I’ve long believed that the Tesla (TSLA) solar business was an overlooked part of Tesla and had the potential to be an important part of Tesla’s future endeavors. However, I wasn’t blind to its many blunders, perhaps the largest of which being its production, or lack thereof. Though, as I will discuss in this article, Tesla’s energy division is finally taking the necessary steps to become an actual asset for Tesla, reversing its history of debt-loading and disappointment. I also will discuss how their energy division will turn a profit, and I don’t only mean become a net positive in quarterly reports, but to also make a return on the $2.6 billion SolarCity acquisition, with an additional $3.25 billion of debt, just over three years ago.
Production and Product Refinement
The Solar Roof is perhaps Tesla Energy’s greatest disappointment to date. After its unveiling almost three years ago, the product has struggled to get off the production line and has gone through three different iterations. The slow output has even forced Panasonic (OTCPK:PCRFY), Tesla’s exclusive photovoltaic solar cell manufacturer and partner at Gigafactory 2, to sell the cells manufactured in Buffalo to foreign companies. However, this third iteration is finally ready to move to the mass market. According to Electrek, one of the key changes that satisfied Musk was custom fittings, allowing for a more integrated solar roof. Musk was notoriously particular about the aesthetics of the roof, wishing them to be perfect before mass production began, and it seems that this step has eased his conscience quite considerably. Additionally, a patent granted for curved solar roof tiles, to be utilized on the faux terracotta design, further improves the installation ease and aesthetics of the product. It does seem that Tesla’s greatest refinement of the Solar Roof involved ramping its production, which is, according to Musk, supposed to reach ~1,000 roofs per week by the end of the year. Of course, skeptics will point out the obvious. Musk has made many promises about production and other aspects of Tesla’s business that are wildly inaccurate or just plain misleading. However, this is not, and cannot be one of those. The reason I believe this recent update to be accurate is because of Musk’s most recent SEC deal and the lack of noise from the commission after the tweet. Additionally, when asked about the tweet by The Buffalo News, a Tesla spokesperson didn’t decline to comment or try to backtrack on their CEO’s statement, but instead said “the company had nothing to add, beyond Musk’s tweet.” This response both acknowledges what was said and backs it up as the company now stands by the remark. There is no doubt that this is a good product, but it suffered from being revealed too early, long before production was really ready to begin.
Tesla’s solar products aren’t limited to the Solar Roof though, they also have a business with traditional solar panels. At Gigafactory 2, Tesla has a similar relationship with Panasonic as they do at Gigafactory 1. However, instead of manufacturing the battery cells, Panasonic is manufacturing the photovoltaic (“PV”) cells used in Tesla’s panels. These PV cells are the same being used in the Solar Roof, but they have never been a bottleneck for production, unlike the battery production at Gigafactory 1. Instead, Tesla has been dramatically lagging behind Panasonic’s production, forcing them to sell their PV cells to outside buyers in order to profit off of the facility. While I’ve already discussed Tesla’s goals to ramp their Solar Roof production, their solar panels are a different story altogether. The factory itself was expected to reach annual production of 1 GW, or 10,000 panels per day, until further analysis allowed Tesla to upgrade expected output to 2 GW. This ultimate production goal provides some insight into what Tesla’s solar production will be beyond the Solar Roof. Assuming that Tesla will ultimately stay at 1,000 Solar Roofs per week, Tesla will be able to manufacture ~2,205 complete home solar systems per week, or ~114,667 systems annually at 1 GW, but this will improve to ~5,410 per week, or ~281,333 annually at 2 GW (to clarify, these numbers are with Solar Roof production subtracted), at peak production (estimate based off of average home solar system size in the US and author calculations).
This ramp should be much easier to accomplish than the Solar Roof, which is quite a bit more of a technical product, as all it really requires is the somewhat quick assembly of Panasonic’s PV cells. I anticipate that, while the original intention was for the end of this year, the Solar Roof will achieve production of 1,000 roofs per week by the end of Q3 2020. By the end of 2020, Tesla will be capable of 1 GW production with traditional solar panels reaching their target production of 2,205 per week by the end of 2020 as well. However, it will likely take Tesla until the end of Q2 2022 to reach their goal of 5,410 solar panels per week. I believe that I feel confident that this ramp will be mostly accurate because Tesla has settled on a final design for the Solar Roof and seems ready to actually begin volume production. The panels themselves are of much less technical difficulty, and with employment requirements approaching (to be discussed more later), Tesla has the drive to ramp their production.
