3 More Reasons to Add SolarCity to Your Roth IRA

Here are three more reasons why SolarCity, a business which is changing the delivery process for energy, is worth a closer look by patient long-term investors.

Apr 11, 2014 at 7:33PM

The Pencils IRA Project is dedicated to building a portfolio of promising businesses that can be followed and replicated by both young and new IRA investors. Each holding of the Pencils IRA Project must meet the five pillars of a "megagrower" business -- purpose-driven business, innovative products, visionary leadership, increasing cash-flow production, and strong company culture -- with significant potential to create stakeholder value and substantially beat the market over the long haul.

I recently explored the first two "megagrower pillars" of SolarCity (NASDAQ:SCTY), a business which is revolutionizing the delivery of energy in the U.S. Here are the three remaining reasons why I added SolarCity to the Pencils IRA Project portfolio.

Pencils

3. Visionary, experienced, involved leadership
SolarCity was co-founded in 2006 by two brothers, Lyndon and Peter Rive. Lyndon assumed the role of CEO, while Peter serves as chief technology officer. Both remain heavily invested in the business, owning a combined 4 million shares -- about 4.3% of all shares outstanding.

Lyndon Rive has set an ambitious goal of increasing SolarCity's current customer base tenfold to 1 million by 2018. Says Rive:

I think [SolarCity] could be the largest electric-energy company in the United States. We started this company to be your next energy company. Our goal is to become the most compelling energy company of the 21st century.

SNL Energy, a business intelligence firm, named Lyndon Rive one of the 10 most influential people of 2013, citing the way that SolarCity's business model is quickly disrupting entrenched traditional electric utilities.

It was originally Elon Musk -- founder of SpaceX and Tesla Motors (NASDAQ:TSLA), and also a cousin of the Rive brothers -- who encouraged Lyndon to pursue entrepreneurial opportunities in solar energy. Today, Musk serves as chairman of SolarCity and owns 23% of the company. What is especially noteworthy, however, is that Musk has entrusted his $1 billion-plus stake in SolarCity to his cousins. "Those guys are just awesome in terms of their execution of SolarCity," explains Musk. "Thankfully [SolarCity] requires almost none of my effort."

SolarCity's connection with Tesla Motors, however, doesn't end with Musk. Jeffrey Straubel, Tesla's CTO, has served on SolarCity's board of directors since the company's founding in 2006. At the time of the announcement in December 2013 that SolarCity would begin to offer businesses solar energy storage that used Tesla's batteries, Straubel explained, "The economics and scale that Tesla has achieved in the automotive market now make stationary energy storage more cost effective and reliable than it has ever been in the past." These insider connections to Tesla give SolarCity a significant advantage over the competition, especially considering Tesla's plans to build a $5 billion Gigafactory to mass-produce lithium ion batteries, which SolarCity could use to provide more affordable solar energy storage solutions.  

SolarCity has a wide array of innovative talent on its leadership team, which has been the same since day one. This leadership core is a key component of the success SolarCity has seen up to this point, and it bodes well for the business as it continues to expand across the U.S.

4. Consistently increasing cash-flow production
From 2011 to 2013, SolarCity grew its operating cash flow at an average annual rate of 118% to $174.52 million. While this rate has outpaced its 35% average annual growth in capital expenditures over the same period, SolarCity's free cash flow still stands at negative $542.43 million as of 2013.

SolarCity's business model requires extensive capital up front to cover the entire cost of installing solar systems. Until the company begins to produce positive free cash flow, SolarCity will depend on external funding. Thankfully, the Rives have done a tremendous job of forming strategic partnerships with banks and corporate lenders (which include Google), and they are in the process of developing a Web-based platform where individual and institutional investors of all sizes will be able to invest in SolarCity financial investments. 

SolarCity has also developed partnerships with more than 100 homebuilders in nine states, which enables SolarCity to collaborate with homebuilders to build homes on which customized rooftop solar systems are efficiently installed. These strategic partnerships, coupled with the company's continued efforts to reduce its internal costs as the business scales, give me confidence that SolarCity will attain the necessary resources to fuel growth until the business produces positive free cash flow. 

5. Strong company culture
In 2013, SolarCity was honored as one of the top 20 places to work in Glassdoor's Employee Choice Awards among companies with 1,000 or more employees. Employees currently give the company a rating of 3.8 out of five on Glassdoor, and CEO Lyndon Rive has a strong 89% employee approval rating. Thus far, the Rives have done an excellent job of developing a company culture that recognizes innovation and change as key components of SolarCity's long-term success. 

Foolish bottom line 
SolarCity's stock is bound to be volatile going forward, with its share price having fallen 37% since the end of February. The stock undoubtably has a high price-to-sales ratio at roughly 34, but SolarCity's contracts represent a secure revenue stream for at least the next two decades. This, along with the fact that the company has grown its customer base by more than 145% since 2012, gives me confidence that SolarCity has what it takes to continue growing at levels that justify a premium valuation. It is unlikely that we will see SolarCity shares trade at a valuation that looks "cheap" anytime soon using standard metrics such as P/S or P/E. 

SolarCity's long-term prospects remain as strong as ever. The company's 100,000 customers are a drop in the bucket in comparison with the customer bases of traditional utilities, but I anticipate that SolarCity will reach its goal of 1 million cumulative customers by 2018. Even 1 million customers, though, is just the beginning of the company's potential. Given SolarCity's early success and ongoing leadership in the field of solar-energy delivery, I am glad to welcome SolarCity to the Pencils IRA Project, and I anticipate market-beating returns over the next 10 years and beyond.

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David Kretzmann owns shares of SolarCity. You can follow David on his Foolish discussion board, Pencils Palace, on CAPS, or on Twitter @David_KretzmannLearn more about David's Pencils IRA Project at Fool.com. The Motley Fool recommends and owns shares of SolarCity and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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