SolarCity Corp.'s (SCTY.DL) growth trend continued in the first quarter of 2015, which shouldn't be a surprise to anyone following the company's lofty goals. It grew installations 87% year over year to 153 MW, and 217,595 customers now have a SolarCity solar system on their roof.
Growth continues at a rapid rate, but it requires a massive investment in sales personnel, which resulted in higher costs in the first quarter than a quarter ago. I'll get into why those costs shouldn't alarm investors today, but they should bring some caution into the market over the next two to three years.
The growth machine continues
SolarCity's installations jumped from a year ago, although they were down slightly from the fourth quarter. That shouldn't be too surprising, because Q1 is always a seasonally weak quarter for installations, after the rush to install in Q4 for tax purposes and typically bad weather in parts of the country.
Source: SolarCity.
The installations resulted in a whopping 1 TWh of electricity production in the past 12 months, a huge milestone for the company.
The growth in installations didn't exactly lead to a lot of revenue growth, though. Revenue was up just 6% to $67.5 million, although that was because of a big drop in solar system sales, for which revenue is recorded immediately. The net loss improved from $24.1 million a year ago to $21.5 million, or $0.22, in the quarter.
As usual, these numbers don't tell the whole story for SolarCity. The company signs long-term contracts to sell energy to customers, so value creation will happen over 20 to 30 years.
How much money does SolarCity reall make?
In the past, SolarCity has given investors an idea of value creation each quarter through a metric called retained value. This is a metric I've been critical of, because it has very rosy assumptions and didn't include debt costs for the projects the company built.
That changed some this quarter, when SolarCity introduced some new metrics, including the following table. Management has done a much better job explaining the company's cash flows each year and what they mean to investors.
Source: SolarCity.
This data also shows some of the challenges I see for SolarCity going forward. One of my critiques of retained value in the past was that it assumed a lease renewal, for which there's no evidence to support, and it's unlikely customers would agree to pay 90% of the cost of their previous lease, as the model currently assumes. By the time a lease expires 10 to 20 years from now, why would a homeowner continue the lease on old panels when a new system would probably cost less?
The new data shows how much value is being assumed from this lease renewal number and -- more importantly -- just how important tax incentives are to SolarCity. Here are a few notes from the numbers that investors should keep in mind.
- Gross cash flows over 30 years total $403 million, with an NPV of -$26.3 million at a 6% discount rate. This doesn't include the investment tax credit, or ITC, and other tax incentives, which creates more than 100% of the value SolarCity is generating for shareholders today.
- Gross contracted cash flows over the first 20 years (the terms of a lease/PPA contract) are $103 million, including state rebates and prepayments of $16 million.
- SolarCity is reporting $147 million, or $1.07 per watt, of net project cash flows for Q1 deployments. But if we include only the first 20 years under contract, that figure falls to about $81 million (that's my own calculation, based on reported numbers).
What happens beyond 2017?
The reason I point out these numbers is that the ITC pays for a large percentage of a system's cash cost, and it expires in 2017 for residential owners and falls to 10% for commercial owners (like SolarCity). That could eliminate a huge chunk of the value the company creates from each installation, especially if you don't assume a lease renewal.
It also makes cost reductions very necessary to remain competitive. Costs fell $0.30 per watt from a year ago to $2.95, but they rose slightly quarter over quarter because of a major investment in sales.
Source: SolarCity.
The green bars you see there are important, because they cover the variable cost of building a system. But what I'm concerned about right now is the sharp rise in sales costs per watt. Management is investing heavily in a growing sales force, but it's costing more per watt than previous years -- when growth was higher -- and brings great risk for 2017.
The sales force, installation teams, and other fixed costs that have been put in place will be put to the test in 2017. If the ITC isn't renewed, installations are expected to fall, and those that are still put in will be at a lower margin.
Source: GTM Research Solar Market Insight Report.
Paying for growth now is a risk SolarCity has to take to fend off competitors in the residential and commercial market, but if the ITC doesn't get extended, 2017 and 2018 could be painful years.
Growth with risk
Whether you're a bear or a bull on SolarCity stock, there was probably little from the first-quarter report that changed your mind. On the plus side, the company continues to grow like a weed and is adding hundreds of millions in long-term contracted value. On the downside, its value creation may not be as high as advertised, and rising operating costs increase the company's risk if subsidies are cut.
We won't know how this debate plays out until 2017, and there are hundreds of companies along with SolarCity that will be waiting with bated breath on whether Washington, D.C., continues its tax subsidies on solar. If it does, the sky is the limit for SolarCity. If not, there's a lot of uncertainty ahead.
