Image source: SolarCity.
Shares of SolarCity (SCTY.DL) are now down over 50% since their all-time high, and the company may finally be near value territory for investors. There are certainly risks ahead, but with a clear hold on the No. 1 spot in U.S. residential solar, a new solar panel manufacturing facility on the way, and a potentially lucrative energy storage business, I think the future looks bright for it.
Here's what I need to see before becoming a buyer of this solar stock.
SCTY Market Cap data by YCharts.
Value has always been SolarCity's No. 1 problem
It has always been hard for me to justify SolarCity stock's valuation. In early 2014, when the company's valuation peaked above $7 billion, it had installed just 285 MW of solar in 2013 and had just $1.05 billion in gross retained value. The only way to justify the company's valuation was to assume tremendous growth for many years to come.
Sure, if we assume SolarCity will double installations annually, all of its customers pay their contracts on time, debt remains low for the next 30 years, and customers renew contracts in 20 years, you could justify a high valuation for the company. But I never thought all of those factors were guaranteed, and a valuation of $6 billion or $7 billion left little margin for error for investors.
Today, SolarCity has proven that its growth projections could become reality. It has over $7.7 billion in contracted payments over the next 20 years (up from $2.0 billion at the end of 2013), $3.06 billion in retained value, and the stock has fallen considerably from its peak to a valuation of $3.95 billion. It's no longer a stretch to say that the company could be a value for investors long term.
Proof is in the pudding
The three biggest factors that make me think SolarCity is a better stock today than it was two years ago are growth execution, a transition to loans, and executing on higher-efficiency modules.
The growth narrative is pretty self-explanatory. Just look at the chart below and the compound annual growth rate of 96% since 2010 to see how quickly this company can grow. But now, instead of paying for growth potential, we're paying for growth we've already seen take place.
Image source: SolarCity presentation.
Moving from leases to loans was a long-overdue shift in solar, especially for SolarCity. Leases lock customers into contracts that can make their homes less valuable, present a big risk for the lease provider, and may not be competitive with the grid if escalators exceed the growth in electric grid prices. Plus, a lot of value companies like SolarCity offer leases with renewal 20 years from now, which is a ridiculous assumption in an industry that changes by the week.
Instead, I think loans are the future of the industry. In fact, solar marketplace EnergySage recently reported that 90% of the customers who use its market are using loans or cash sales rather than leases. EnergySage argues (and I agree) that these are highly educated home buyers, so they should exemplify the future of residential solar. I'm not a fan of the fact that SolarCity's MyPower loans complicate the company's financials further, or of the financial risk SolarCity is putting into offering its own loans, but moving to loans is the right move, and it shows the flexibility that's needed to stay ahead in residential solar.
Maybe the most important thing SolarCity has done in the past two years is find a way to differentiate itself technologically. I've long been bullish on SunPower, which has outperformed SolarCity since its IPO, and a key reason is its superior technology. Now that SolarCity is completing a solar panel manufacturing facility in Buffalo, New York, that's making panels as efficient as 22%, it has a technology differentiation, too. Better yet, the state of New York paid for the plant, so it's an almost no-risk proposition for SolarCity.
Add in the energy storage SolarCity may be able to incorporate long term with sister company Tesla Motors' Powerwall, and the innovation that can happen around solar and energy storage, and you have a company built for the future.
When I'll buy
The big complaint against SolarCity lately is that it's more of a financing company than it is a solar installer. That's what Jim Chanos has railed against with his short call against the stock.
A few weeks ago, I covered point by point where I think Chanos has good points and where his analogy of SolarCity as a "subprime finance company" is overstated. With that said, the company has billions of dollars in counterparty risk in a solar market that changes very rapidly, so I think it needs to evolve from a finance company to a world-class technology company to be a great value for investors.
Specifically, what I'm looking for is SolarCity's transition to more system sales or loans than leases. And I think a better position than the current MyPower loan would be to sell systems and offload the risk to a financial institution that assesses financial risk for a living. That's what SunPower does with its partnership with Admirals Bank, and other solar companies are moving in that direction as well.
The final thing I want to see from SolarCity is the ability to make money. Growth is great, and it's wonderful to project billions in cash flow decades into the future, but SolarCity hasn't been able to turn those cash flows into bottom-line profit, and as an investor I'd rather see slower growth and more profits.
If we've learned one thing from the last decade in the solar industry, it's that debt and growth can become a curse over the long term. Q Cells, Suntech Power, and Yingli Green Energy are just a few of the companies that grew at breakneck speed and eventually lost everything (or close to it) for investors. The other thing they had in common is that they weren't profitable, which is why the bottom line is a warning sign for me.
The risk/reward balance is finally starting to look more attractive for investing in SolarCity than it has since the company went public. If management can prove continued execution in the third and fourth quarters, and the stock stays suppressed, I may finally jump into this solar stock.
