Tuesday, May 14, 2013

Solar City ( Nasdaq - SCTY ) -- Losing Money Despite Massive Subsidies

Solar City's stock (SCTY $32.00) has quadrupled in price since it became publicly traded last fall.  The company has done a masterful of job of influencing Wall Street expectations.  In the March quarter a loss of $.36 a share was reported (adding back stock option expense).  Sales improved 21% to $30.0 million.  The shares surged in advance of the report and maintained most of those gains despite the relatively dismal showing.  Gross margins narrowed by 7% on the solar systems the company sold in the quarter.  The gross margins on leased installations, which are depreciated over 30 years, also fell by 5%.  (For income tax purposes, depreciation is taken on an accelerated basis over 6 years.)  Solar City reported it cut production costs significantly.  The only explanation for the reduced manufacturing margin is sharply lower selling prices.  Selling and administrative expenses climbed 40% in the March quarter.

Solar City's explanation is that most of the "profit" it generated was deferred into future years.  The company's leased systems require homeowners to pay monthly fees for electricity that escalate at a 2.9% annual rate over 20 years.  Solar cell efficiency, using today's technology, generally deteriorates 2%-3% a year as a result of use.  Solar City uses financing partners that take advantage of the 30% tax credits issued by the U.S. Treasury for solar installations.  The company still pays interest on the balance, which it projects to decline from current levels.  The company is installing systems at a rapid pace, to be sure.  If the payment stream holds up, and the re-sale value of the systems is as good as the company expects after the initial 20 years, (recall, depreciation is taken over 30 years), and market interest rates don't rise, earnings could develop at some future time.

U.S. Treasury subsidies are scheduled to end in 2016.  That will force costs to decline by 30% just to break even on current pricing, which still is inadequate to produce a profit.  More worrisome, Solar City is betting against the likely trend in solar technology advances.  Modest improvements won't upset existing buyers.  But if nanotechnology based cells or other advances make it into mass production huge gains in efficiency could be achieved.  Those units could make today's systems look like horse and buggies.  Solar City no doubt would hire swarms of lawyers to force its existing customers to stick with their old fashioned systems.  But enormous write offs could occur if that effort fails.

Solar City's antagonistic approach toward the utility industry is likely to breed further trouble.  Electric utilities to date have put up with the inefficiencies and poor economics associated with solar power.  But as more homes go off the grid that accommodative policy is unlikely to continue.  Over the long haul the utilities themselves are almost certain to become solar installers to keep control of their networks.  Independents like Solar City may wind up resigned to serving niche markets.

The Enron style of accounting used by Solar City presents additional concerns.  For years Enron was the apple of Wall Street's eye, even though few if any of the analysts following the company were aware of its off balance sheet activities.  Every analyst we've talked to about Solar City can't explain the company's financing partnerships, either.  Perhaps they're structured to generate a huge windfall in the future.  More likely, they entail a complex structure with a variety of danger points.  These shares probably will fare well as long as the music keeps up.  Enron was a high flier for nearly a decade.  We think investors are playing with fire when it comes to these shares, though.  Better speculations are available.

Sevcon ( Nasdaq - SEV ) -- Makes the Adjustment

Sevcon (SEV $4.25) reported unexceptional Q1 results.  The company is a leading independent supplier of controls for electric and hybrid vehicles.  The systems take directions from the driver and make the engine respond, maximizing efficiency and power.  Sevcon has a long history in the work machine market.  That segment fell on hard times last year when demand for mining and construction equipment declined.  Electric forklift truck demand slipped in the March period, as well.  Part of that is believed to the result of a shift towards natural gas powered trucks.  Sevcon entered the on road electric vehicle segment a few years ago via a relationship with Renault.  The company provided the controls for the 2-seat Twizy city car that Renault introduced, initially to relatively strong demand.  Weak economic conditions in Europe subsequently caused volume to slide, though, and that trend continued in Q1.  Off-road electric motorcycles and ATVs remained solid.

