SolarCity Is Eyeing a New Solar Energy Market

A major strategy shift may be in the works for SolarCity (NASDAQ: SCTY  ) , which currently dominates the residential solar leasing market. Loans have emerged as a new option for installers, and as the industry's leader in market share the company is testing the financing option as an offering for consumers.

The challenge for SolarCity is that it creates far less value for shareholders with cash or loan sales of solar systems than it does with leases. A strategy change may boost installations, but it could reduce value in the process. But competitors like SunPower (NASDAQ: SPWR  ) are quickly expanding loan offerings, leaving a conundrum for SolarCity.

Lease financing options make it possible for places like the Copper Ridge School to save money by going solar. Photo Credit: SolarCity

The future of residential solar
Leases played a big role in making residential solar accessible for homeowners by lowering costs for homeowners. They could go solar for $0 down and a lower cost per kW-hr, making solar a cost-saving product for consumers. For investors financing solar, installers offered tax savings that also offered high rates of return. It was a win-win for everyone involved. 

SolarCity workers install a residential solar system. Photo credit: SolarCity

But there are downsides to leases long term. Homeowners don't own the solar systems, which has recently been found to be an issue when trying to sell a home to a new buyer. SolarCity has also built increasing solar electricity rates into leases, which could be problematic if grid rates don't increase at rates they've predicted.

Most importantly, about 35% of the $1.29 billion in retained value SolarCity says it has from leased systems comes from renewing leases after 20 years. If a system is sold to a homeowner that long-term value goes to the homeowner. 

Now that the cost of loans are coming down, loans make more sense for homeowners and are beginning to gain traction in the market. GTM Research predicts that leases will peak at 68% of the residential solar market this year and fall in coming years, particularly after tax incentives drop in 2016.

The implication for investors
SolarCity has long pushed its retained value as a gauge for value to investors. As of March 31, 2014, retained value stood at $1.29 billion, or $1.56 per watt contracted. With installation guidance of 500 MW-550 MW this year and 900 MW-1 GW next year it's easy to see how billions more in retained value will be added by the end of 2015 if all of its systems were leased.

Solar communities are becoming popular, especially among homebuilders. Photo credit: SolarCity

But if loans gain traction we could see another story for SolarCity investors. Systems the company built and sold last quarter generated just a 4.9% gross margin, meaning that overall they're money losers when operating expenses are included. Moving to loans would mean moving away from the high-margin lease business to low-margin cash or loan sales.

Long term, the problem is that moving to cash or loan sales means SolarCity will be competing on price. When it comes to the final installation, there's no inherent advantage of a SolarCity system versus Vivint Solar, Verengo, or any number of other installers around the country. So, SolarCity would be competing on price and therefore see lower margins as a result. 

The differentiator in residential solar
Where companies can garner higher margins than competitors is if they can offer a differentiated product, particularly higher efficiency, that packs more energy production from the same size roof. That's why SunPower is my pick in solar and a reason it can sell solar systems big and small and still generate overall gross margins of around 20%. SunPower has also said it generates $2 to $3 per watt in retained value because its systems generate about 50% more power than conventional panels.

SolarCity has a lead over competitors today, but a shift to loans would result in less value creation per watt installed, and the company would have to compete on price. Today, it may have lower costs than competitors and could be able to maintain market share, but there's nothing SolarCity does that can't be replicated by competitors. 

I think SolarCity is a high-risk stock, especially with a market cap of $6.6 billion. The company will grow along with the residential solar market, but if it transitions to loans it will create less value per watt. That's something investors need to be aware of because it may mean SolarCity creates significantly less value per watt installed than it does today.

Read/Post Comments (4) | Recommend This Article (3)

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 August 06, 2014, at 6:44 PM, chaolyst wrote:

    "When it comes to the final installation, there's no inherent advantage of a SolarCity system versus Vivint Solar, Verengo, or any number of other installers around the country. So, SolarCity would be competing on price and therefore see lower margins as a result."

    So this is where brand differentiation will come in, as well as where the long tail of the solar industry, the small installers, will start to gain their marketshare.

    Small installers can better differentiate themselves because they go to the same grocery store, have kids on your kids' baseball team, etc. They know the local gossip. In the construction trades, trust and knowing someone personally and knowing they will be accountable to you and the community is a big deal.

    In Australia, many installers maintain their businesses on VOLUME. Their margins are much lower than in the US. Compare the average installed residential system price in the U.S. was $4.93/W and Australia’s $2.56/W (source: RMI time-and-motion study).

    SolarCity may have to ramp its offerings in its other installation sectors more (commercial, efficiency, EV charging, etc).

  • Report this Comment On August 07, 2014, at 3:47 PM, photonics wrote:

    If SolarCity attempts to enter the loan financed system sales industry, it will probably be the beginning of the end for them because they cannot possibly compete on price with dealers that are already established in this market. Their overhead is now far to great.

  • Report this Comment On August 07, 2014, at 6:53 PM, CloudPonderer wrote:

    Using lease renewals as "retained value" is a meaningless farce. They may be able to wrangle a few customers into renewing their lease, but the smart ones will simply snub SolarCity.

    The value of a twenty-year old solar electric system is anybody's guess, however, it will certainly be less than the cost of removal and scrap or resale. All a customer needs to do is tell SolarCity to remove the system and SolarCity will most likely decline, and the system will belong to the homeowner.

    The early contracts, one of which I signed, even said that the system belonged to the homeowner, if SolarCity did not contact them within 90 days of the lease term ending. That sounds to me like SolarCity was counting on getting all their profit out of the lease within the term, which would be smart. I don't believe that the "retained value" will ever be realized.

  • Report this Comment On August 07, 2014, at 10:58 PM, VABoston wrote:

    Consumers should always shop around and get quotes from at least 3 solar installers. SolarCity is one of the hundreds of high quality options that consumers have and it will help them get the best deal - whether its for solar loans or solar leases. I recommend - its an easy way to comparison shop for solar online.

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Travis Hoium

Travis Hoium has been writing for since July 2010 and covers the solar industry, renewable energy, and gaming stocks among other things.

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