Can SolarCity Corp Secure Its Bottom Line?

The solar industry has become a highly competitive place with a number of major players competing for market share. Downstream solar companies have more flexibility to adapt to changing market trends because they have less capital trapped in manufacturing. However, this also increases their reliance on Chinese suppliers, which have relatively lower quality products. SolarCity (NASDAQ: SCTY) has been using this flexibility to increase its revenue, but at the expense of its bottom line.

The business
SolarCity does not produce its own solar panels. Instead it designs and installs solar systems and sells or leases them to individual consumers and enterprises. So the company is known as a downstream solar business. 

Downstream businesses have the ability to generate more margins than panel manufactures. SolarCity generates almost an equal amount of revenue from operating leases and system sales. Asset securitization and a downstream business model are both positive aspects. However, investors must also keep an eye on the company's financial performance and the technology of its suppliers.

The company generated revenue of $63.5 million in the first quarter of 2014. This translates to 112% growth in comparison to the same quarter last year. This growth was supported primarily by revenue from operating leases, which was up 93% due to an increase in its operating lease MW deployed.



The asset securitization model, channeling funds from investors to rooftop solar deployment at a lower cost of capital, is proving promising for the company. The consumer does not have to purchase the system and pays on a monthly basis, hence the increased MW booking. SolarCity has booked around 136 MW this current quarter, up by 34% on a sequential basis. Operating leases are quite beneficial for the company at a 45% margin, and the growth of this business can help it return to profitability in the next few years. However there is one problematic trend.



As you can see, the solar energy systems segment grew to take a larger share this quarter. This is just a 5% margin segment and has a minimal impact on the bottom line. The company is not going to return to profitability until either its margin in this segment improves or it increases the share of leases going forward. The good news is that due to asset securitization, the lease segment is also gaining traction. Improvement in this segment can go a long way in improving the bottom line and strengthening the financial position of SolarCity.

Cost management
SolarCity is making efforts to reduce its costs. Fixed costs per watt are following a downward trend and OPEX per watt is also decreasing. These costs will come down further due to economies of scale as the MW deployed are expected to increase in the future.




The chart above indicates that volume should be increased in order to reduce costs, and in turn, gain profitability. SolarCity is guiding for 900-1,000 MW for the year 2015. Hence, the loss position of the company is expected to improve in the coming years.

Future prospects
Most importantly, the securitization model is expected to spur growth and enable SolarCity to deploy more MW in the future.



However, competitors with differentiated products like SunPower (NASDAQ: SPWR) will restrict SolarCity's leased solar system margins. SunPower is also pursuing a leasing business model in the residential market and competes with SolarCity.

The problem with SolarCity is that it uses panels from suppliers like Yingli Green Energy, and this involves a cost risk -- i.e. if the supplier increases prices. SunPower, on the other hand, produces panels in-house and has more control over the pricing. Moreover, SunPower's panels are more differentiated than Yingli's.

The significant challenge for SolarCity is to provide off-grid electricity. This will be done through deploying Tesla Motor batteries, but this will not be a cost-effective solution because of the cost associated with the batteries. Industry insiders put a cost of $1,000/ KWh on a battery, and home battery backup would cost around $25,000, which is almost equal to the cost of the solar system itself. On the other hand, SunPower is planning on launching its own energy storage solution, and this will put more pressure on SolarCity to drive down costs. Battery storage is not a feasible option as of now; cost and size barriers must be overcome in order to provide an attractive alternative to conventional utility supply at night.

Bottom line
Solar demand is on the rise and companies with downstream solar businesses are expected to benefit the most. SolarCity is a downstream solar business and by that logic it should end up on the winning side. But the company has been posting consistent losses and is expected to continue this trend for the next year or so.

Asset securitization and the rooftop market hold promise, but the current deployment of around 500 MW is not enough to help its quest for profitability. SolarCity has to increase volume in order to spur profitability. The company is facing headwinds, but the game is not over yet as it is gaining some serious traction in the residential lease market.

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Muhammad Saeed has no position in any stocks mentioned. The Motley Fool recommends SolarCity. The Motley Fool owns shares of SolarCity. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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