SolarCity's (SCTY.DL) shares dropped 16.7% yesterday after the company reported third-quarter results that were actually a little ahead of expectations. Is now the time to buy this high-flying solar stock, or are First Solar (FSLR 0.59%) and SunPower (SPWR -4.50%) better buys in solar?
The answer may depend on just how much risk you're willing to take, not just today but 20 years from now.
What we know
We know that SolarCity is the largest residential solar installer in the U.S., deploying 60 megawatts on rooftops last quarter out of a total 78 MW installed. For some perspective, that dwarfs the 16 MW of residential solar SunPower installed last quarter.
We also know that SolarCity expects to install between 475 MW and 525 MW of solar next year, up from 278 MW this year. Improved installation efficiency, a growing footprint, and acquisitions that expand SolarCity's sales channels drive the astounding growth rate.
A vast majority of the company's installations are residential, each usually done with a solar lease and requiring an up-front cost for SolarCity that is paid back over 20 years by the homeowner. At of the end of last quarter, SolarCity had $1.7 billion in remaining contracted payments due from customers and $496 million in retained value for those contracts. In essence, if SolarCity liquidated its business tomorrow it would still be worth the $496 million in retained value.
It's this retained value -- which is the present value of all ingoing and outgoing cash flows -- that we should judge SolarCity on, not a net income or loss this quarter or next.
What we don't know
Here's where things get fuzzy for SolarCity. The company wants us to believe that it will be able to renew solar leases after 20 years and generate more revenue with little cost. In total, it expects $350 million in additional retained value for lease renewals, 70% of the value already contracted. But will a homeowner with 20-year old solar panels want to sign a new lease in 2033?
Assuming homeowners will renew their leases in 20 years is like assuming a car owner will renew a 5-year-old auto lease when a new car gets better mileage, is better looking, has higher quality, and may cost the same.
We just don't know what homeowners will do in 20-years, which is why assuming a lease renewal in SolarCity's value is questionable at best. I think SolarCity should be valued on what we know, not what we don't.
Where we stand now
With that in mind, the company installed enough solar projects to grow contracted retained value by $132 million last quarter, a $528 million annual run rate. We know it expects to grow up to 90% next year. Even after considering the likely drop in value per watt installed going forward I don't think it's tough to see $1 billion of contracted retained value being added annually in five years.
Subtract about $300 million in annual operating costs and I could see $700 million in value added annually in five years. If we put a 10 times multiple on that ballpark projection I could see a $7 billion company, about an 80% upside from the current stock prices.
Keep in mind that I'm assuming the leasing business is prevalent in five to 10 years. If that's not the case then SolarCity becomes a solar installation contractor, which comes with much lower margins. That's the real downside risk for investors.
A good buy in solar?
I can see a path to value for SolarCity, but we have to assume a lot of growth and very little competition squeezing margins. On the other hand, First Solar trades at 13 times the top end of 2013 earnings estimates and SunPower is going for 20 times estimates.
The decision to buy SolarCity over First Solar and SunPower comes down to the known and the unknown. If you think SolarCity can continue to grow at breakneck speed, continue to command extremely high margins, renew leases in 20 years, and out-innovate the competition there's a lot to like with the stock. If all of those factors play out the stock could be up another 300%-400% in the next few years.
If your crystal ball doesn't see quite the same optimism for SolarCity, First Solar and SunPower present tangible value and are already profitable. Who are you betting on in solar?