Source: SolarCity.
There's no question that SolarCity (SCTY.DL) is the biggest installer of residential solar in the U.S. and one of the leaders in the solar industry in general.
What is in question is how sustainable that lead is, and whether SolarCity's business model of holding projects on the balance sheet and keeping customers long term is good for shareholders. Fellow Fool Jason Hall gave a good look at the story as SolarCity wants to tell it yesterday, but there are some skeptical numbers investors should keep in mind as well.
What is the value of renewal?
SolarCity's entire business model is built on building solar systems and then leasing them to customers through power purchase agreements. To back that up, system sales were just $24.5 million in the second quarter, and the company's gross margins on the segment were just 10% -- hardly enough margin to make a profit.
Here's where the company gets complicated, and where sweeping assumptions either make this a great investment, or a place to burn money in the stock market.
First, let's look at the cash flow from projects before equity financing or other debt. As SolarCity itself said, and you can see below, it cost $483 million to build solar systems in the quarter (including $17 million in state subsidies), and the company has $33 million of annual cash flows from those projects. I'm not including years 20-30 in the calculations below because we really have no idea what will happen with residential solar systems after their contracted life of 20 years.
Source: SolarCity.
I start with the "Gross Project Cash Flow Forecast" line because it doesn't include tax equity financing that takes advantage of the investment tax credit of 30%. This subsidy is going to fall from 30% to 10% in 2017, so it's important to look at how project economics work without it.
If you look at just the gross project cash flows from the first 20 years of solar systems, SolarCity's internal rate of return is 3.2%, well below cost of capital, no matter how you calculate it. That's key because it shows just how dependent SolarCity is on tax equity financing and low-cost debt to fund projects.
SolarCity isn't alone in this dependence, and long term, it may not be a problem at all. But SolarCity has to hit cost reduction targets to maintain margins after the ITC falls.
What happened to falling costs?
The most alarming figure in the second quarter is that installed cost per watt fell just 3% to $2.91. Even core installation cost per watt fell just 7% to $2.13.
Management will tell you that the added cost for SG&A will lead to greater growth in the future, but the fact is that SolarCity's growth rate is actually slowing. The company is no longer doubling in size; it "only" grew installations by 77% last quarter.
Source: SolarCity.
What this is showing is greater competition in the residential solar space and the cost of SolarCity's scale. It takes a lot of overhead and sales staff to run such a large organization, especially with such a focus on growth.
Cost per watt will be a key metric to watch in the future, especially in light of the potentially low post-ITC returns I pointed out above. If cost reductions don't hit the 2017 goal of $2.50 per watt the company may not have the same high margin business investors expect it to have.
Still the top dog in residential solar
I've pointed out a couple of challenges SolarCity faces as the solar industry evolved, but as the top residential solar installer in the country it's well positioned to adjust to a changing market. Investors should just know that cost per watt and low cost financing are important growth drivers for the business. Watching how those evolve will tell us whether the company can continue to grow or hits a rough patch in 2017.