Tesla’s solar products should also see high demand, the Solar Roof especially. Tesla’s traditional solar panels are nothing special, they look pretty much the same as the average panel, but the Solar Roof is different. The Solar Roof is a one-of-a-kind product that creates a compelling option for people who want solar, but don’t like the look of it. The Solar Roof is also able to cover all of the needs of a traditional roof, such as insulation and protection, and Tesla even claims that it functions significantly better than a traditional shingle roof in these areas, with Tesla even so bold as to provide a lifetime warranty for the shingle itself (note that solar generation is only guaranteed for 30 years). A new Californian law, requiring all new homes built in 2020 and after to have rooftop solar, will obviously have a dramatic impact on the state’s solar installations, with analysts expecting this to result in 100,000 solar installations per year in California alone, Tesla’s Solar Roof will see a dramatically larger market than it can even account for. Tesla boasts that the Solar Roof will be cheaper than the total cost of a traditional roof with solar panels. This particular point makes the Solar Roof very appealing to Californians building their new homes because they are in need of both a roof and a solar system. It doesn’t seem likely that a customer who isn’t in need of a new roof would consider this product, unless they are wealthy enough to do so, as this would then make the Solar Roof considerably more expensive than just solar alone. With over five million new roofs constructed in the US each year, Tesla can likely capture a meaningful portion of those who wish for solar power. Even just 1% of that market would likely be more than Tesla will ever be able to account for, giving them strong demand to last. Additionally, the product already has strong demonstrated interest, proving the marketability of the product and the ideas expressed in this paragraph. With all of these new roofs every year, Tesla’s Solar Roof is likely to be the prime candidate for people to choose with its sleek look and affordability with demand to outpace its production.
Tesla’s traditional solar panels will not suffer as a result of the Solar Roof’s strong demand. In fact, they too will see a rise. The rapidly increasing California market certainly won’t hurt, but the introduction of a new pricing system for residential solar, a subscription service, as Tesla puts it, for as little as $50 per month with no long-term contract, will likely help make Tesla’s own solar offering even more appealing to a broader audience. Tesla claims that this product will generate net positive cash for the owner based off of reduced electric bills and the ability to sell electricity back to the grid. Through this offering, Tesla still technically owns the solar panels, but all of the electricity generated by the panels goes directly to the home they’ve been installed on. Owners can cancel the contract at any time and can choose to either leave the dormant panels on their roof, or get them removed for $1,500. This removal fee allows Tesla to avoid any real loss on the system as they can then resell the units. Customers also have the option to purchase a system of the same size for $10,773 upfront. All states offer their own subsidies for the purchasing of solar panels, often resulting in a dramatic drop in the price. Tesla decreased the price of these systems to be noticeably lower than the national average, as low as $1.75 per kWh as opposed to the national average of $2.09 per kWh. With these low prices and fast installations, Tesla is improving upon their product offering, especially compared to competitors. The subscription service that Tesla offers for their solar panels will likely be an incredibly strong product offering with high demand as there is nothing else like it on the market and provides a very attractive finance option for most customers. While some may choose to buy the panels upfront as well, as they would prefer to own the panels themselves, Tesla should see strong demand for its traditional solar panels as well. An initiative by Tesla to install solar panels 24 hours after ordering is also likely to improve demand as customers want to receive their panels, and get them installed, as fast as possible. However, unlike the Solar Roof, the panels have uses beyond residential solar. With the rapidly growing solar market, expected to reach $22.9 billion by 2025, Tesla will be able to maintain high demand for its traditional solar panels through large commercial and potential utility projects too.
To ensure strong demand, for all of their energy projects, Musk has said that they will begin selling their solar products in Europe. Tesla already offers the Powerwall in Europe, even as they have their massive backlog in America to work through, which will now be able to be coupled with Tesla solar if the customer so desires. However, even if they don’t, Tesla should see a large market for their solar products in Europe. Europe has quite a large solar market, even larger than in the US, with 11 GW of solar panels installed in 2018. On top of America’s 10.6 GW of installed solar in 2018, Tesla would need to capture just 4.6% of both markets to sell all of their solar products, even before the market growth. In the US, solar installations are expected to reach 15 GW per year by 2024, and Europe will likely see similar growth. So, while Tesla should see sufficient demand in America for its solar products, the addition of Europe to its customer base will guarantee it an incredibly large market.
