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Take SolarCity With a Grain of Salt

Solar is growing by leaps and bounds. In 2013, the Federal Energy Regulatory Commission (FERC) reported that solar was the second biggest contributor to new and expanded generation capacity. Yet, growth does not mean stability. Lately, the rooftop solar installer SolarCity (NASDAQ: SCTY  ) has seen its stock endure extreme bouts of volatility. Given SolarCity's regulatory challenges, it is best to consider SolarCity along with other big players in the solar market. 

SolarCity's challenges
Being concentrated in the rooftop market is difficult. Rooftop installations pose a direct threat to utilities and their business model. The utilities are pushing back against rooftop installations with successful grid connection surcharges in places like Arizona. While the charge of $0.70 per installed kilowatt (KW) is reasonable, if the utility had gotten its way, the charge would have been $8.00 per KW. There is no guarantee that other states will not side with the utilities and enact elevated surcharges that substantially reduce the economics of distributed solar generation.

In the first quarter of 2014, SolarCity estimated that it had $1.56 of retained value per watt, or $1.29 billion in discounted cash that will come into the company's coffers over the next couple of decades. Even at a market cap of around $4.7 billion, investors are pricing in a substantial amount of growth.

The problem is, if you assume only 66% of consumers renew their contracts and use a more conservative 10% discount rate, the resulting retained value is only $0.92 per watt. SolarCity's goal of a 1 million potential customer base by 2018 and a market penetration of 2.4% means 6 GW of capacity. At $0.92 of retained value per watt, there is $5.52 billion in future retained value. Its current market cap around $4.7 billion is already pricing in a large portion of this future growth. These numbers are only rough estimates, but they show the challenges with SolarCity's valuation.

De-risk your portfolio
Buying shares of solar panel manufacturers or utility solar is a smart way to compensate for some of the risk in SolarCity's shares. Utility solar installations have decreased costs thanks to economies of scale. Utilities consistently account for a large portion of new U.S. solar installations. In the first quarter of 2014, 66% of new PV installations were utility projects. 

First Solar (NASDAQ: FSLR  ) is a great example of a play on utility solar. Its projects have been well received by utilities, and it expects to pump out $290 million to $340 million in operating income in 2014. First Solar still has some regulatory risk. As U.S. utilities move closer to meeting renewable power goals, demand for utility solar in some states will decrease.

First Solar is working to deal with its regulatory risk. From Q3 2014 to Q1 2014, it was able to boost its expected modal shipments by 0.1 GW. At the same time, Latin America and the Middle East make up around a quarter of its potential booking opportunities.

When it comes to investing in PV manufacturers, it pays to be careful. Solar panels are expensive, and very cyclical. For this reason, high debt loads are dangerous. Trina Solar (NYSE: TSL  ) is dealing with new U.S. import tariffs, and its total debt to equity ratio is 1.16. Its $983 million in debt is not massive, but it is a big enough number to cause worry. First Solar's total debt-to-equity ratio of 0.04 puts it in a very different situation.

Another way to de-risk your portfolio is to look at SunPower (NASDAQ: SPWR  ) . It profits from the growing distributed generation market, and yet its power plant sales limit the impact of adverse rooftop regulations. In 2014, it expects around 613 MW of its expected 1250 MW of total shipments to come from power plants.

The U.S.'s decision to put tariffs on Chinese suppliers will support SunPower's distributed generation operations. Already, SunPower's premium panels produce 75% more energy than a comparable sized conventional system over the life of the system. By boosting Chinese prices, the U.S. government only makes SunPower's panels more attractive.

SolarCity holds promise and caution
SolarCity is one of the most exciting solar stories, but as a pure play on distributed generation, it has its set of risks. By buying SolarCity along with strong solar panel manufacturers like First Solar or SunPower, you can remove some of the risk of future grid surcharges hurting distributed generation demand. The big utilities that First Solar and SunPower sell to find solar an attractive alternative to expensive peakers, and they don't mind spending big bucks on new solar systems. 

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  • Report this Comment On June 17, 2014, at 1:12 PM, guluj wrote:

    Solar power is an industry with organic growth prospects over decades. With the turmoil in Iraq and prospect of higher oil prices, Solar would be in demand. That way higher oil price is good for solar stocks. I do believe that solar industry has turned the corner and we will see much more installations over roof tops in the near future. I do not believe this revolution is stoppable. Among all the green technologies, Solar is most green and abundant and high tech always found ways to reduce cost and improve efficiency. Expect even more efficient solar panels in the future.

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Joshua Bondy

Joshua Bondy works in the energy and materials sector. He works hard to bring to light the underlying forces that drive prices and move the market.

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