SolarCity (SCTY +0.00%) has accomplished a remarkable feat in the last four years: Its managed to nearly double its solar installations every year and plans on doing so again next year.
Image source: SolarCity earnings presentation.
The compound annual growth rate of 99% is impressive for any company, but especially one that's trying to upend the energy industry as we know it. The question is: Can SolarCity keep growing anywhere near this rate in the future?
The law of large numbers
To put SolarCity's year into perspective, it's expecting to install 505 megawatts-520 megawatts of solar in 2014, enough for over 100,000 homes and 8% of the total 6.5 gigawatt U.S. market. That's a high market share, especially considering that residential solar is only about 22% of all solar installed in the U.S.
But going from 520 megawatts this year to 1 gigawatt next year is a smaller leap than doubling in 2016 and 2017 for a number of reasons. First, 1 gigawatt of annual installations implies about 200,000 households going solar, or more homes than the city of Austin, Texas, the 11th largest city in the U.S. At 2 gigawatts you're talking about SolarCity being one of the largest solar installers in the world and such a large base makes it hard to grow at the same rate. It's just the law of large numbers.
Doubling to 4 gigawatts in 2017 would also be challenging when you consider that's when the biggest tax benefit driving growth is set to expire.
SolarCity workers install a rooftop solar system. Image source: SolarCity.
The ITC will be a roadblock
Unless Congress acts to extend tax benefits for solar, the investment tax credit, or ITC, expires for residential systems in 2017. This is a 30% tax credit that can be deducted from either a homeowners tax bill or a business that owns the system and then leases it to the homeowner. This is how SolarCity finances most of its solar systems, bundling tax benefits into something called tax equity ownership structures that are bought by banks and other large institutions.
This is a big deal. Without the ITC the lease structure makes less sense because it's used to unlocking tax value. That's a big reason I think the market will move to sales and SolarCity seems to agree, recently introducing a loan product called MyPower. In a sale, when the ITC expires, the solar systems SolarCity sells for a cost of $3.65-$3.92 per watt today will cost $4.35-$5.60 per watt (today's sticker price).
SolarCity then has a choice in the sale of its solar systems. It can accept lower margins by lowering prices and continue to grow, or keep margins high and grow more slowly because fewer locations would be economical for solar. At the very least, the ITC expiration will be a challenge SolarCity has to overcome.
SolarCity won't grow unimpeded forever
The other challenge on the horizon is from competitors who have seen SolarCity's success and are ready to grow into the market. Most notable is the recent growth of Vivint Solar (VSLR +0.00%), which has grown to nearly half SolarCity's size in just over two years.
There isn't inherently anything proprietary about what SolarCity does, so it'll be relatively easy to copy the model and compete if a company is willing to invest in the business. SolarCity buys commodity solar panels, hires workers to build rooftop systems, and finances them through tax equity partners as many other solar companies do. It's more efficient and has better processes than most, but not enough to grow 100% annually unimpeded.
Competitors could easily come in and undercut SolarCity on price, something we're already seeing it react to in California. Major utilities like NRG Energy, Southern California Edison, and NextEra Energy are also finding ways to move into the distributed generation market and could be competitors long-term.
SolarCity's triple digit growth rate won't last forever
Don't set your expectations for growth too high with SolarCity. Competitors are already eating into its market, forcing more competition based on price alone. Long term, I think there's also a challenge ahead when tax incentives expire. Installing anywhere near 2 GW of residential systems without the current tax structure will be difficult in 2017.
Solar energy may be below grid costs on a utility scale, but residential solar still relies on tax incentives to be below grid parity. That'll change over the next five years, but if tax incentives expire, it could lead to some growing pains for SolarCity.
