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.

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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.

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MIT Scientists Develop Nuclear Waste Reactor

The biggest complaints about nuclear power are its safety and its waste.Two MIT Ph.D. students are developing a nuclear reactor that combats both of those concerns. Their Waste Annihilating Molten Salt Reactor (WAMSR) runs on nuclear waste from other plants. Current nuclear waste takes hundreds of thousands of years to lose its radioactivity. The pair's new reactor would expend about 98% of the waste's remaining energy, which would reduce the decay time to only a few hundred years. Leslie Dewan and Mark Massie founded Transatomic in 2011, and are working on a prototype. They hope to have the working model ready by 2015, and have the new reactors operational by 2030. 
The technology actually dates to the 1950s. Oak Ridge National Laboratory developed the molten salt reactor, but light-water reactors became the preferred choice in the United States. Dewan and Massie have retooled the reactor so that it is "fuel agnostic," and can run on uranium or thorium. The nuclear waste is dissolved into a liquid, which can stay in a reactor longer and generate more energy. And there is plenty of nuclear waste laying around, waiting to be utilized. The world produces about 9,000 metric tons of nuclear waste per year. The U.S. accounts for 2,000 of those metric tons, which it stores in depositories like Yucca Mountain. Transatomic says it can take the roughly 270,000 metric tons of nuclear waste worldwide, and turn it into enough energy to power the entire world for 72 years, even accounting for increased demand. 

The WAMSR is also safer than conventional light-water reactors. There are two "loops" to the design. The primary loop contains the molten salt and nuclear waste. The molten salt mixture's high boiling point provides a fail-safe. If the mixture becomes too hot, it expands and keeps the fuel atoms too far away from each other to continue the reaction. And unlike light-water reactors, the mixture is under low pressure so there is less wear and tear on the machinery. A second loop filled with steam adjoins the primary loop. The steam is heated and spins a turbine, just like a conventional reactor. A WAMSR plant would also be safe if it lost power, which is what happened in Fukushima. The WAMSR has an electrical "freeze valve" at the bottom of the primary loop. The valve is a block of electronically frozen salt mixture. If the power goes out, the block melts and the molten salt pools into a container below, where it will cool into a solid in a few days.

The technology's still far off, but solutions like the WAMSR could help nuclear power make a resurgence. Transatomic and similar companies, like Flibe Energy, are just starting out, but they could have a big impact on world energy. We'll keep an eye out.

Tesla Motors: Ramping Up Production

It’s a make or break year for Tesla Motors (TSLA $35.30). The high-end electric car manufacturer is ramping up production on its Model S almost tenfold from 2012, to an expected 20,000 vehicles. The demand is there; the question is whether or not Tesla can keep up with production without hurting margins. We’re estimating that Tesla will post positive pretax margins this year (2%), a first. The company’s guidance suggests that gross margins will approach 25% by the end of the year, not counting the zero-emissions credits it receives from the government.

Right now, about three-quarters of sales are made in North America. Model S sales have been almost exclusively made in the U.S. so far. Elon Musk, the CEO, mentioned in the Q4 earnings release that only two Model S sedans were on the road in Europe at that point. Sales in Asia were almost non-existent. But Tesla plans to market more aggressively in those places this year. 

Tesla will be in a good position if it gets close to its 20,000 vehicle goal. We’re estimating $1.7 billion in revenue for the year, right around 17,000 cars sold. Musk also claimed that the negative review in the New York Times would cost Tesla $100 million this year. The effect remains to be seen, but it seems an exaggeration. The company could withstand a hiccup in production here or there since there isn’t much in the way of direct competition. Fisker, its chief rival, just had its founder step away, the latest in a series of mishaps. Electric cars from major manufacturers like the Nissan Leaf don’t offer comparable performance or luxury to the Model S. There is some competition with gas-powered luxury sedans, but for the most part sales are made to people who are already interested in driving an electric car. Since Tesla is relying on word-of-mouth, it’s got to keep its customers happy. Significant delays would lead to cancelled orders, and some potential buyers would put off buying a Tesla or lose interest altogether.

Shares are likely to post earnings this year. We estimate a $.17 EPS, but that’s achieved by adding back the stock-based compensation expense. Our calculations suggest income of about $30 million. Tesla’s official accounting will be closer to break-even. The stock price is high compared with earnings, and Fisker’s troubles show that there is plenty of risk in electric cars. Tesla will be in a much better spot if it can get through 2013 without any major trouble. The company’s crossover style Model X is due to start shipping early in 2014, and the car is already receiving reservations. Musk thinks the market for Model X will be about 70% that of the Model S.

