SCTY

In the 1YPEG spreadsheet, the earnings shown are GAAP, i.e.,
-$0.03 $0.31 -$0.26 -$0.52 $0.21 -$0.04 -$0.22 -$0.23
These are quite different from non-GAAP
($0.43) ($0.46) ($0.82) ($0.96) ($0.77) ($1.33) ($1.52) ($1.61)

Is this intentional?

Note, the non-GAAP were taken from Schwab, which someone previously had found reliable. In doing some more checking of my own, I have found Schwab to match the figures in the 1YPEG sheet except in a few isolated cases … and, of course, SCTY where there are GAAP numbers instead of non-GAAP.

Other examples:
GILD 3Q14 2.05 Schwab, 1.84 website
INVN 2Q`14 .15 Schwab, .21 website
SCTY 4Q14 -1.37 Schwab, -1.47 website
SCTY 3Q14 -.77 Schwab, -.75 website.

It is disappointing that Schwab is not 100%, since it certainly makes the research easy. I have a message in to them to explore the issue and I’ll let you know if I get any meaningful response.

Note too the SCTY appears not to have the figures on their website prior to 3Q14, so I’m not sure how to go about updating the 1YPEG spreadsheet.

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Just to close this out, I had an exchange with the VP of IR at SCTY. He gave me a link for the 2Q14 figures and explained that prior to 2Q14, SCTY did not publish non-GAAP EPS, so they aren’t there to be found. I have now updated the 1YPEG spreadsheet with 3 quarters of GAAP and 5 quarters of non-GAAP.

Makes for a rather amazing -1205% YoY growth in EPS!

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I have now updated the 1YPEG spreadsheet with 3 quarters of GAAP and 5 quarters of non-GAAP.

It is practically useless to evaluate SCTY based on GAAP or non-GAAP EPS. The company will continue to post accounting losses for a very long time. This is because they have to pay expenses for installations, yet they collect revenue over a period of 20 years. Accounting rules do not allow them to recognize the value that the company is creating upfront. However, each installation is profitable subject to a few assumptions.

Assumption 1: customer keeps paying for 20 years.

Assumption 2: inflation will not get out of control; remember that they are paying in today’s dollars and collecting over 20 years; yes, there are 2.9% annual rate increases (I believe that’s the contractual increase that SCTY builds into their customer agreements). High inflation will really hurt SCTY.

Assumption 3: maintenance and component replacement costs will remain low.

Assumption 4: the company will continue to grow their installations so that operational expenses do not overwhelm preexisting installations.

For investors who want to value SCTY, the company provides additional information in its quarterly shareholder letter that is released together with the earnings release. It contains a measure called net retained value which is the net present value (with costs removed) of future collections from existing customers. Each quarter this net retained value grows as more and more customers enter into power generating contracts with SCTY. Net retained value also has several assumptions such as the discount rate (I think they use 6%) to convert future cashflows into today’s dollars.

So how does SCTY make money? They basically get investors to loan them capital which is used to install systems for new customers. The investors can get a tax credit and a rate of return, but SCTY structures these deals so that there is additional revenue leftover for SCTY. SCTY can also securitize portfolios of customer contracts and sell these as investments so they don’t need to wait 20 years to collect. I believe that investors and securitization are the two methods that SCTY uses to fund new installations. It’s really an innovative way to obtain capital and it’s allowing SCTY to very rapidly grow. Two stats that I’ve heard are that SCTY has 40% market share of the new solar installations (I think residential) which is still more than their 70 next largest competitors (I think 70 or something close to it was the figure). The second stat is that SCTY is hiring something like 500 new employees per month.