Tesla’s solar panels cost $2,636.05 per kW (author’s calculations using Tesla sales information) while the Solar Roof currently costs $6,839.58 per kW, though Musk claims that they can get it down even more. For the purpose of this analysis, I will use a cost of $6,839.58 per kW, which has been proven and is therefore more reliable and likely. The target margin for their traditional solar panel is likely around 20%, above the industry standard of 15.2% (based off of the most recent quarterly reports from JinkoSolar (NYSE:JKS), JA Solar (now private), and Trina Solar (now private)), which is standard for Tesla’s other products as well. The Solar Roof will likely have a margin of around 25%. Tesla has been targeting this margin for its vehicles for years, and as this product is more pricey and specialized, it will likely have a slightly higher margin like most premium products. Similar to the Model S and Model X, it is a lower production, higher margin product. Additionally, 25% is only slightly higher than the 20% margin of standard solar, making this a feasible margin to maintain. I also anticipate that Tesla’s subscription service will capture ~25% of its solar panel customers, bolstered due to the competitive pricing that the system offers, but limited by the drawback of not actually owning the system. Using the above production ramp, margins (assuming that margins tend to be lower towards the beginning of a production ramp), and finance options, Tesla will make a gross profit of $350 million in 2020, $491 million in 2021, $470 million in 2022, and $406 million in 2023 and beyond off of their solar products (solar subscription upfront costs for Tesla were subtracted from estimates while monthly; subscription payments were included at $13.157 per month per kW [author calculations with Tesla sales information]). The reason that these numbers shrink, even as total production increases, is that, even at just 25%, subscription solar costs more than Tesla’s other traditional panels are making. So, as it catches up to the Solar Roof production, Tesla encroaches upon its own profit margins.
Tesla’s solar subscription service will take a bit less than 18 years to equal to the cost of buying the solar panels upfront, meaning that these gains will take a while to actually manifest, dramatically reducing initial profits. Tesla owns $6.2 billion worth of solar panels left over from SolarCity’s own leasing days and will now continue to add to this number through their subscription service. Tesla also took on $3.25 billion of SolarCity’s debt, bringing the total cost of this acquisition to $5.85 billion. So, the products that have been engineered under SolarCity’s brand, with Tesla, will be able to cover the cost of the acquisition in due time – just over 14 years.
Controversy and Risk
There has recently been a resurfacing of the controversy around the acquisition of SolarCity. At the time, Tesla used the Solar Roof as a way to justify the acquisition, but it’s been three years, and we still don’t see the product being mass produced. Additionally, Tesla, an already financially distressed company, was forced to pay $2.6 billion to acquire SolarCity and take on its $3.25 billion debt. This was the real kicker. The company was going under, but Tesla still pushed for the merger to happen regardless. To this day, I believe that Tesla will forever be worse-off with this acquisition taking place and should not have happened. After all, most of the products I’ve discussed above don’t rely on SolarCity at all and even the Solar Roof probably could have happened without SolarCity. The PV cells themselves are made by Panasonic, and the Solar Roof is Tesla-made tech. The early announcement of the Solar Roof is a direct result of this acquisition as well, which has caused high levels of criticism for the company. In essence, I agree with the outrage of investors, but I also don’t believe that anything will come of the lawsuit. The reason I believe this is because Musk will likely be able to hide behind the technicality of himself not voting on the acquisition and the overwhelming support of Tesla shareholders at the time of the acquisition. So, while this lawsuit against Musk and Tesla will likely be lost, the anger surrounding this acquisition is certainly justified.
Another major point of concern lies with Variable Interest Equity (“VIE”) obligations that Tesla took on with the acquisition of SolarCity, an issue that I will provide a brief summary of myself. Tesla took on $1.289 billion worth of VIE obligations, and these credits are often taken out of Tesla’s operating cash flow. This makes profitability increasingly hard for Tesla to attain and has therefore hurt Tesla’s business as their profitability is often at the forefront of investors’ minds. So, on top of SolarCity’s debt, Tesla was now forced to take on these VIE obligations that hurt their profitability and overall profit margins.
