- SolarCity has a strong growth quarter and several operational improvements from prior quarter.
- SolarCity's rapid growth continues to be driven by its access to low cost financing (as low as 4.03%).
- The Company's business model, however, is fundamentally challenged and unlikely to end well for long-term investors.
Operationally the company is on a tear. MW Deployed of 107 MW is up 102% year-over year. MW Booked totaled 218 MW, up 216% as compared to Q2 2013. The Company's much abused retained value metric jumped to $1.8B from $1.29B in the prior quarter.
While the growth story seems rosy, the Company's fundamental structural problems remain. We discuss below the major items from the Company's earnings release and the subsequent conference call.
What we like about SolarCity:
- The Company continues to reduce its installation costs at a rapid pace. At about 11% a year in cost reductions, the Company's cost curve has stayed ahead of the industry trends. Thanks in large part due to its Zep mounting system, the Company's installation cost of $2.29 per watt is competitive with other large non-public installers. These installation costs, however, are higher than those of smaller regional installers.
- Thanks to yield chasing investors and the perceived low risk of solar assets, the Company is able to raise considerable amounts of low cost capital easily. The cost spread over benchmark rate has decreased considerably in the recent past and has tightened 85 basis points from LMC1 to LMC III. We have no doubt that SolarCity's access to low cost capital (as low as 4.03%) will continue to drive Company growth.
- Commercial growth, which was anemic in past quarters, has resumed. We believe the commercial segment is critical for the Company's long-term growth.
- As a sign of strong ongoing operational performance, the Company's growth guidance is exceptional. For Q3, the Company is forecasting MW deployed in the range of 135 MW - 150 MW, indicating an approximately 80% year-over-year growth. For 2014, the Company expects to deploy 500 to 550 MW and to almost double the number again in 2015.
- The Company is taking steps to remove escalators as part of its energy contracts by offering customers a choice on the escalator. We see this as a net positive, as it is likely to reduce the long term default rates.
- At current growth rates, the Company can easily consume all of Silevo output from any of the planned manufacturing locations including the New York gigafab. Strong internal demand implies that underutilization of the fab is not likely to be a problem.
What we dislike about SolarCity:
- SolarCity's business model is fundamentally flawed due to likely high default rates over the term of the lease/PPA. The Company's stated retained value metric continues to be inflated until the Company corrects its assumptions. Management stated that less than 1% of the Company's revenue stream has been problematic. However, investors should note that about 90% of SolarCity's customers have PPAs for less than 2 years. Even a sub 1% failure rate at this point can be a sign of things to come. These leases and PPAs will only get toxic as time progresses and as the gap between market prices and lease prices increases.
- We find SolarCity's stated $0.15 per KWH rate in customer contract rife with risk. There is a substantial headwind developing from the utilities in the form of fixed connection rates and lower tariffs. Combined with the ITC expiration in 2016, we foresee significant risk of lower contract prices by 2017.
- While the installation costs of SolarCity, at $2.29, are competitive with larger installer, we find the overall cost structure of $3.03, excluding stock based compensation, to be disadvantageous. While an apples-to-apples comparison is tough to get, we estimate that all-in costs of regional contractors are closer to $2.50 a watt.
- Finally, the Company's lease model depends largely on uniformed customers buying the unattractive lease/PPA products. The supply of this class of customers is likely to be plentiful as the Company targets new geographies but we expect the supply of gullible customers to decline as solar penetration increases. Over time, the lease model will in large part give way to loans and other more customer friendly products.
Driven by access to cheap capital, SolarCity continues to be on an aggressive revenue growth path, but the Company's business model is fundamentally flawed. As we have written in the past, we see the intrinsic value of this Company is about $10.
If David Einhorn's righteousness and patience are being tested at Herbalife (NYSE:HLF), he should look at SolarCity.
Our Sentiment: Avoid