as well as all of the cost savings from going solar. As solar loans become more prevalent, we'll see rates fall to somewhere near SolarCity's securitization deal, meaning homeowners will be able to take advantage of solar financing without giving ownership out to someone else.

I also think we'll see installers compete on cost of installation as the number of installers grow, which will cut margins. It's far easier to compare two cash offers from installers than a 20-year lease to a fixed cost to install a system, which may be the case today. Since SolarCity has better infrastructure in financing, it can offer better rates on leases, expanding margins, but won't have the same advantage competing for cash sales.

Reasons to be cautious about SolarCity's stock
That's why I see SunPower, which makes the industry's most efficient panels and sells through partners, and RGS Energy, which offers a suite of sale options, as better values in the current marketplace. With a $6 billion valuation, SolarCity is priced as if it will generate $2 in value from installations for years to come, but I think that number will fall, particularly as cash sales increase. 

If the shift away from leases does happen, SunPower and RGS Energy will be better able to compete and offer more upside for investors with $4 billion and $200 million market caps, respectively.

SunPower is already profitable, RGS Energy expects to be EBITDA positive in Q4, and SolarCity is still losing money quarter after quarter and can't generate positive margins on cash sales today. You'd have to assume leases continue to grow and margins remain high to think SolarCity is a value today and that's not the way I think the market is headed. 

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Read/Post Comments (22) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 19, 2014, at 5:38 PM, oTeslaManiax wrote:

    $1000 hot water tank is still being rented in most homes. Most Americans can't even pay the monthly mortgage. How can they fork out $20K for solar panels ? Give them a free panel lease that saves them 10 to 20 percent off utility rate is a win.

  • Report this Comment On March 19, 2014, at 5:54 PM, eddiemoy wrote:

    sorry, doesn't make much sense... the number of energy contracts at the end of 2013 was 83,265 from their Q4 earnings presentation on feb 24. from their recent announcement on march 18th on their GAAP earnings, they mention they just signed their 100,000 customer in early march. that is 16k new contracts for Q1 and the quarter isn't even over.

  • Report this Comment On March 19, 2014, at 6:24 PM, oTeslaManiax wrote:

    So far for 2014 Q1, they are signing a new customer contract every 2.3 minutes assuming 7 day work week, 8 hours a day.

  • Report this Comment On March 19, 2014, at 6:27 PM, oTeslaManiax wrote:

    Correction in my calculation above... make that about every 4 minutes they add a new customer.

  • Report this Comment On March 19, 2014, at 6:46 PM, TMFFlushDraw wrote:

    The 100,000 number referenced this week is customers, not cumulative energy contracts. They could be cash or lease customers. SolarCity very clearly spells out the difference in each presentation's appendix and uses terms very specifically, so you have to compare apples to apples.

    The same goes for the referenced 100 MW booked and plan to reach 475 MW - 525 MW deployed. It says nothing of whether these are cash sales or leases and if cash sales are a higher % of mix it's concerning for valuation.

    Travis Hoium

  • Report this Comment On March 19, 2014, at 6:57 PM, ronwiserinvestor wrote:

    Excellent article! Your statement : "it would be concerning to see sales pick up and lease mix drop. But that's exactly what we've seen recently." hits it right on the nail head. Purchases of systems are in fact picking up dramatically.

    Our company Solarhome .com has been selling grid tie solar systems, nationwide since the Solar Buy Down Program began in 1999. In the 16 years that we have been in business, we have never experienced a first quarter like we have this year.

    Consumers are being quoted by S.C. and other leasing and PPA companies and then contact us for a comparison and we are easily converting these previously quoted and even contracted (during the 72 hour right of rescission) parties into purchasing customers with our $0 down loans and cash sales.

    Pricing has dropped so low that we are easily able to quote an installed system, after the 30% federal tax credit at less than 1/3 the cost of a $0 down 20 year solar lease or PPA. There is just too great of a difference in cost between a purchase and a lease or PPA for consumers to ignore now.

