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A sunny outlook for at least one solar energy company

While the U.S. stock market is hitting new highs, one sector hasn't been invited to the party: solar energy companies.

To diss stocks in the solar business as dogs would be impolite to canines. Solar has been just about the most dreadful investment around, as a glut of cheap panels has caused profitability to evaporate. Suntech Power Holdings Co. Ltd. traded at $3 (U.S.) a year ago, but now changes hands for only 44 cents. LDK Solar Co. is down to $1.11, a dramatic fall from prices near $15 three years ago. Even First Solar Inc., the class act in the business, is at $27, down from a high of more than $150.

All this carnage makes the rise of SolarCity Corp. all the more remarkable, and suggests something with money-making potential might finally be happening in the sector. Investors – both those following green energy and electric utilities – should be taking note.

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SolarCity went public in December at $8 a share. In a buying frenzy reminiscent of the dotcom era, the stock surged 47 per cent on the first day of trading and is now around $18, more than double the issue price.

Investors are flocking to California-based SolarCity because it seems to have figured out a way to deliver solar panels to the masses, through zero-money-down leasing arrangements. The company will slap panels on a home's roof at no cost, and sell the homeowner the electricity being generated at a price cheaper than that from the local utility.

In effect, SolarCity is a retail electricity provider, able to undercut the traditional utilities that run wires into homes and run power plants. It's a technological development that potentially relegates utilities to becoming mere back-up power providers at night, or when the sun isn't shining.

While most investor attention in the solar space has been on panel manufacturers, it now looks like the real money may be made from leasing, rather than making, the panels. SolarCity is the big name in the concept, but it isn't the only one to have the same idea. Other publicly trade companies include Sunpower Corp. and more tellingly, mainstream electricity utility NRG Energy Inc., which has set up a unit to get into the retail panel leasing business.

NRG Energy's CEO David Crane made waves last week in an interview with Bloomberg at the annual MIT energy conference, where he said consumers using the panels are figuring out that "they don't need the power industry at all."

Coming from the largest power provider in the U.S., that's quite a statement.

U.S. investment dealer Needham & Co. did some number crunching on SolarCity in a recent report. Its numbers suggest solar electricity is around so-called grid parity, or the same price as conventional power.

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In California, SolarCity's main base of operations, retail electricity costs around 18 cent to 20 cents a kilowatt hour, or the amount of juice required to run 10 light bulbs each rated 100 watts for one hour.

SolarCity signs 20-year lease deals with homeowners for power at 15 cents kwh, producing immediate savings.

At the moment, this model works in jurisdictions with high electricity prices, including Arizona and Hawaii, and the panels are flying off the shelves. SolarCity installed 117 per cent more capacity in 2012 than in 2011. This year's guidance is for a further increase of about 60 per cent, to about the same amount of capacity as a medium-sized generating station.

To be sure, part of the reason SolarCity is able to beat traditional utility prices is because of a U.S. tax credit equal to 30 per cent of the price of the panels. The credit is set to drop in 2017 to only 10 per cent. Interest rates are also low, allowing cheap financing.

But the eventual reduction of the tax incentive may not be fatal to the business model. Panel prices have been dropping sharply, while retail electricity rates have been rising by a couple of percentage points a year. If these trends continue, solar panel leasing could become economic in additional jurisdictions, and possibly with minimal tax subsidies.

SolarCity has a high-profile, visionary entrepreneur heading its board: chairman Elon Musk, CEO of Tesla Motors and co-founder of electronic payments system PayPal.

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Of course, caution is warranted. A speculative growth story like this often strikes out. About 10 per cent of the available float has been sold short, suggesting some investors are skeptical.

Needham & Co. recently switched its recommendation to "hold" from "buy" after the stock reached its $17 target amid signs that its strongest installation growth will occur later in the year. The broker would wait for a pull back or confirmation of accelerating panel growth before jumping in.

Still, investors should be on alert for the possibility that a disruptive technology is entering the staid electric utility business. If this ends up being for real, the electricity business will never be the same.

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