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.

No comments:

Post a Comment