    Personally I think the party is over for the solar lease and PPA companies. Couple $0 down solar loans with tax deductible interest and much lower system pricing (sub $2.20 per watt after the 30% tax credit) and the retention of other applicable financial incentives plus system ownership and 25 year warranties on the solar modules and inverters and it spells the death of the solar leasing and PPA solar rental model.

  • Report this Comment On March 19, 2014, at 7:09 PM, ronwiserinvestor wrote:

    @pTeslamania the average 4.75kW residential solar system doesn't cost $20,000.00 anymore.

    Today's pricing after the 30% federal tax credit has reached less than $9,700 for an installed 4.75kW system. And consumers don't even need a penny of that to install a system now that $0 down FHA solar loans and $0 down PACE financing, (both with tax deductible interest) or $0 down non-collateralized LightStream loans are available.

    There is absolutely no need for leases and PPAs with their non-tax deductible payments anymore. Solar leases and PPAs might have made sense back in 2008-2012 when no other form of $0 down financing was available but in today's market a solar lease or PPA makes absolutely no sense when compared to a purchase at today's dramatically lower pricing.

  • Report this Comment On March 19, 2014, at 7:16 PM, oTeslaManiax wrote:

    My first calculation was correct...a new customer every 2.3 minutes... I was shocked at the rate they are adding customers.

  • Report this Comment On March 19, 2014, at 8:44 PM, clanza875 wrote:

    Hmmm I wonder why SPWR doesnt break out its margins?

  • Report this Comment On March 20, 2014, at 7:41 AM, hedgeoctopus wrote:

    I am struggling to make sense of this. Q3 seems to be higher lease to sale ratio than quarter 2. Q4 seems to revert to Q2!!! A chart of lease to sale ratios quarterly going back 2 years might be more helpful in seeing if there is an actual trend.

  • Report this Comment On March 20, 2014, at 8:32 AM, eddiemoy wrote:

    still doesn't make much sense. the difference between energy contracts and customers is 16k as of beginning of march. so there is only less than 16k of direct sales vs leases?!?!?! those numbers don't look right if interpreted that way.

  • Report this Comment On March 20, 2014, at 8:32 AM, oTeslaManiax wrote:

    Sales deals are usually commercial deals. Lease is more common in residential. Solarcity targets residential lease deals more because of more than double margin. As of jan 2014, solarcity has 32 percent of the residential market share and growing, eclipsing next few competitors combined.

  • Report this Comment On March 20, 2014, at 8:34 AM, eddiemoy wrote:

    hey solar home, if you are so handily beating solar city at all the competitive bids and you are taking their lunch, how come they are signing up so many customers and have 32% of the market and growing?!?!?

    sounds like a lie.

  • Report this Comment On March 20, 2014, at 11:02 AM, TMFFlushDraw wrote:

    @hedgeoctopus

    The market has changes so fast and SolarCity is growing installations so quickly that going back more than a couple quarters doesn't give equal comparisons. Sales used to be a higher percentage of the mix and the shift to focusing solely on lease has really come in the last few quarters, not coincidentally as lease margins have increased.

    @eddiemoy

    They had 92,998 customers as of the end of 2013. 100,000 as of the beginning of March is just over 7,000 signed in just over two months.

    By comparison, they signed 12,386 new customers in Q3 and 10,763 new customers in Q4. So, the pace of customer sign-ups is slowing, although there's a higher mix of commercial customers (paying cash) so MW are still growing.

    It's the higher mix of commercial MW that's impacting cash sales versus lease mix.

    Travis Hoium

  • Report this Comment On March 20, 2014, at 3:35 PM, ronwiserinvestor wrote:

    @eddiemoy Because they borrowed millions to launch their company and they were first to market with a $0 down (but expensive) financing option.

    We on the other hand chose to grow our company organically without the need for taxpayer money or hundreds of millions in borrowed money.

