SolarCity (NASDAQ: SCTY) stock is down 45% in the past 30 days, but if you think this is your chance to buy into a solar provider at a discount, think again. Many investors believe that SolarCity should continue growing at historical rates. However, it seems its growth may be limited by something a bit mundane: access to capital.
Think of SolarCity as a bank, not a solar company
Traditionally known for disrupting the outdated energy industry by providing renewable electricity directly to homeowners, SolarCity has trumpeted the massive growth in the solar market. Its customer base, now over 300,000, has grown at a 94% annual rate since 2012. Still, the company believes it's penetrated only 1% of the U.S. market. Revenues last quarter were $114 million, compared with a massive $60 billion total electricity market.
However, its business may not be as straightforward as it seems.
In its simplest form, SolarCity's business can be broken down as borrowing at a low rate and lending at a higher one. The company finances the installation of solar panels in return for long-term monthly payments, like a loan. Because banks can accept deposits and access the Federal Reserve, they typically have a reliable source of funds. SolarCity's business model doesn't have that luxury, meaning it's consistently reliant on further sources of funding to continue growing.
For example, when a customer elects to switch to solar power and chooses SolarCity as their provider, they don't need to pay for the upfront cost of the system, SolarCity does. Through monthly payments through either loans or Power Purhcasing Agreements, the customer slowly pays off SolarCity for providing this initial up-front capital to purchase the system. This should seem similar to the way a lot of loans are structured, specifically home mortgages. Mortgages however are typically provided by banks, considering they require significant amounts of capital to start the loan. As mentioned, most banks have fairly established ways to continue garnering capital. SolarCity however needs to continually tap the equity and debt markets to continue funding projects.
A recent announcement from the company shows how, despite massive industry tailwinds, the company can't always grow as fast as it wants, or the market expects.
On Oct. 30, it announced that is was significantly cutting back expansion plans, with finite access to capital to blame. While new sources of funding are still ample (it recently closed a deal to finance $400 million in solar projects), cash isn't flowing in fast enough for the company to maintain its impressive growth rates. According to CEO Lyndon Rive, "Though we expect our deployments to grow in 2016, we are not targeting the same growth rates that have gotten us to our current scale going forward". Note that the company still anticipates continued growth, just not at the pace investors were expecting.
As investors slowly accept that SolarCity can't grow as fast as used to, the premium that investors had been assigning the company for rapid sales growth has fallen dramatically. In May, the company's stock was trading at 23 times sales. Today, that's down to only 8 times sales. Revenues are still growing too (up 10% last quarter), so the drop in share price is almost entirely due to lower investor optimism for future growth rates.
Is there still opportunity?
Still, there are still plenty of things going right for the company.
Foremost, the underlying industry is still growing, and should for some time. Switching to SolarCity as your solar provider is a simple decision: will your monthly rates be lower with solar or traditional electricity. That simple decision is getting increasingly easier to make.
Since 2004, the average utility bill for a U.S. residence has risen by over 30%. In the regions that SolarCity operates, rates are up nearly 50%. The price of solar meanwhile has been getting cheaper for years. In 2012, it cost SolarCity $4.73 per watt to install its solar systems at customer homes. This year, costs are down to $2.84 per watt. By 2017, the company expects it to fall even further to just $2.50 a watt.
SolarCity is able to lower costs for a few reasons, the biggest of which is scale. For example, the cost of installing solar in Germany is roughly half the price as the United States. A majority of this gap can be explained by the size of the market. In Germany the market is big enough for providers to gain critical scale to spread out costs. What this means is that whichever U.S. solar company can scale the fastest will most likely gain a significant cost advantage. On that front, SolarCity is the undisputed leader.
In 2009, the company controlled only 6% of U.S. residential solar installations. However, its share has grown every year since, reaching a market-leading 36%. Now, SolarCity should be able to continue using its unmatched scale to consistently lower costs, most likely resulting in even more market share gains.
A bet on SolarCity is not necessarily a bet on solar
If you're anticipating a long-term move toward solar, an investment in SolarCity is not is simple as it seems. While it should be able to leverage its market-leading size and cost advantages, it will still be limited by funding requirements. If you own SolarCity for the long-run, you'll need to be confident in both the industry and the company's plan to finance its growth.