With many analysts bullish on SolarCity Corp. (Nasdaq: SCTY) stock right now, should investors buy it?
It’s clear why investors are tempted by SCTY shares...
SCTY has a pretty good track record. Since its December 2012 IPO, SolarCity stock is up 423%.
Visionary Elon Musk of Tesla Motors Inc. (Nasdaq: TSLA) is chairman of the board.
And solar power installations is a huge growth industry. According to the Solar Energy Industries Association, photovoltaic (PV) installations in the United States have soared from 852 megawatts in 2010 to 6,201 megawatts in 2014. That’s a sevenfold increase in just four years.
SolarCity has been a key player in that growth. With more than one-third of the market, the San Mateo, Calif.-based company is the biggest residential solar installer in the United States.
Over the past two years, quarterly revenue grew from $28.2 million (in Q1 of 2013) to $67.48 million (in Q1 of 2015). The company’s guidance for the current quarter forecasts a 42% to 50% jump in revenue to $86 million to $92 million.
What’s more, the market for solar installations has barely been tapped. SolarCity estimates that just 1.1% of homes that could install solar in the U.S. have done so.
That’s why so many analysts like SCTY stock...
After SolarCity reported its Q1 earnings earlier this month, Credit Suisse Group (NYSE: CS) raised its price target on SCTY stock from $97 to $99. SCTY stock closed Wednesday (yesterday) at $61.27, so that target represents a 61.5% gain.
Other analysts are nearly as optimistic in their price targets on SCTY stock. Morgan Stanley (NYSE: MS) has a target of $92 on SCTY shares. Merrill Lynch has forecast a SCTY stock price of $95.
But what these analysts are missing is SolarCity stock carries some very serious risks...
Plenty of investors recognize those risks – the short interest in SCTY is a lofty 34% of the float.
Money Morning Capital Wave Strategist Shah Gilani understands why so many investors are betting against SCTY stock – and he agrees with them. Here’s why he’s not buying SCTY stock now...
“Simply put, SolarCity doesn't make money. They lose money. The market capitalization of the company is almost $6 billion, but they've done nothing but lose money every quarter,” Gilani said.
In fact, SolarCity has posted losses in 10 straight quarters. And the most alarming part is that the more SolarCity sells, the more money it loses.
It all has to do with SCTY’s unusual business model.
You see, SolarCity customers don’t pay up front for their solar installation, which can cost anywhere from $10,000 to $40,000 depending upon your home and the state you live in. Instead, they sign a 20-year lease.
That might seem like a good idea – SolarCity gets a 20-year income stream from each installation. But SolarCity doesn’t have the cash flow to finance the installations by itself, so it relies on partnerships with several banks. In essence, the banks own the solar power equipment leased to the customer.
At the moment, solar power enjoys a lot of tax advantages as the government encourages the use of green energy. But because the banks effectively own the equipment, the banks get the benefit of the tax breaks.
When the tax breaks are exhausted, ownership of the solar power equipment “flips” back to SolarCity. The company calls this “retained value.” SolarCity says this retained value rises every quarter as it adds customers. It’s $1.3 billion right now.
Many analysts have adopted the retained value figure to determine the value of SCTY stock. But it’s a squishy number. For example, SolarCity does not include the marketing or operating costs that went into generating the original sale. The cost of debt – SolarCity has $1.55 billion of that – is left out as well.
SolarCity also builds in an assumption that customers will renew their 20-year leases for 10 more years. That’s far from guaranteed. All this adds up to a much lower retained value for SolarCity – and implies a lower value for SCTY stock, too.
But the dependence on those tax breaks is an even bigger problem.
“What's worrisome to me is that SolarCity is a financing scheme that is fronting a solar energy business,” Gilani said. He pointed out that the banks will lose enthusiasm for the partnerships if the tax breaks go away.
“The Investment Tax Credit that the financing scheme relies on expires at the end of 2016. If it isn't renewed, the financing game is over for SCTY,” Gilani said.
Then there’s the role that the electric utilities play in all this…
SolarCity promotes the fact that customers can sell excess power back to their utility, increasing the financial benefits of installing a solar system. But utilities are wising up.
Where once they bought back power at the same rates at which they sold it, now they treat solar customers as “wholesalers” to be paid at lower rates. And that’s not all.
“Utilities are starting to charge fees just to have access to them, even if you don't use them because your solar system is a net excess producer of energy,” Gilani said. “And the grid owners are starting to charge grid maintenance and access fees.”
Of course, solar customers could opt to disconnect from the grid altogether. But that would necessitate spending $5,000 for a Tesla battery backup system.
Such complications and reductions in savings all serve as major disincentives to buy a system from SolarCity.
That SCTY stock has two competing narratives makes it tough to play.
“If the market goes down it will take SCTY with it, because it’s a darling stock that will be one of those story stocks to take a first-round beating,” Gilani said. “If it gets hit it’s going to $45.”
On the other hand, shorting SolarCity stock, while popular, is just as risky. If SCTY stock nudges up just a few dollars higher, Gilani said, it could trigger a short squeeze that would send shares up to the $75 to $80 range.
Frankly, investors should simply avoid SCTY stock altogether right now.
Look at Tesla Stock Instead: While Elon Musk hoped to help SolarCity with his new “Powerwall” line of batteries, his vision is much bigger. He also hopes to sell these batteries to homes and businesses as a backup for power outages, and to store cheaper, off-peak power for use at peak times. It’s just one of the reasons Money Morning’s experts see Tesla stock as a long-term buy…