    Being first to market with $0 down financing and all that financial backing has given them momentum. But like the tale of the tortoise versus the hare, the $0 down loan option with its tax deductible interest, much lower pricing (less than $2.20 per watt installed after the 30% tax credit) and higher performance products will win this race in the end.

    Look at the numbers, The hare is beginning to tire long before reaching the finish line.

  • Report this Comment On March 20, 2014, at 3:53 PM, ronwiserinvestor wrote:

    @eddiemoy "sounds like a lie" ? We post our pricing online on hundreds of websites. We offer to beat any nationally advertised price on our same, in stock, top of the line systems or your system is free. If that were a lie, we would have been sued into oblivion many years ago. We can beat the final cost on any $0 down solar lease by thousands of dollars hands down.

    I challenge you to present any legitimate quote on any $0 down solar lease from any solar leasing dealer on the planet and we'll see who lying.

  • Report this Comment On March 20, 2014, at 7:00 PM, TMFShaggy wrote:

    I think people should remember what it is Solar City is trying to accomplish here. Solar City wants to become a national Utility company.

    That means they provide power much like a municipal utility would provide power. A municipal utility company owns the entire supply chain of getting power to your door. This is why Solar City wants to avoid selling systems for cash. Solar City wants to own the entire process. Could a customer go out today and buy a system that will cost them less than a Solar lease over time by a decent amount, of course, Ron is absolutely right. There is a business model for local installers to sell cash systems, but Solar City is thinking much grander scale.

    Imagine a utility company allowing their customer base to own a mini coal fired plant at their house. Owning the mini coal fired plant may make sense in the long run, but who wants to deal with buying coal, shipping it, maintaining it, worrying about what happens if it breaks down. No one can go without power, any interruption is a problem.

  • Report this Comment On March 20, 2014, at 11:27 PM, ronwiserinvestor wrote:

    @TMF Shaggy That's the beauty of a modern grid tie solar system. Even if your system fails to produce power for any reason, you're never without power because you're never disconnected from the grid. The grid is there to back you up.

    Modern grid tie solar systems are extremely reliable. Our techs are like the Maytag repairman. Once the system is installed, that's pretty much it for the next 10 to 12 years. The only component that's likely to fail at year 10 to 12 is the inverter. And since our inverters comes with a 25 year warranty, there's only a small $200-$300 fee to pay to have an electrician change the inverter out.

    No moving parts and no maintenance and no worries other than an occasional rinsing of the solar panel glass to remove accumulated dust if you live in a dusty area. Otherwise the rain takes care of that.

  • Report this Comment On March 21, 2014, at 5:52 AM, hedgeoctopus wrote:

    We are trying to analyse Q4 and it is almost Q2!! This SC is really annoying with it's late reporting and lack of clear presentations of data. How they can be spending 200 million dollars a year on sales and admin and can't even produce financials properly is beyond me. Not a good sign.

  • Report this Comment On March 21, 2014, at 11:14 AM, roofopportunity wrote:

    SolarCity is sailing into rough waters. Questionable leadership, high employee turnover, and increasing customer dissatisfaction.

    The head start they have is well deserved, but time is slowly eroding their advantage.

  • Report this Comment On March 21, 2014, at 8:26 PM, EurogirlinOR wrote:

    All these pro's and con's and nothing leads to one or the other. The company smells all rosy and is ravaging users and sales in the speed of lighting. The employees love the company; so what's wrong with this picture?

    Who will win and who will loose? Any suggestions? What could make the company make and break? Should they change their strategies and if so, how?

  • Report this Comment On March 24, 2014, at 12:18 AM, EurogirlinOR wrote:

    What happens after 20 years when the lease has been paid up? who owns the equipment then and will all the incentives go back to the homeowner then?

    Solarcity and its investors such as Google are making money off the Federal subsidies and State offered rebate that encourage clean power. What a concept? Its all dependent on our government and conscientiousness.

    Comments?

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