Shares of SolarCity (NASDAQ:SCTY.DL) have been rocked over the past month along with most of the solar industry. A rapid decline in oil prices has been a catalyst, which doesn't make much logical sense because there's no direct tie between oil and solar, but the selloff has continued nonetheless.
Another potential downside catalyst was the announcement that SolarCity will begin financing and selling solar loans instead of pushing the high-margin solar lease it's currently known for. This shakes up SolarCity's business model and has some investors uneasy. The big question is whether or not the stock's drop has created a buying opportunity?
Growth is SolarCity's strong suit
The biggest thing SolarCity has going for it is growth. The company installed 280 megawatts of solar last year, expects to install 500 megawatts-550 megawatts this year, and will grow to as much as 1 gigawatt next year. Doubling each year isn't something most companies would even attempt to do but SolarCity does it year after year.
One of the advantages SolarCity has is that it's growing into a growth market. Solar energy has only recently become economical for businesses and homeowners -- SolarCity's target market -- and as costs fall the opportunity only grows. With solar energy accounting for less than 1% of electricity generated in the U.S. each year there's a lot of growth left for SolarCity.
Lyndon Rive, Elon Musk, and team have stated that SolarCity could be installing tens of gigawatts of solar each year in the future, so growth isn't going to stop anytime soon. If there's one reason to like SolarCity it's this massive potential.
What's the value of solar?
The big question now is how to value the megawatts SolarCity is installing. So far, SolarCity has tried to sell investors on a concept called retained value. This is a calculation of the present value of all future cash flows from solar assets after they're under contract. As of the end of last quarter, SolarCity had $1.8 billion of total retained value or $1.72 per watt. But this model assumes up to 30 years of cash flows from customers, something that may be a stretch in a fast-changing industry.
We also need to consider that costs are falling as well and as a result so should the value generated per watt. Even SolarCity's new loan program called MyPower promises to lower the cost of going solar for consumers. Long-term, the value generated per watt will fall from over $2 today to between $0.50-$1, which could be the profit on a system sale, the retained value of a lease, or some combination. I just think that generating nearly $2 per watt in retained value on a system with installation costs of $2.29 per watt (SolarCity's cost in Q2) can't last as competition increases.
Even if the drop in value per watt downside is factored in, SolarCity is still creating value for shareholders with its sheer size. Let's say that it can create $1 in value per watt on 1 gigawatt of installations next year. That's $1 billion of value for a company that's worth $4.6 billion today.
The big risks ahead for SolarCity
The big unknown for SolarCity is how it executes on an audacious business plan that includes vertically integrating into almost every nook and cranny of the solar industry. The biggest question I have is: How many things can any single solar company do well?
When SolarCity came public it was essentially a sales, engineering, and installation company that had found an effective way to finance its product. Since then it has acquired a racking company, a solar panel manufacturer, a telemarketing company, and essentially become a bank by offering its own loans. Can SolarCity do all of those things best in class over the long term?
That's the risk that faces SolarCity and its investors. Competitors are vertically integrating in many ways, but SolarCity is taking it to another level, and that could be a strength or a weakness.
All things considered, now is a good time for investors to go solar
To me, the upside potential for SolarCity and other solar companies today is too good to pass up. Yes, there are risks, but this is a growth industry that's just starting to hit its stride. Even if value created per watt falls in the future it will be more than made up for by growth.
SolarCity's stock seems down and out right now, but its future is still bright in the solar industry. I think investors willing to look at the company and industry long term should see this as a buying opportunity and one that might not last for long if the second half of 2014 is as strong as it's expected to be.