When I was forced to sell shares of Power-One a few months ago in the Messed-Up Expectations portfolio (the Real-Money Stock Picking portfolio I run for The Motley Fool), that kicked me out of investing in solar energy, something I didn't exactly like. That's because I believe that alternative energy (solar, wind, and the like) will become a bigger and bigger part of the world's source for electricity and I want to take advantage of that.
I know. We've all heard that story before, clear back to the Carter administration. But, it's becoming more and more true today. From 2010 through 2012, $750 billion was invested in all forms of renewable energy. Solar capacity grew from 40 GW installed worldwide at the end of 2010 to 100 GW at the end of 2012. In 2012, the U.S. added 3.3 GW of capacity, nearly doubling its total to 7.2 GW . (Yes, that's less than 0.5% of the total we generate , but it's growing quickly.) Of that total, 288 MW -- 4% -- has been installed by a single company: SolarCity (NASDAQ:SCTY.DL).
Bringing power to the people
The company installs roof-top solar panels for residential customers as well as commercial and government customers. (Walmart Stores (NYSE:WMT) and homes for U.S. military are among the latter .) It then sells to the customer the power produced – at prices lower than what they would pay to the local utility -- via long-term leases, usually lasting 20 years. Doing this, it has built up a reserve of future payments due in excess of $1.4 billion .
Its financial statements are complicated and it is currently losing money on a GAAP basis. However, if you think of it as a utility, it becomes easier to understand. It raises funds from investors through partnerships and, eventually, bonds. It uses those funds to pay operating and sales expenses as well as the purchase and installation of the solar electricity systems. From the cash flows generated by the leases, it repays the investors, as well as upfront rebates, administrative costs, parts replacement, maintenance, and insurance for the systems .
With five years and counting of installations under its belt, its estimates of those costs gets better, which means it improves its knowledge of what price to charge customers as well as what interest rates it can afford to pay on its financing. Plus, as it collects electricity use data from each installation, it can use that to craft better sales pitches and help customers save elsewhere through suggestions on better appliances to install. Finally, as it grows a longer baseline of stable cash flows – something bond investors crave – it will be able to sell bonds based on those cash flows to continue expanding (just like a utility).
What's messed up?
Part of its current business plan relies upon government rebates based upon the value of the systems installed. As a weekend Barron's article pointed out (and had been previously disclosed by the company), the government is investigating the fair values claimed by the company. The company would have to make up any shortfall to its investors.
There's also the belief that solar electricity is still too expensive relative to utility-supplied electricity. However, costs of solar panels have dropped from $4 per W to below $1 per W in many areas and predictions for reaching grid parity in most major markets range from 2017 to 2020 . In several places, grid parity has already been reached , according to Deutsche Bank.
Finally, utilities increase prices at healthy rates. That alone pushes utility electricity to become more expensive than solar electricity systems installed today in just a few years , even accounting for declines in panel efficiency. One estimate says that after taking both time-of-use electricity pricing from utilities and lifetime value of solar power production into account, one-third of the U.S. population would reach grid parity within the next five years.
The uncertainty about the government rebates it's getting as well as uncertainty about when (if ever) solar power becomes competitive with utility power (with or without subsidies) is leading to uncertainty about the company's future. However, given the long-term growth of solar power and consistent declines in the costs of components, I believe the company will be able to flourish.
Because SolarCity's not yet profitable, it's difficult to value it. However, taking what the company calls "Retained Value" (RV) – which is the present value of those future lease cash flows after removing costs to operate the solar systems and pay back investors, it is possible to estimate a value. At the end of the last quarter, the company reported RV of $662 million . At last night's market cap of $2.3 billion, it's trading at 3.5-times that.
The model assumes that SolarCity's estimates are correct for installing 270 MW of capacity this year (which would be 72% year-over-year growth ), and halves that growth each year through 2017. It also decreases the amount of RV from estimated increases to future lease payments. These estimates try to account for a rising cost of capital (which would lower RV), as well as loss of government subsidies and potential increases in the costs of panels. From this, I get about $1.6 billion of RV at the end of 2017. If the company trades at 3-times that (a lower multiple than today), it would have a market cap of $4.8 billion, a bit more than twice last night's price.
Note that 45% of the $662 million of RV comes from assuming all of its customers will sign up for another 10-year lease after the current lease expires . Cut that down to 1/3 of its customers doing so, and the 2017 projected market cap drops to $3.8 billion .
The return from last night's price to either of those projected prices in 2017 is significantly higher than the market's long-term average. Therefore, I'm going to be buying SolarCity for my MUE port as soon as possible.
I'd be happy to share my valuation model or discuss the company and solar energy prospects on the MUE discussion board. Hope to see you there!