So will SCTY be a good investment? As of 6/30/2015, SCTY had 262K customers and they have stated that their goal is to reach 1M customers by 2018. Achieving this would mean roughly doubling the customer base every 18 months or increasing by 300% in 3 years. The net retained value (using the company’s assumptions) is currently about $3B so if they quadruple their customers, then one might expect the net retained value to increase to $12B in 2018. The current market cap is about $4.7B. Now, we must also remember that net retained value is the present value of the remaining cashflows of existing customers; this does not count any value to future customers. Therefore, assuming that the company assumptions are accurate and they manage to increase their customers to 1M as similar levels of profitability per customer as to date then we can expect a net retained value of $12B in 2018. Assuming 3% share dilution per year we get a dilution of 9.3% in 3 years. Therefore, based on net retained value alone, SCTY should be worth about $11B or $114 per share when share dilution of 3% is included. Now, remember that this would be the value of the customer cashflows of the customers that they have signed up until 2018 with zero value assumed for the engine that signs up future (from 2018 forward) customers. Of course, there is additional value in the company because it will be adding additional customers which will add additional cashflows. Now, one could also argue that continuing improvements in lowering the cost per watt generated will lead future customers to be more profitable than past customers. If you factor in these aspects, then you should get a value in excess of $114 in 3 years.

So, again, you can’t get a handle on the value of this company by looking at EPS (GAAP or non-GAAP).

Chris

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As per the SCTY board:

Understood, Chris. I was taking the Saul 1YPEG method and applying it to my portfolio. One of the things which was clear before I started was that there was some portion of the portfolio which would not produce a “Saul” stock, but I wanted to apply the method consistently across the whole. Then, I could sit back and consider the implications. In a couple of cases, it led me to reconsider some long term holdings, resulting in me lightening up on them because they were not performing now like they had in the past. In some cases, it made me feel good about my choices. In other cases, like SCTY, I just had to recognize that it was an approach which would never select this stock, but I wanted to select it anyway.

Among other things, I think accounting is like that. Certainly any investing metrics are. It would be interesting if someone could come up with a company that also sold predominantly through leasing to compare to, but I’d bet there would be enough differences to make the comparison meaningless in most cases.

tamhas,

Among other things, I think accounting is like that. Certainly any investing metrics are. It would be interesting if someone could come up with a company that also sold predominantly through leasing to compare to, but I’d bet there would be enough differences to make the comparison meaningless in most cases.

I agree that the comparison would likely be meaningless. It would be meaningful to come up with an estimate of what you think SCTY is worth today and what you think it will be worth in the future. The resulting growth in value can then be compared to your other stocks that can be evaluated using Saul’s method.

SCTY is not unique in that it requires large amounts of upfront capital to receive small amounts of consistent cashflows over a very long period. With such a business using DCF to value the company is a good method. There are a few other industries that are similar. One is the airline industry which requires the upfront purchase of very high priced capital equipment in exchange for a long stream of future cashflows. However, comparing SCTY to an established airline, is probably not a good comparison for several reasons. First, an airline with an existing large fleet is probably not making as large upfront CapEx purchases compared to the existing stream of cashflows from the existing equipment. Second, SCTY is still growing its customer base very quickly in percentage terms. Third, SCTY’s future input costs and rate increases are much more predictable that an airline’s future fuel costs and ticket prices. A second possible industry for comparison is the utility industry. Many utilities, though, are established and, therefore, growing very slowly. Furthermore, their plants are usually already built. Many are very slow growers that pay a dividend.

Chris

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Chris I get the math and it makes sense to me. That is not what troubles me.

The question I keep turning over in my head is, what are current SC customers going to do/think in 5-10 years when the cost of solar equipment is a lot less than it is today, and they are locked into paying more? Will they keep paying? Or somehow walk away? Will they tell their friends how they got locked into a virtual solar timeshare and have no recourse?

Now the wireless carriers make a ton of money keeping people locked into noncompetitive contracts, and the cable companies, but the terms are much shorter and regardless that’s not the kind of company I’d wish to keep. I’d be torqued if I had to pay more than my friends and neighbors, when I was the brave early adopter.

SC could respond by lowering prices for new customers I suppose. I dunno if they could lower prices for existing customers without dramatically affecting their financials.

I’m not sure how likely this scenario is (feel free to comment) but it was enough to make me sell a while back. Hopefully I’m worried for no reason as I love the idea of widespread green power. Climate change sucks, way worse than most Americans realize I think.

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Chris,

I understand your concerns but I don’t share them.