Tesla’s controversy doesn’t end with the SolarCity acquisition. Tesla’s second Gigafactory, located in Buffalo New York, is responsible for the manufacturing of Tesla’s solar products, but more importantly, Gigafactory 2 is responsible for 1,460 jobs by the end of April 2020. If Tesla fails to meet this, they are charged $41.2 million for every year they fail to meet this requirement. This all came about because Tesla received $750 million to help subsidize the building of the factory, as long as they promised to meet certain employment numbers, the first of which they met in April of this year. If Tesla is truly able to ramp production as they expect, it seems likely that the company will be able to meet this workforce demand and Governor Andrew Cuomo has also stated “It’s his confidence that matters – and our contractual protections. A contract is a contract.” It would actually likely be cheaper for Tesla to front the cost of hiring unnecessary employees than to take the $41.2 million hit for failing to comply with the contract. Even such, Tesla would likely not want useless workers in the factory, forcing them to ramp the production of their product in order to be more efficient. So, even if Tesla is unable to successfully ramp their production, they won’t be hit by this penalty because, financially, it doesn’t make sense for them to avoid hiring these employees.
Beyond the controversy are the risks associated with this thesis. Two of the greatest of which being a lack of deployment infrastructure and the cost of fronting these solar panels, the latter being the cause of SolarCity’s financial distress. Tesla is already financially distressed and likely cannot afford to add on more debt, on top of its current $11.366 billion of debt. With $5 billion in cash and cash equivalents, the highest level in Tesla’s history, they do have a relatively strong liquidity right now that could cover the cost of this business for a bit, but this is still likely not sustainable for the company. Long term, this fronting business will be profitable for Tesla, but they simply can’t afford to wait 18 years to break-even, considering their current financial state. At peak operation, if Tesla were fronting the cost of each solar panel, it would cost them $1.451 billion per year (author calculations using previously disclosed information). While that’s not all of their liquidity, it’s a pretty meaningful part that’s being used to then not be seen for another 18 years. Even though there will still be a large portion of Tesla’s customers buying the panels upfront, Tesla will have to end this business before it becomes too much of a burden on its financials, likely within a year. However, I have left the analysis as is, with much weaker numbers, due to the possibility that Tesla chooses to uphold this, initially unprofitable, business. If Tesla were to end this business after 2021, they would see a gross profit of $1.167 billion in 2022, and a gross profit of $1.423 billion in 2023. These substantially larger profits demonstrate the greater success that Tesla would see if they were to drop their subscription service, but it seems that they currently want to prioritize growth over profit in the solar sector yet again.
Declining sales are not much of an issue, though some may point to it as a lack of demand. This is not the case, as I’ve discussed in the article, the demand for Tesla’s solar products remains quite high and the reason that Tesla began to drop its solar installations is as simple as a lack of supply and focus. Tesla, when bringing its Model 3 sedan to market, was focused on the production and success of its vehicles and not as focused on solar. This caused production issues to be left unresolved and therefore caused Tesla to lack supply of panels to retrofit homes with. The dropping of solar retrofits was certainly a symptom of a problem with Tesla, though it was a logistical and production problem, not a demand issue. The logistical issue seems to also be on the mend with the previously discussed 24-hour installation and the new fittings designed to make installations even faster. These faster installations don’t only allow for higher margins and demand due to the reduced construction work, but it also allows for Tesla to complete more installations as they can work through their backlog much faster without having to worry about needing to hire many new employees to account for higher demand.
Last, but certainly not least, Tesla is facing a lawsuit from Walmart (NYSE:WMT) for faulty solar panels that caused fires at multiple locations. Firstly, I should clarify that solar panels should not catch on fire and that it is indeed very rare for such an event to occur. The records of what happened between Tesla and Walmart, reported by Reuters, demonstrate that, while this problem began before Tesla acquired SolarCity, Tesla itself, after the acquisition, failed multiple times to remedy the problems caused by their panels. Quite frankly, Tesla should not win this lawsuit as it does appear that they were given multiple chances to remedy the problem and failed each time. While it does appear that Tesla has improved their installation and inspection methods since the fires, they should still be held accountable for their previous blunders. This suit will likely force Tesla to cover the cost of the systems itself, though I don’t think that this suit is indicative of Tesla’s current practice. While Tesla was likely in the wrong here, I believe that they will not have issues of fires in the future.
Disclosure: I am/we are long TSLA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.