SolarCity (SCTY) is a company led by Elon Musk that specializes in rooftop solar panel installation. The premise of the business is you save money on your utility bills by purchasing rooftop solar panels and inverters with little to no cost to the consumer up front. The customer pays a licensing fee to SolarCity, which would be less than the current utility bill, saving the customer money. The customer wins obviously by paying less money on utilities while SolarCity wins by signing people up for long-term lease deals (20 years is typical). This guarantees revenue for SolarCity for years to come. This business model has helped increase the value of SolarCity to its current market capitalization of almost $4.6B. Below is a graph from stockcharts.com that shows the stock price volatility since its IPO in December 2012 at $8/share.
Getting in on the IPO would have had netted a huge return on your investment with a return of over 323% as of May 19th, 2014. Looking further into the business brought up some concerns about SolarCity in terms of investing at current valuations.
Right now there are significant government subsidies for solar companies. The Federal Government currently offers a 30% investment tax credit under Section 48(a)(3) of the Internal Revenue Code, or the Federal ITC, for the installation of certain solar power facilities under December 31, 2016. This is done to push solar companies into advancing the technology for general adoption for the public. If solar energy can be harnessed, it would easily supply all of the world's energy demand.
So why do I bring up this tax credit? It has to do with the most important aspect for every business ever started in the history of mankind. This aspect is making money, a concept SolarCity does not currently do. Here are the net income values for SolarCity since 2011 from total operations (values can be found in the Annual Reports for SolarCity.
- In 2011, SolarCity lost $73.71 Million
- In 2012, SolarCity lost $91.58 Million
- In 2013, SolarCity lost $151.76 Million
The trend is SolarCity is losing money on operations. A real tough pill to swallow is in the income statement, SolarCity spent $188.75 Million in selling, general and administrative expenses. The revenue was $163.85 Million. This doesn't take into account cost of goods sold. There should be some pass due to the cost of obtaining customers and once the revenue growth increases due to many customers and leasing income, the net income value may turn positive eventually. This is not something to take for granted though since this switch to profitability may never come. If SolarCity cannot increase revenue to outpace costs by 2016, the losses incurred will be higher as the tax credits expire.
There are many players in the solar business including First Solar (NASDAQ:FSLR) and SunPower Corporation (NASDAQ:SPWR). Below is a figure showing the stock prices for First Solar and SunPower since the SolarCity IPO.
SolarCity has actually outperformed both SunPower and First Solar in terms of stock price appreciation since December, 2012 which may suggest SolarCity has performed better than First Solar and SunPower. A direct comparison on some key financial metrics was done comparing SolarCity with First Solar and SunPower proves otherwise.
Table 1 shows the income statement related comparisons.
|Table 1 - SolarCity vs. First Solar vs. SunPower (Income)|
|Market Cap ($B)||4.6||6.0||4.2|
|Gross Margin (%)||49.3%||33.2%||23.5%|
|R&D Spending ($MM)||0.0||134.3||58.08|
|Selling/General/Admin Expenses ($MM)||188.75||273.03||271.48|
|Net Income from Total Operations ($MM)||(151.76)||353.04||33.55|
SolarCity does not spend any money on R&D since they depend on third-party suppliers for their solar panels. On the other hand First Solar and SunPower spent in 2013 4.1% and 2.3% of total revenue on R&D, respectively. In 2013, both First Solar and SunPower were able to operate at a profit from total operations while SolarCity losses grew year-over-year. The spending on selling, general and administrative expenses is almost on par with First Solar and SunPower for less than 10% of the revenue. SolarCity needs to be able to control costs before they spiral out of control. Only then can they have a chance at profitability.