The question I keep turning over in my head is, what are current SC customers going to do/think in 5-10 years when the cost of solar equipment is a lot less than it is today

Have a look at the latest investor presentation. It shows the cost per watt installed. Yes, the rate of cost reduction has been dropping and I think the rate will continue to slow. They are at $2.91 per watt as of last quarter and they want to be at $2.50/Wa in 2 years. They are probably closer to $2.80/Wa now for residential since there were some inefficiencies last quarter and commercial installations are higher cost. SCTY is probably the lowest cost (I mean their cost here) for-profit installer in the US. I think that will retain this and one should remember that if the tax incentives go away then the real installation cost (after taxes and adjusted for inflation) could actually be higher in 2 years. But all this is not the main point. A smart company will not price its product/services based on its cost. It will base it on the market, and SCTY’s whole spiel hinges on savings versus what each customer pays to the utility. Most customers will move forward because they will save money versus their bill. And those customers who signed up in the past will likely see the delta between their cost for electricity increase further because the utilities will increase their rates by more than 2.9% (SCTY’s annual increase).

they are locked into paying more? Will they keep paying? Or somehow walk away? Will they tell their friends how they got locked into a virtual solar timeshare and have no recourse?

Again, I think customers will compare versus the utility, not versus their friends and neighbors. And how many neighbors are there? Solar is about 1% if electrical production in the US. That’s 99% percent not being generated by solar. So how many friends and neighbors??? Most will not have solar. In the next 3-4 years, solar may go up to 3-5% of electricity production…still not at lot. In my mind, this says a lot more about how big the opportunity is for SCTY. It’s so huge it’s staggering. Customers will pay because they need energy for their refrigerator, computers, lights, etc. They need energy 24/7 and it is not something someone will cut. It is probably more important than anything else in the household budget. And what is the alternative? Have SCTY uninstall the system and go back to the utility and pay more???

SC could respond by lowering prices for new customers I suppose. I dunno if they could lower prices for existing customers without dramatically affecting their financials.

I don’t think this will happen. SCTY’s cost per Wa installed is dropping while utilities are raising prices more than SCTY is. I think this will continue. If this changes, you will see this coming a mile away because utilities must get their price increase approved by the state regulators. Remember that SCTY is mainly competing against utilities (not against their past installations). I see SCTY’s cost dropping and their prices increase which makes it an even better investment because they get higher margins. Bottom line: lower cost solar is a benefit for SCTY because it makes it easier to get new customers and gives them higher profitability.

Hope this helps.

Chris

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Also, if one has been saving money over the utility for 10 years, isn’t it a bit scroogy to whine that a new install is doing even better. Isn’t that the standard thing in technology? If it got to be 2-3X, then maybe, but do you think that is going to happen in the course of the lease? Especially, since the reference point is the utility’s current charge. If that keeps going up the improvement is going to seem less.

E.g., completely made up example. Suppose the current utility cost is 1.00 and this goes up 5% a year. By year 20 the utility cost is 2.53. If the SCTY installation cost starts at .95 and goes up 2.3% a year (wasn’t that one of the options), then by year 20 one is saving 1.06 over the utility instead of .05. At year 10 it is .39. If the cost of a new SCTY installation declined 2.5% a year, then by year 20 it is down to .59 (.78 in year 10). That mean that one could be saving 1.94 over the utility (.70 in year 10), but one has accumulated 8.22 in savings by that point (1.65 in year 10), so waiting is clearly not advised. If one picked the flat lease and assume the first year the cost is 1.0, then by year 20 one is saving 1.53 (.55 in year 10). In the first case, a magic, no cost switch would add .88 to the 1.06 savings in year 20 (.41 above .39 in year 10). In the second scenario the add is .38 on top of 1.53 (.20 on top of .55).

I have no idea if those are even vaguely reasonable numbers, but it seems to me that the increment is likely to be modest over the savings and it couldn’t, of course, be a cost free switch. Now, if one bought a house with 18 years on it, it might be worth renegotiating to get a new system.

I do wonder some about the renewals after 20 years, but those might come at lower rates anyway, if no additional installation is required.