Made an investment in Solar City (SCTY) on 15 May 2015 at a price of $63.12. Many people have long talked about the future of solar power and other forms of clean energy for years now. Some may have even made investments in them years ago. My interest was only perked in SCTY when it came to my attention the crazy fast pace they are growing. If you had invested in solar companies years ago, you may have been well ahead of time. I believe now is a great time to re-look at clean energy.
But first, let’s look at the macros:
A Macro view on Solar Power
A rising tide lifts all boats.
The cost of producing solar panels is dropping.
Solar modules prices have dropped from $10 per watt in the 90s to $1.05 a watt today. Cost of solar power in America will drop to $1.00 per watt by 2017 under the SunShot initiative.
The cost of installing solar panels is also dropping.
If you had noticed in the first part of the infographic, it explained that because people lease, installation costs is zero. The lease means that the household will sign a long term contract to pay the solar power companies their electricity bills instead of paying the upfront installation costs. ( I will explain why this is important to Solar City later on.)
Because installation costs is zero, the adoption of solar panels is growing at a rapid rate: One new solar power system is installed in every 4 minutes in the USA; Solar power capacity has grown by 418% from 2010-2014. Solar power is also projected to be the fastest growing energy source over the next year. The best part is, despite all that fast growth, solar power only accounts for 0.4% of electricity in USA. The potential for it to grow is huge.
The traditional utility companies are fighting back though. They are trying all ways and means to hinder the growth of solar. The utility companies in certain states are not only trying to reduce the tax incentives given to solar companies, they are also asking to impose grid usage charges on households that utilise solar. ( Basically, the utility companies want to charge households a price for using their energy distribution network. By doing so, the costs benefits for the households to switch to solar energy is removed.)
But I honestly don’t believe that utility companies can win the fight against solar, given the tremendous amounts of benefits that they provide to the customer. Also, the decreasing costs of solar allows solar companies to pass this cost savings down to the consumer. So even if utility companies try to control the grid charges, I wonder how long they can put up this fight when all the consumers in US will be against them.
Solar City – The Leader of the Pack
Solar City is the one solar company that stands out from the pack. Based on Q3 2014 data, Solar City installed more solar panels than their next 70 competitors combined. That is a strong sign of Solar City’s popularity and dominance in the industry. Their referral program is one of the factors spurring the growth. As you can see from the graph above, their nominal contracted payments remaining grew by a staggering 141% Y/Y.
The main factor is SCTY’s very popular business model. SCTY will install solar panels on your rooftop for free, but you have to sign a 20 year lease with them to make payments for electricity. The costs, after selling excess energy back to the grid, brings your electricity down to almost 85% of your current bill.
So not only do you get to have solar panels installed for free, you get a significant cost reduction on your electricity bill AND you get to make money if you successfully refer a customer to Solar City.
Tell me, how can you reject his offer??!!
Financials and Valuation
SCTY financials are kinda hard to follow. It has been making negative earnings, negative cashflow and increasing debt as it borrows more money to chase growth. Over the past 8 years, they have been raising money by issuing debt and equity, tax equity funds (this is a method unique to the solar industry- investors who cough out the money get to earn tax credits to offset their own bills), and finally, they are issuing corporate bonds which are currently rated +BBB. Issuing bonds to finance their growth turns out the be the least costly choice and this cost may go down further as SCTY establishes itself as a stable business.
As most of the revenue goes to paying debt, the company is not generating any earnings. It has came up with a way for investors to value the company; by looking at this metric known as the Retained Value. The retained value basically sums up all the future payments that SCTY will receive (as customers sign on for a 20 year contract). The retained value is discounted at a rate of 6% and assumes that 90% of all customers will recontract with SCTY for 10 more years after their 20 years commitment. Obviously, this has led to widespread criticism that the calculation of the retained value is too aggressive. The company currently has a market cap of $5.67B and a retained value of $2.7B. If we were to take the company’s assumptions, SCTY is valued at 2.1x retained value.
The investing world is still divided over the valuation of SCTY so this a grey area which I took note of, hence only a tiny position is allocated to this stock.
Why did I even buy this stock if the financials aren’t that strong (yet) or the valuation is hazy?
Lyndon Rive, CEO of SCTY is the cousin of super entrepreneur Elon Musk, who was the co-founder of this company. Elon Musk had told his cousin that solar power is the future, and used the money he earned from his Paypal sale to provide the capital for the company at the start. Elon Musk is still the chairman of SCTY. Having Elon Musk on board SCTY gives me much greater confidence that this company knows what the heck it is doing.
There could also be possible collaborations between SCTY and Tesla in the future as Tesla’s production of its new battery gives insight to where the company is heading (besides electric cars.) Although SCTY thinks that using the Tesla battery “does not make economical sense“, I think this innovation is still at its infancy and has more chances to improve in the future. Hey, it’s Elon Musk!!!
Summing everything up,
The pros: Favourable industry economics, rapid growth, leadership in the industry, strong financial backing, backed by real life Iron Man.
The cons: Hazy valuation metrics – difficulty in assigning value.
The counter: Solar power comprises only 0.4% of energy usage. SCTY has tremendous opportunities for growth. Holding this stock for long term (10-20) years may just reduce the current valuation risks itself. Remember, I can always dollar- average into this stock if current valuations turn out to be too high.
The conclusion: I like my odds of this company thriving in a sun-rise industry.
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