Over the past month, we've seen multiple articles going over the many reasons why SolarCity (NASDAQ:SCTY) is overpriced and a terrible investment. Today, all of the analysts are patting themselves on the back, as SCTY plunged to under $20 after reporting disappointing earnings and Q1 guidance. I whole-heartedly agreed that the stock was overpriced when it hit the high $50s in late December, but with the most recent move under $20, I decided the stock deserved another look. Thus, I'm planning a small series of articles analyzing the sector and SCTYs prospects going forward.
My first goal was to address a critique of SolarCity that has been brought up by many analysts recently; SolarCity's model is not sustainable because they're simply taking advantage of their customers by getting them locked into 20 year solar leases.
The argument is that someone getting into a solar lease would be much better off simply buying the system outright. Theoretically, this made sense to me, but I wanted to be sure. Thus, a couple weeks ago, I wrote an article taking an initial look at rooftop solar leases. To my surprise, under the assumptions I used, a solar lease was actually not a terrible deal. In fact, over 20 years it ended up being just as good of a deal as purchasing a system outright for anyone that wasn't able to take advantage of the ITC credit on their own. Considering that 45% of households didn't have any federal income tax burden in 2015, solar leasing seemed to be a reasonable proposition for many people.
My article sparked some great comments, some of which felt that I had used numbers that were to favorable to solar leases. These included the following:
- I assumed that the customer would save 32% off their electric bill the 1st year with a solar lease, whereas in reality it averaged 20-25%.
- I should have used the full 30 year life savings of the purchased system in my comparison, rather than only comparing 20 years.
- My assumption of $3.50/Watt cost of installation was too high.
Given all these concerns, I decided to incorporate them into a new model, as shown below. This new model uses a $3/Watt install cost, and a utility rate that starts off 24% higher than the SolarCity solar lease. I also analyze the total costs over both 20 and 30 years.
It's important to note that each of these variables could be adjusted multiple ways, which can potentially cause drastic changes to the results. I've assumed that electricity prices increase by .5% annually. Over the past ten years the actual increase has been 3% annually. However, its completely possible that we see rates actually drop by 1-2% annually over the next couple decades. I'm actually leaning towards the latter, but decided to use the middle ground.
The results seem pretty clear. A solar lease ends up saving the customer about $2,900 over the 20 year lease term, about 10% compared to simply paying for the electricity. In contrast, purchasing the system outright with the ITC would result in 20 year savings of over $13,200! If we extend the analysis out to the full 30 year assumed life of the system, purchasing the system outright ends up saving even more money! Using this analysis, it seems that the skeptics are totally correct; solar leases are a terrible deal!
However, when I was looking at the annual cashflows, a thought came to me: What if we looked at the Net Present Value [NPV] of the annual cash savings compared to simply purchasing from the grid? The solar lease starts off with a 24% savings the first year, whereas buying a system requires plunking down cash upfront.
Its important to understand that when analyzing the options on an NPV basis, the chosen discount rate can have a large effect on the results, especially over the long 20 and 30 year periods we are analyzing. A low discount rate favors direct ownership of the system, while a high discount rate favors up front savings from a solar lease. I've decided to use a 6% discount rate, which I feel is a reasonable average long term, given that it is similar to an average 30 year treasury yield (average is key here, since obviously rates are currently much lower).
|20 Year NPV||30 Year NPV|
|Buy System Outright||$1,335||$4,699|
|Finance with Loan||$1,670||$5,033|
On an NPV basis, the results are much closer. The initial cash outlay of the system means that it takes over 16 years for an owner to end up with a positive NPV. Over the initial 20 year lease term, the SolarCity lease actually has the best NPV. However, when we assume a 10 year renewal to match the full assumed 30 year life of the system, the NPV of the owned systems surges ahead.
However, its important to realize how much the assumed discount rate changes the results. If I was to have assumed 7% discount rate instead of 6%, it would take 28 years for the owned system NPV to catch up to the leased system. Alternatively, at 4%, the owned system is already better after 20 years.
Based on this analysis, I would argue that SolarCity's solar leases can actually be the best decision for many of the people in the states in which the company operates. Assuming the money saved during the initial years of the solar lease is reallocated to an investment portfolio that can average 6% annual returns over the 20 year lease term, the NPV is actually better than installing a system over that term. Of course one could argue that many people will simply spend the cash savings, but they would never install their own system in the first place!
One could also argue that even $3/watt is too expensive to use as an example for a purchased system. MacAfrican has pointed out in multiple comments that in Europe the average system is installed at under $2/watt. I tend to agree with him, and wouldn't pay more than $2/watt for my own system. However, most typical consumers are not going to shop nearly as intelligently, and most installers are taking advantage of the ITC credit to keep their quotes at over $3/watt on smaller systems like the one in my example.
My key takeaway is that for the average consumer, a solar lease from SolarCity or a competitor can result in a better NPV than an outright purchase, and thus I expect to see the company's leases perform better than the critics expect.
The next step is to see if the company can generate any long term value for stockholders.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SCTY over 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.