Raymond James analyst Pavel Molchanov takes a close look at SolarCity in light of the company’s delayed financials.

SolarCity SCTY FSLT TAN

Recommendation. While this textbook “story stock” has, in our view, become somewhat overheated, SolarCity Corp (NASDAQ:SCTY) is executing well – notwithstanding the (basically inconsequential) accounting glitch that delayed 4Q13 results. Its position as the top non-utility downstream pure-play in the U.S. market is secure, despite a competitive landscape that is getting tougher as vast amounts of capital flow to other lease providers as well. Balancing the impressive market position with a rich valuation, we maintain our Market Perform rating.

SolarCity 4Q13 financials include overhead-related restatement

On February 24, SolarCity Corp (NASDAQ:SCTY) disclosed that financials were not yet ready amid delays due to a review of how corporate overhead costs are allocated between system (cash) sales and operating leases – a distracting but ultimately minor accounting issue. At the time, the company reported 4Q revenue, deployments and retained value. With full financials now reported, the most notable delta versus our model was higher-than-expected operating expense: $65.2 million ($58 million ex-M&A costs). As before, GAAP EPS are not meaningful for SolarCity, but in case you’re curious, there was – purely in a technical sense – positive net income, thanks to a $66.5 million assist from the perennial “non-controlling interest” black box.

More details on 1Q guidance

The February preannouncement included reaffirmed 2014 deployment guidance (475-525 MW) and initial 1Q deployment guidance (78-82 MW), the latter reflecting normal start-of-year seasonality. The outlook for 1Q financial metrics doesn’t contain any major surprises (revenue is a bit light), though there is no escaping the fact that operating expense (rising to $70-75 million) continues to escalate faster than we’ve been anticipating. As such, our GAAP loss estimates widen as shown below – but, again, this is of minimal relevance to how investors look at the business.

Retained value update

While the underlying methodology inherently carries plenty of “tail risk,” this is the most important metric to track for SolarCity Corp (NASDAQ:SCTY). As preannounced, 4Q ended at $1.052 billion, up 24% q/q. On a unit basis, the metric improved from $1.37/watt to $1.51/watt, implying incremental additions near $1.90/watt. As before, let’s restate the two key assumptions in these company-reported headline numbers. First, the 6% discount rate implicitly ascribes credit to future improvements in the cost of capital (such as November’s securitization, and a second one targeted for 2Q). Second, the company ascribes credit to 10-year renewals at the end of the 20-year lease term.

Valuation

In the absence of sustainably positive earnings under SolarCity Corp (NASDAQ:SCTY)’s existing business model, retained value – with the caveats described above – is the most relevant approach. As detailed on page 2, our assumptions through 2017, in the context of management’s retained value framework, indicate that the company would “grow into” its current market cap in 2018. This lofty valuation partly reflects SolarCity Corp’s scarcity value in the public market – the only public pure-play of its kind – but this scarcity will surely not last forever.