Sevcon responded to the slowdown last year by moving into the hybrid controls segment.  That effort hasn't resulted in large production runs yet.  But several programs are believed to be in the pipeline.  Sevcon's new Gen-4 system is geared primarily for the hybrid market.  The company also has beefed up marketing efforts in northern Europe, where the economy remains sound.  And pick-ups appear to be underway with the Renault and forklift truck lines.  Results probably will improve modestly over the next 1-2 quarters as the new opportunities reach fruition.  Significant gains are possible beyond.  Electric vehicle demand could advance in the wake of Tesla Motors' recent success.  The move into hybrid applications offers even greater potential.  Our 2014 estimates may prove ambitious.  But it won't take much to get earnings moving since only 3.35 million shares are outstanding.

( Click on Table to Enlarge )

Friday, May 10, 2013

Tesla Motors ( Nasdaq - TSLA ) -- Turns the Corner

Tesla Motors (TSLA $77.00) reported excellent better than expected Q1 results.  The electric car manufacturer sold 4,900 luxury Model S sedans in the period, driving revenues up 18.6x to $561.8 million.  All of those were delivered to U.S. customers.  About 100 cars ended the quarter in inventory.  Fully taxed earnings came in at $.08 a share.  Production costs were elevated in the period as Tesla scrambled to meet demand.  More efficient operations are expected in upcoming periods, which should help margins.  Federal tax benefits bolstered performance.  Those subsidies are expected to decline in the next two periods and disappear altogether in the December quarter.  In spite of that manufacturing margins are predicted to rise materially and plateau at around 25% in the final quarter.  Overall margins will depend on how much Tesla spends on product development, marketing, and service.  Those investments probably will stay high to lay the groundwork for additional growth beyond.  A solid profit performance appears attainable, nonetheless.  We estimate fully taxed earnings will finish the year around $.50 a share.

Unit volume growth will exceed revenue gains in 2014.  Tesla plans to introduce a leasing program to broaden its potential market.  The company will collect 100% of the sales price from its financing partners.  But from an accounting standpoint revenue will reflect the underlying lease payments, spreading results out over a three year period.  Tesla is guaranteeing the re-sale value of its cars after three years.  That conditional adjustment requires to use of the lease accounting treatment.  Volume should benefit as well from the beginning of international sales.  Most of that will occur initially in Europe where gasoline prices are unusually high, making electric power even more attractive than in the U.S.  Sales to Asia may begin, too.

Sales of power trains and battery packs to Toyota and Mercedes offer additional leverage.  Toyota is building an all electric RAV; Mercedes, a B-Class sedan.  Both rely on Tesla's underlying technology.  Tesla's own next generation vehicle, the crossover Model X, remains in an early stage of development.  Final  design is slated for mid 2013.  Deliveries could start in late 2014.  The Model X is expected to sell for approximately two thirds of the $90,000 charged for the Model S sedan now in production.  That will be a high risk, high return product line.  Today's luxury model is being purchased mainly by extremely affluent customers who typically have other cars they can use in case they need to travel significant distances, or just need to travel period if the power goes out.  The next group will consist more of everyday users.

Electric car technology remains a question mark.  E-vehicles are likely to carve out a variety of niche markets where range isn't a limiting factor.  Tesla is trying to expand its cars' driving potential.  But the upside to that is limited by the company's use of lithium batteries.  Mechanical and software engineering tricks may boost performance somewhat.  But it is unlikely lithium ever will re-charge quickly or materially extend driving range.  New battery technologies aren't showing much potential these days.  So a competitive leapfrog is unlikely.  Without major improvements, though, electric cars will have a hard time overtaking gasoline, diesel, and natural gas to become mainstream vehicles.  Tesla is a great company and is well positioned to thrive in the electric car segment.  Whether it break out from there remains to be seen.

( Click on Table to Enlarge )