A growing number of people are going solar, driving growth for SolarCity. Image source: SolarCity.

SolarCity's (NASDAQ:SCTY.DL) days of wowing investors with growth figures that top even its own projections may be coming to an end, and investors look like they're starting to realize that as well. Third-quarter earnings results came in after the market closed today, and while they weren't disappointing, they didn't impress investors, especially when it comes to future growth.

Overall, revenue was up 20% to $58.3 million in the quarter, and the company recorded a $70.1 million loss, or $0.75 per share. But revenue and earnings never really tell the full story at SolarCity, and it's beneath the headlines where we need to look for the true story at SolarCity.  

SolarCity is what they said they were
When SolarCity came to the market in late 2012, it continually impressed investors with how fast it was growing. It would set a target publicly and then blow by it the next quarter. The legend grew, and pretty soon SolarCity's stock was so highly valued that it would have to keep outperforming just to make the market happy.  

Today's earnings release showed that SolarCity is living up to what it said it will install but may be done wildly outperforming expectations. Installation guidance for 2014 was narrowed from 500-500 MW to a range of 505-520 MW, the low end of the previous range. The low end of 2015's guidance was bumped up slightly to 920 MW from 900 MW, but the top end of the forecast was still 1 GW.

I'm not suggesting that doubling installations every year is bad. In fact, it's incredibly impressive if SolarCity can keep doing it. But the days of outperforming expectations may be over, especially when you consider how quickly competitors are adapting to what's working in the solar market.

Competition is picking up
One of the challenges SolarCity faces long-term is that it's really in the construction business, which is very competitive. As it pushes solar loans through the new MyPower product it recently launched, it'll have to compete with SunPower, Vivint Solar (NYSE:VSLR), and many other companies based on how much it charges to install a solar system, which is very different from selling leases in a market you dominate.

This quarter, we got a peak at what increased competition is doing to SolarCity. In the following table, you can see the number of MW booked and deployed, but what's key is that contracted payments and added retained value didn't grow at the same pace.


Q2 2014

Q3 2014

MW Booked

218 MW

230 MW

MW Deployed

107 MW

137 MW

Contracted Payments Added

$811 million

$803 million

Added Contracted Retained Value

$405 million

$294 million

Source: SolarCity earnings releases.

The slower growth in retained value can be partially explained by the fact that no securitization offerings were completed in the quarter, which adds a one-time benefit to retained value. But the contracted payments added growth also didn't keep up with MW booked growth, which is concerning.

SolarCity's own numbers show that retained value per watt was flat in Q3 at $1.72 per watt. Last quarter we saw retained value of $2.32 per watt, so implied margins fell dramatically despite a lower installation cost. Competition looks like it's creeping into the residential solar industry.  

A growing number of SolarCity's installations may soon be financed with loans. Image source: SolarCity.

The biggest concern with solar loans coming
The biggest change SolarCity is going to make in the near future is moving to system sales through its MyPower solar loan product. The challenge here is that it'll be competing directly based on system costs per watt, not just lease costs where it can leverage its financing capabilities.

In the earnings presentation released today, SolarCity said it anticipates selling solar systems for $4.35 to $5.60 per watt, which would lead to a strong operating margin of 33%-48%, given its $2.90-per-watt cost for installation and SG&A.

But I don't think lofty margins like that can last long in a competitive solar environment. Vivint solar is quickly expanding its reach across the country, and SunPower is already making lease, cash, and loan sales.

Time will tell how customers and competitors react in the cash sales market, but typical construction operating margins are more like 5%-10%, not near 50%. And I highly doubt SolarCity has that big of a cost advantage over competitors.

A more realistic goal long-term may be generating $0.50 per watt in operational profit. Even with a 1 GW annual installation base that would be $500 million in operating profit and could grow significantly with the business. That's where I think MyPower will bring SolarCity in the future, but time will tell if competitive pressures decrease margins or not.

SolarCity is still the clear leader in residential solar in the U.S., but there are cracks in the armor starting to form. Watch to see if margins and retained value per watt come under further pressure in the coming quarters, because that will tell the direction of this high-flying solar stock.