Table 2 looks at some key balance sheet information between the three companies.
|Table 2 - SolarCity vs. First Solar vs. SunPower (Balance)|
|Long-Term Debt to Equity||0.84||0.04||0.35|
|Total Debt to Equity||3.55||0.53||2.49|
|Return on Assets||-5.4%||5.1%||0.9%|
|Return on Equity||-24.6%||7.8%||3.0%|
Due to negative income, return on assets and equity are both negative for SolarCity. Both variables are favorable towards First Solar. As well, long term debt and total debt to equity is highest with SolarCity and lowest with First Solar. Debt if not managed correctly can cripple operations and is something to track for SolarCity moving forward. The quick ratio for all above 1 with SolarCity and First Solar having twice as much current assets compared to current liabilities (not taking into account inventory).
Why is it important to note that First Solar has performed better than SolarCity in some key financial metrics? It is because First Solar plans to enter the residential rooftop business, effectively competing with SolarCity. With much more experience with solar panels since First Solar produces and sells them, they may prove to be a very tough competitor. Based on financial metrics alone, First Solar seems to have a huge advantage moving forward and may catch up to SolarCity soon.
Don't let the solar in SolarCity fool you into thinking SolarCity specializes in solar technology in the traditional sense. Unlike First Solar Inc. and SunPower Corporation, SolarCity does not product solar panels in-house. They depend on third-party suppliers for solar panels and inverters. Special contracts have been made that allow SolarCity to purchase solar panels on a need-to-buy basis under master contractual agreements. This is important as new technology has led to the cost of manufacturing solar panels to decrease.
In the 2013 Annual Report, SolarCity reports 9 patents issued and 48 pending applications with the U.S. Patent and Trademark Office. Here is a passage from the Annual Report describing the contents of the patents.
These patents and applications relate to our installation and mounting hardware, our finance products, our monitoring solutions and our software platforms. Our issued patents start expiring in 2025. We intend to continue to file additional patent applications. "SolarCity," "SolarGuard," "SolarLease," "PowerGuide," "SolarStrong," "SunRaising," "PowerSavings Plan," "Rooftop Rewards," "Solar Made Simple," "Zep Solar" and "Zep Groove" are our registered trademarks in the United States and, in some cases, in certain other countries. Our other unregistered trademarks and service marks in the United States include: "Better Energy," "SolarBid," "SolarWorks" and "DemandLogic." -SolarCity 2013 Annual Report
All the patents deal with the financial products, installation hardware and monitoring solutions.
This is not in and of itself an issue. SolarCity acting as a middle man can be a wonderful strategy since the R&D costs improving solar panel technology would be incurred by the suppliers and not SolarCity directly. The issue comes from the fact that they don't control their feedstock (solar panels) and are dependent on the third-party suppliers. Unlike McDonald's (NYSE:MCD) and Wal-Mart (NYSE:WMT), which have huge sway over suppliers, SolarCity is not at the scale which could lead to higher costs in solar panels moving forward.
Growth Prospects in SolarCity
There are benefits with SolarCity and those are mainly a good business model that guarantees revenue for long time periods and a growing business. Below is a graph comparing SolarCity growth in revenue, from 2012 to 2013, with SunPower and First Solar.
First Solar actually saw a decrease in revenue over the past year. With the introduction into the rooftop business, this has a chance to get back into the black. SolarCity saw an increase of 27.3% in revenue which is great. Some other key highlights from the 2013 Annual Report include:
- Cumulative number of customers increased from 48,419 (2012) to 92,998 (2013) or an increase of 92%
- Total number of contracts increased from 40,685 (2012) to 83,265 (2013) or an increase of 105%
With these stellar increases in customers, SolarCity may eventually increase revenue enough to outpace costs and become profitable. At this point though, this is an assumption.
SolarCity has a lot of positives going for them. They are a leader in rooftop implementation of solar panels, a solid business model and high growth numbers. The downside is that SolarCity has stiff competition, dependent on third-party suppliers for solar panels and are not profitable. At this point, they do not seem to be a solid investment but in time if the growth in customers increases revenue enough to outpace costs, turning SolarCity profitable, they may deserve a second look.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.