Tesla doesn’t advertise its cars like traditional manufacturers. The company does have ads, but has gotten the word out principally through its Tesla Stores and word-of-mouth. Most of the Stores in North America are located in malls. This helps to lure in curious shoppers, and the centralized locations are convenient for people who live in the area. There are currently 25 Stores open in North America (24 in the U.S.), with four more opening in the coming months. There are more service centers opening up for customers that don’t live near a gallery. At the moment though, the network is sparse if you live in, say, Cleveland. The closest Store is in Toronto, the closest in the U.S. in Chicago. And the nearest service center would be two and a half hours away in Columbus. For now, the convenience really only applies to people in Southern California and New York/New Jersey. 

The company needs to develop a strategy to deal with bad press. John Broder’s New York Times piece is the most well-known example. He claimed the Model S’s battery struggled during cold temperatures. Musk responded with data logged during Broder’s test drive, and claimed the Times report was dishonest. At its core, it’s a he-said, he-said feud, and all it will do is invite others to investigate the battery’s performance. This post shows cold weather has a significant impact on battery life.

The battery itself has also come under attack recently, from Wall Street Journal opinionist Bjørn Lomborg. We’ll take what he says with a grain of salt, because he is a known green energy nemesis. He argues that electric cars, despite claiming zero emissions, actually leave a greater carbon footprint than gas vehicles. Research shows that it takes twice the amount of energy to manufacture an electric car than a gas-powered one. Most of this energy is spent mining lithium for the battery. Charging the car also uses electricity, which is still predominantly generated using fossil fuels. Tesla’s Supercharger stations are solar powered, but there are only nine of them in the United States. The company plans to install 100 by 2015. The company suggests keeping a Model S plugged in when not in use, because the battery depletes even if the car isn’t running. Unless owners can find a renewable energy source to keep their cars plugged into, the Model S becomes less environmentally-friendly than advertised. Lomborg says government incentives to electric car manufacturers and buyers don’t match the actual environmental savings. This technology is still fairly new though. Lomborg should realize that a true zero-emissions car won’t just appear out of the blue. It’s going to take some work. 

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Under Construction: The State of Solar

By Eric Ramsley  

The Los Angeles freeway system is in disarray. There is a lot of work that needs to be done. But there is so much traffic that there isn’t a whole lot of time to get anything fixed. Even when roads are temporarily shut down, like the 405 was earlier this year, no discernible progress is made. And by the time any construction is finished it will be time to start all over again. The roadways resemble the handful of Frankenstein cars driving along them: Pieced together with spare parts and clinging to dear life, unrecognizable from what they once were.

Swap out a few words and you’ve got the United States’ power grid. A jerry-built electrical network owned and operated by competing companies that is being stretched to its limit. Improvements have been proposed, but much like the highways in Los Angeles, by the time they are complete it will be time for the next round of emergency surgeries. Some have suggested that the grid’s poor state leaves it vulnerable to a terrorist attack; others argue that it is so shoddy and unpredictable that such an attack might ultimately fail.

Los Angeles is so developed that replacing the highways is highly improbable, if not impossible. But it’s at least conceivable that a new power grid could be built around the existing one, with the old system providing power up until the new system is complete. The benefits should outweigh the costs. The U.S. could have a state-of-the-art grid in place, securely and efficiently meeting increasing demand. This would also keep power companies in control of distribution. As much as some of them seem to want to believe it, the current setup will not be around forever. 

Sevcon ( Nasdaq - SEV ) -- Better Days Ahead

Sevcon (SEV $3.75) reported lower than expected Q1 (Dec.) results.  Sales dropped 22% to $6.64 million.  Earnings slid to a loss of $.39 a share.  Sevcon is a leading provider of controls for electric vehicle engines.  In general, half the business is directed towards off-road work machines.  The rest is used in small city cars, motorcycles, and all terrain recreational vehicles.  Both segments were hit hard in the latest quarter, continuing a slowdown that began earlier in 2012.  European volume nosedived 44% due both to the poor economy and a break in production by Renault of its promising city car line.  U.S. volume declined 18%, mainly due to the election.  The Obama Administration implemented stringent E.P.A. rules that will force a large increase in electric work machines.  Producers of those fork lift trucks and other vehicles delayed implementation, hoping Mitt Romney would be elected and moderate the impact.  Asian demand picked up by 17%, but that represents a small part of the business currently.

Work machine volume is poised to accelerate over the next 3-5 years.  E.P.A. regulations that go into effect in 2015 and 2017 will require less pollution and greater fuel efficiency.  Sevcon is working on a number of programs, mainly in the hybrid engine area.  The electric car segment promises to recover, as well.  Renault built a limited number of city cars to begin with in 2012.  Demand was strong.  Bigger production volumes are slated to begin in March.  Motorcycle and ATV demand has been consistent.

The long term outlook remains positive.  Electric vehicles will remain a niche segment until improved battery technology expands their range.  That's not on the horizon.  But there are millions of short range commercial, industrial, and consumer vehicles that are candidates for hybrid and electric engines.  The share count is low. So any meaningful improvement could support substantial stock price appreciation.

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