Where SolarCity Should Turn Its Focus in 2016

By Markets Fool.com

Image source: SolarCity.

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There's no question that something is fundamentally wrong at SolarCity Corp . Management can't seem to predict how many installations it will do in a given quarter, it's starting to lose the regulatory battle with utilities, and sales costs seem to be out of control.

For all of SolarCity's problems, it could adapt to today's solar industry and maintain a solid market position, and even make money. But it would require a big shift in management's thinking, something I'm not sure they're ready to do.

Loans could fundamentally change the game

One of my complaints about SolarCity's business model has been its very optimistic assumptions about the future. It signs up to 20 year contracts with customers and then assumes that customers will want to renew those contracts for another 10 years, despite the fact that equipment will be old and outdated by then. There's also the annual escalation in contracts, which goes against the constantly falling cost of solar energy. That could make defaults more common than SolarCity assumes 10 or 15 years into each contract.

But that could be solved by simply selling solar systems to customers when they're built. No more financing mumbo jumbo, no more grandiose assumptions, here's what we sold and here's how much money we made.

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The introduction of a new solar loan recently was a step in that direction, and could reduce the company's reliance on leases going forward. And I think it would really unlock value for the company.

SolarCity could be more transparent AND more profitable

SolarCity has always touted itself as the lowest cost installer in the solar industry, which is hard to refute because the only companies that advertise their cost data are public companies Vivint Solarand Sunrun. If that's true, it should have an advantage over the competition in solar cash and loan sales. The only complication is that we don't know the cost structure of hundreds of small, local installers that are in the business as well, which dominate the cash and loan business today.

One way to get an idea of how SolarCity may fare in solar sales is looking at EnergySage's recent Solar Marketplace Intel Report for the end of 2015. The company is like a Priceline for solar, meaning customers can ask for multiple bids from different companies and choose the best one. If you look at the national data, the cost per watt for an average solar system is $3.69. Bids vary wildly from $2.00 per watt to $6.50 per watt, but on average the $3.69 figure is a good ballpark.

Image source: EnergySage.

Now, compare that to SolarCity's general cost structure of $2.70 per watt before some dislocations in the first quarter. If SolarCity sold all of its solar systems for $3.69 per watt and its costs were $2.70 per watt, it could generate about $1 per watt in profit without any of the back end risk currently associated with leases.

Compare that to the $3.12 per watt in project financing SolarCity got in the first quarter, equating to about $0.42 per watt in margin, and sales are potentially a much better deal for the company -- plus it would get cash up front. Loans could be less risk AND higher guaranteed profit.

Will loans be the future for SolarCity?

Part of the challenge is fundamentally changing what SolarCity is as a business. The company has been about financing and selling energy on a per kWh basis since it was founded, and selling loans could fundamentally change that.

But with the market questioning the assumptions that go into SolarCity's finance model and the margins that will be generated long-term, it's a move that could be good for the company. If SolarCity is indeed the low-cost installer in solar, I think loans will be its future. And that could be great for investors.

The article Where SolarCity Should Turn Its Focus in 2016 originally appeared on Fool.com.

Travis Hoium has no position in any stocks mentioned. The Motley Fool owns shares of and recommends 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.