SolarCity is growing its presence in commercial solar projects like this one. Image source: SolarCity.
In covering the solar industry, one of the hardest stocks to analyze today is SolarCity (SCTY +0.00%). The company is growing faster than nearly every competitor and has built a dominant market position in U.S. residential solar. The potential for growth is almost immeasurable.
But it's reliant on others to finance projects and builds in a single market, one that could be crushed if the investment tax credit ends as planned in 2017. Then there are questions about how it's creating value and whether or not customers will live up to their expectations 10, 20, or 30 years from now.
Here's how I look at SolarCity as a stock today.
Growth is what we do
SolarCity's growth has been nothing short of tremendous over the past five years. At the midpoint of this year's 920 MW to 1 GW installation guidance the company will have put up a 99% compound growth rate over five years. The growth has resulted in a 39% market share in residential solar.
Image source: SolarCity Q4 2014 earnings presentation.
This growth has put SolarCity in the enviable position of dominating a U.S. residential solar market that could grow more than 100x and still not reach full saturation. That's even before talking about bringing operations overseas.
If SolarCity can grow, and do so profitably, for years to come it will be a great investment. It's the cost that goes into that growth and the profit side of the business where my biggest questions arise.
Growth is costly
When SolarCity says it added $3.0 billion in nominal contracted payments in 2014 or that it increased retained value by $1.4 billion it's talking about what happens after a customer signs a contract. But before the customer signs a contract SolarCity has to pay sales staff, advertising, administration, R&D, and other costs that go into operations. These operating costs fuel the growth in retained value.
The trouble is that SolarCity is spending incredible amounts on operations. Last year, operating costs increased 119% to $414.2 million, compared to a 79% increase in installations. This was partly due to a ramp-up in hiring to drive growth, but operating costs per installation should be falling long-term, not rising.
Since operating costs are sunk cash expenditures it's something investors should watch closely. When you compare the costs already spent with the questions I have about future inflows, measured by retained value, I become more uneasy about the stock.
Commercial solar projects like this one come with lower margins than residential solar projects. Image source: SolarCity.
The future is uncertain
No questions in solar stump me more than those about the future of residential solar. In 10 years will potential homebuyers be willing to take over a 10-year lease for 10-year-old solar panels at a price higher than they could get on the open market? Will those who leased panels for 20 years renew leases for another 10 (as SolarCity assumes)? At what rate would they renew?
Then there are questions facing the future of the industry as a whole. Will efficiency be a growing differentiator or are SolarCity's commodity panels the best strategy? What financing options will be popular in the future? Is a national footprint (as SolarCity has built) the right strategy or is using local distributors (SunPower's (SPWR +0.00%) strategy, among others) going to be more efficient long-term? What happens to residential solar in 2017, when the investment tax credit for residential solar buyers expires? Will it even expire or will it be extended?
How these questions are answered will tell us whether or not SolarCity continues to grow, how profitable it can be, and how it competes as competitors grow in size and capability.
Is SolarCity a buy today?
SolarCity has demonstrated the ability to grow at a rapid rate but my questions about the stock come down to the cost of acquiring that growth and ultimately the value added to shareholders long-term. To measure this, I think it's more important to look at the full picture of value add rather than SolarCity's advertised retained value number.
When I look at SolarCity's reporting figures, I think it's reasonable to use contracted retained value (excludes the speculative assumption of renewal after 20 years) minus operating costs to acquire that retained value and minus debt assumed to fund projects (SolarCity is moving to pull this value out as well). This should give us value add.
Contracted Retained Value-Operating Costs-Debt Financing = Annual Shareholder Value Add
Before you see what the numbers are, ask yourself if this is a reasonable way to look at value? Now here's what the numbers are for 2014.
$1,025 million-$414.2 million-$872.4 million = ($261.6 million)
Based on these numbers, SolarCity actually decreased shareholder value by $261.6 million, despite tremendous growth. The company's net loss of $375.2 million for the year may not tell the whole story, but the calculation above uses SolarCity's own value numbers and I think it shows they're not creating as much value as they say.
Stack on top of that the questions I have about the residential solar market in the next decade or two and I think there are better options in solar. For example, SunPower and First Solar (FSLR +3.15%) are both profitable and businesses diversified around the world instead of being reliant on the policies of one market. I'd rather bet on either of those stocks than SolarCity. Despite its tremendous growth, SolarCity stock is just too high a risk for me.
