SolarCity (SCTY.DL) has been a highflying stock since it went public in 2012, but it's recently hit a bit of a roadblock. Expectations have gotten so high that even incredible growth can't please investors, as the stock's slide after earnings shows.
Fourth quarter results also showed a few trends investors should keep an eye on in the future. Here are the three biggest reasons to be wary of SolarCity's stock right now.
Guidance miss is troubling
When you're looking at a high growth company like SolarCity, the growth rate matters tremendously. The compound effects of even a small change in growth rates are startling. For example, the difference between growing 20% per year and 25% per year over ten years is the difference between growing 619% and 931% overall.
That's why even a small miss in guidance, for the second straight quarter, is troubling. During the third quarter conference call, management said it would install between 179 and 194 MW in Q4. In reality, they only installed 176 MW.
That's a small miss from the bottom end of the target, but remember that just a year ago SolarCity was crushing its own installation guidance and increasing expectations for investors. Right now, they appear to be heading in the opposite direction. The Q4 miss was blamed, in part, on a commercial project that was finished a week into 2015, but it's notable that 2015 installation guidance of 920 MW-1 GW was unchanged.
On top of this miss, there are a lot of questions about what SolarCity's growth will look like in 2017 when the solar investment tax credit expires for residential solar buyers and is reduced to 10% for third party owners, like SolarCity's leased systems. If the tax credit isn't extended, SolarCity could snap its growth streak and even shrink year over year in 2017.
Spending is out of control
One of the downsides of growing 100% year after year is that you have to spend tremendous amounts of money to fund both operations and sales. On that front, 2014 showed some very troubling signs.
For context, installations rose 79% from 2013 to 502 MW, but operating expenses jumped 119% to $414.2 million, including a 145% increase in sales costs to $238.6 million for the year.
These costs are key because operating costs, including sales, aren't included in SolarCity's reported retained value figure. Retained value only includes cash inflows and outflows after a sale is made. So high spending upfront becomes a problem if the 20-year contracts customers are signing aren't living up to expectations.
Value may not be what it seems
SolarCity, and other companies who report retained value, want investors to take at face value the assumptions they've made in calculating retained value. But retained value includes incredibly generous assumptions, not only about how reliable customers will be in paying back loans, but also what the industry will look like in 20 years.
- "Retained Value of Renewal" assumes that at the end of the current lease a customer will renew their solar lease for their 20 year old panels at 90% of the rate they paid in year 20. Consider that the average home will have been sold 3-4 times by the time a lease reaches maturity, and that assumption looks questionable. Then consider that SolarCity's own costs have fallen 40% in the past two years and ask yourself why someone would sign a lease for 20 year old panels when newer technology will be much cheaper in 20 years?
- It's generally assumed that defaults or lease/PPA modifications won't be a problem in solar leases because in the industry's very short history they haven't been. But as solar systems get older and costs for new systems come down, why would a new homeowner take on a solar lease for old technology at a rate higher than the current market? I think in the next decade we'll see home buyers demand lower rates for solar electricity, discounts on home values (we're starting to see evidence of this), or systems to be purchased as part of a home purchase.
- Retained value also discounts cash flows back to today's dollars at a 6% rate, very generous in historical terms. If interest rates rise even a small amount over the next 20 years this assumption could prove off by hundreds of millions of dollars. SolarCity's own sensitivity analysis shows that retained value under contract falls 15% with just a 2% increase in the discount rate.
The challenge for SolarCity is that it's spending real money today (operating and capital expenses) for an uncertain payback in the future. If all goes according to plan, the payback could be huge, as indicated by their $2.4 billion in retained value. But if the assumptions that go into retained value prove to be too optimistic the value proposition for investors deteriorates quickly, a risk I think too many investors are overlooking.
SolarCity certainly has a lot of promise, but there are risks hiding within its own operating metrics.