Downward Pressure On SolarCity

Mar.26.14 | About: SolarCity Corp. (SCTY)


Downgrades and negative articles on SolarCity abound.

SolarCity's valuation is reasonable.

Solar power is not dependent on subsidies (but they help).

The cost of solar continues to drop, similar to Moore's Law.

The long-term trend is up.

By some indications, it is time for SolarCity (NASDAQ:SCTY) investors to take their profits off the table. There was recently a breakdown on the PnF chart, which saw the stock drop by 26% (from $88 to $65). SA author Robert Wagner published a pair [1, 2] of extremely bearish articles, claiming that the 'green economy' was likely to trigger the next financial crisis. Finally, Baird downgraded SolarCity to Neutral ($81 price target) and TheStreet downgraded it to Sell. Baird's decision was based on valuation.

It is difficult to argue with Baird about the company's valuation. This company's value is notoriously difficult to estimate, because all capital investment is funneled towards a recurring revenue stream in the future. We don't know precisely what SolarCity's costs are, and the nature of their accounting (by necessity) is convoluted. I made an attempt to analyze the company's value here; my gut feeling is that Baird's $81 price target is about right for 2014. It's worth noting that SolarCity has funding for $4 billion in solar projects, and has already leased $1.7 billion worth of solar systems. Those two numbers combined are in line with its market cap of $5.8 billion. This company is not so outrageously valued as some analysts believe.

What I can criticize is Robert Wagner's articles regarding the crash of the 'green economy.' Wagner focused more on debunking global warming. There is literally zero economic analysis of solar power to be found in his writing. Specifically, Wagner made a very broad claim that was not supported by any source:

"We know that the vast majority of the 'green economy' is completely dependent upon government support, and are far from being commercially viable."

SolarCity's Growth Trajectory

A Google search for "solar grid parity" is enough to debunk the myth that solar is dependent on subsidies. Multiple studies from reputable sources [1, 2, 3, 4] have calculated that solar power is equally or less expensive than power from the grid in many locations around the world.

The US Energy Information Association calculated an average operating cost of 6.378 ¢/kWh for "fossil steam" (i.e. coal) power plants in 2012. There are multiple solar PV projects that sell power to utilities at less than 6 ¢/kWh. See the SunEdison project in Texas and the First Solar Macho Springs project in New Mexico. Notably, the SunEdison project does not rely on state subsidies. Clearly these two solar projects are a better economic choice than fossil fuels if they sell at a cheaper rate and earn a profit to boot.

In conclusion, solar is not reliant on subsidies in many regions. What's more, a fair discussion of subsidies must also consider the fossil fuel subsidies that are entrenched in our tax code. An example is Percentage Depletion, which gives some fossil fuel producers a significant tax deduction (15% of gross revenue for oil and gas; 10% for coal) for depleting natural resources. Taxpayers hand over about $1 billion per year for this subsidy. A quote from the Independent Petroleum Association of Ameria:

"Percentage depletion plays its significant role in keeping America's marginal wells producing."

Outside of subsidies, one must also consider policy. State leaders continue to recognize and uphold the core solar policy net metering - which is not a subsidy. Most recently, Vermont is about to expand its net metering cap by a factor of four, and two anti-net-metering bills were just defeated in Washington and Utah. In fact, I don't know of a single case where the scope of a state's net metering policy has diminished. Multiple polls show broad bipartisan support for solar power [1, 2, 3].

One last thought for the bulls (before I mention a few negatives about SolarCity). In 1965 the cofounder of Intel predicted that processor computing power would double every two years. His prediction was largely correct, and it lead to the ubiquitous electronic devices that we enjoy today. There is a similar prediction for the cost of solar power known as Swanson's Law. It has been surprisingly accurate since 1977. Investing in solar power today is analogous to investing in Intel in 1965.

Two Negatives to Consider

As bullish as I am, two factors about SolarCity still bother me. First, the battery supply partnership with Tesla Motors (NASDAQ:TSLA) can't be cost-competitive with other battery suppliers. Presently, the cost of a Tesla battery is estimated at 200-300 $/kWh. If the 'Gigafactory' lowers costs by 30%, that would give SolarCity a battery cost of 140-210 $/kWh. It's easy to source backup batteries online for $150-160 $/kWh, including a seven year warranty. So I don't think the Tesla partnership will bring much to the table for SolarCity (beyond namebrand recognition…)

The other bearish factor is that SolarCity's competitors are getting more sophisticated. Much has been made of SolarCity's efforts to streamline installation costs, such as its acquisition of Zep Solar. Zep's specialized mounting brackets are supposed to reduce install time, but competitor Sunrun has acquired its own mounting specialist.

Nor is SolarCity unique in its push for crowdfunding. RGS Energy (NASDAQ:RGSE) has partnered with Mosaic to launch its own crowd-funded platform. Mosaic is an established player that has facilitated large crowd-funded solar projects since January 2013 (and they already have a slick website). So I expect that RGS Energy's crowdfunding platform may go active before SolarCity's. The Mosaic approach is better than the SolarCity approach (in my opinion) because the solar system becomes the property of the homeowner.

Because of these competitive pressures, it won't be easy for SolarCity to continue growing market share.

The Bottom Line

I look at the breakdown on the PnF chart as a buying opportunity, similar to the breakdown in August 2013. After that August breakdown, SolarCity skyrocketed from $28.63 to $88.35 (a 209% gain). It's highly unlikely to see that type of appreciation again, but the long-term trend will certainly be upwards.

Disclosure: I am long SCTY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.