My Pick in the Energy Sector

Frédéric is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

A couple months back, I was looking to add a solar-power company to my portfolio. In my decision making process I wanted to limit my exposure to the price of solar panels and to the constraints of net metering. With those two conditions in mind, I choose SolarCity (NASDAQ: SCTY).

SolarCity is the leading solar provider in the US for homeowners, businesses and government organizations. It provides full-service solar power system design, financing, installation and monitoring services. 

No manufacturing

The company designs, sets up, finances and manages the systems, but it does not actually manufacture the panels. It allows for some flexibility for certain projects and gives a definitive edge logistically. It is always an advantage when a company is not competing against China's manufacturing power.

Most of SolarCity's competitors farm out the installation and the maintenance of the electric systems. SolarCity took a different approach, leaving the manufacture aside to concentrate on in-house sales, installation, engineering and maintenance. 

First Solar (NASDAQ: FSLR) has been particularly affected by a market that’s been flooded with low-cost solar panels from China. It lost 90% of its value in the past five years. Although, in the past year, the stock seems to have stabilized.

First Solar is still a huge player in the international market for solar panels with impressive market shares in Germany and France. At its current 1.1 price/book ratio, it could be an interesting candidate to add to your portfolio if you have a positive outlook on the economic recovery in Europe.

Net metering

Net metering is an energy policy for consumers who own renewable energy facilities, and allows them to use generation whenever needed instead of just when generated.

Diagram from Everblue

Solar companies have managed to achieve profitability with net metering, but it presents some challenges and uncertainties:

  • The rules vary by state and province.
  • Most laws involve a monthly connection fee and/or an annual settlement of residual credit.
  • Important exposure to future changes in the laws.
  • Unwanted partnerships with utility firms.  

I find difficult to recommend investing into a company that relies on its own competitors in order to provide a service, but this is where SolarCity stands out. It recently unveiled a home energy storage system in partnership with Tesla Motors (NASDAQ: TSLA).

Partnership with Tesla

I think this is where there is an interesting upside for both Tesla's investors and SolarCity's. Solar-power systems need to be self-sufficient, so unless the sun starts shinning 24/7, the future of solar power lies in energy storage.

The partnership is simple:  Tesla provides battery units for SolarCity to mount on the wall near the electrical panel in order to store the energy created by the solar panels instead of sending it into the grid for credit. 

It creates an interesting new source of revenue for Tesla and it allows SolarCity to propose an alternative to the net metering system. It is currently only available in selected markets in California (Tesla and SolarCity's home state), but they hope to offer the service nationwide after the trial period. 

Tesla and SolarCity are also linked together by their management. SolarCity's co-founders, Lyndon and Peter Rive are Elon Musk's cousins.

Musk is the co-founder and CEO of Tesla Motors. Tesla launched a network of charging stations that will cover 98% of the US population and parts of Canada by 2015. SolarCity provides solar power for some of those stations and since Musk promised that the service will be available for the whole life of the Model S (Tesla's second car), it seems like SolarCity secured a solid source of revenue. 

Even if the revenue made in partnership with Tesla only represent a fraction of what SolarCity makes quarterly, it is interesting to see the evolution of the stock price in correlation with Tesla's:

Both companies already experienced tremendous growth and are considered expensive by almost all valuation systems. But if they successfully diversify their revenue sources like with those two particulars projects, we might  have to reconsider the potential for more upside on their future growth. 

DoD money

Investors are always looking for companies that will be awarded some contracts from the Department of Defense. SolarCity is one of them. It announced the SolarStrong Military Solar Project, a plan to provide solar power to up to 120,000 military housing units. On July 24, SolarCity announced the installation of solar power systems for 7,500 military homes in Hawaii

In parallel with the SolarStrong initiative, SolarCity is part of a veteran hiring program. The company employs over 100 veterans. Veterans are often hard working individuals and  are quite efficient at their work. For those reasons, I always like it when a company is employing workers with a military background, on top of all the incentives from the government. 

SolarCity as an investment

You will note that I did not go in details about the solar industry, whether or not it is a flourishing industry is another discussion. SolarCity does not actually manufacture solar panels, so it can qualify as a simple energy provider. 

Currently trading at a forward P/E of -28.2 while holding a market cap of $3 billion with only $133 million in revenue last year, it might seems like a terrible opportunity. But with sales growing 116% and government contracts flowing in, if the company can efficiently manage its debt while growing the market (SolarCity only offers its services in 14 states), we could see SolarCity becoming a major player in the energy sector. 

If you are looking for a stock with high dividends, you can stop right here. SolarCity is not profitable and will not be for years to come. It offers financing programs with decade-long contracts. If it turns a profit, it means it stopped growing. What you need to be looking for in SolarCity's growth is the number of new customers and debt management. If it manages those efficiently, it will be successful. 

The stock price went up 24% after the last earnings report. SolarCity predicted between $21 million to $28 million in sales during the second quarter. It will release the results after the market's close on Wednesday, Aug. 7.

The Motley Fool's chief investment officer has selected his No. 1 stock for this year. Find out which stock it is in the special free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.



Frédéric Lambert owns shares of Tesla Motors and SolarCity. The Motley Fool recommends Tesla Motors . The Motley Fool owns shares of Tesla Motors . 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus

Compare Brokers

Fool Disclosure