SolarCity Could Be Headed for a Squeeze

 | Jun 13, 2014 | 3:13 PM EDT
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When it comes to SolarCity (SCTY), there seems be two very different camps of investors. The first camp represents enthusiastic investors who like Elon Musk and solar projects. The second camp represents value investors who look at SolarCity's fundamentals and wonder how the company will survive. The tug of war between camps is causing volatility.

Fundamentally, there is no questioning solar and wind power. It's here to stay. Over the next decade, North America will see massive investments in solar power. The reason is simple: Solar makes money for its investors. If you are not sure, just follow the money.

Of the top 10 largest U.S. utilities, all 10 already have been investing in solar energy. This includes Duke Energy (DUK), NextEra Energy (NEE), Dominion (D), Southern (SO) and Exelon (EXC). Going forward, most of these utilities will be buying even more solar assets.

Joining utilities are technology firms. Apple (AAPL), Google (GOOGL) and Microsoft (MSFT) are investing in solar power. So is Berkshire Hathaway (BRK.A). The list goes on.

However, just because solar appears to be a good investment, that does not mean every solar investment is a good deal. SolarCity is an example.

Last quarter, SolarCity reported revenue (trailing 12 months) of about $200 million, a gross profit (ttm) of $40 million, EBITDA (ttm) of negative $134 million and a bottom line (ttm) of almost negative $40 million. That was the good news.

The bad news is its cash flow. For solar power production, cash flow is the critical success factor. SolarCity reported levered free cash flow (ttm) of negative $785 million.

Facts are facts. However, SolarCity's investors seem to have different interpretations of the company's results. The enthusiasts argue that SolarCity is paying the price to enter a new business. As such, these investors are willing to take a beating in anticipation that financial results will improve. However, simple math suggests that SolarCity's future had better be spectacular for investors to achieve even modest returns.

This is what concerns the other camp, the fundamental investors. They see little evidence of any return, let alone the spectacular returns needed by the other camp.

It appears the market agrees with the second camp. For weeks, SolarCity's stock has been tumbling. Late February, the stock hit a high of $86. Today, it is hovering around $51. That is a 40% drop.

It also appears that the market believes the stock could drop even more. As a reader observed, a substantial percent of SolarCity's float is short. As Bill Maurer reports, "At the end of May, more than 12.3 million shares were short for this stock. The float is just barely over 50 million shares, meaning more than 24.2% of the float is short."

Is a short squeeze possible? The answer is yes. News could catch investors by surprise.

It turns out that there is news. On the cost side, SolarCity recently announced a new panel supplier. On the revenue side, distributed energy is gaining ground in several state houses.

On possibility is Massachusetts. If that state adopts new net metering policies as some anticipate, SolarCity's top line will benefit. Any additional news could see SolarCity's stock react.

More possibilities are in nearby states, such as Rhode Island and New York. They may adopt new policies to encourage distributed generation and solar power. Pushing those policies is a recent decision by federal courts, to encourage states to take on demand-response responsibilities.

However, SolarCity is not the only beneficiary of new policies. Any company offering similar services can take advantage of these changes. SolarCity has competitors. In fact, SolarCity has a new competitor, and it is a big one.

NRG Energy (NRG) plans to move in SolarCity's market. Unlike SolarCity, NRG has a balance sheet, it has access to capital, it does not have to factor its accounts receivable, and it has an existing customer base. NRG is learning from SolarCity's mistakes. Taken together, NRG will likely become the industry's cost leader.

Unlike SolarCity, NRG is not a pure play on distributed solar. In fact, NRG owns all sorts of assets, including coal. However, its solar assets are growing, and its coal assets will be declining. For the long term, NRG is about distributed energy and renewable energy.

SolarCity's long-term outlook is unknown. It is true that it is the first to market. However, the first does not always end up on top.

NRG is first to reach second. It is stronger, it is more experienced, and it is well positioned. For the long term, it is more stable.

Investors who are gambling either way on SolarCity might want to give up the fight and move over to NRG. Instead of worrying what Elon Musk will announce next, they can sit back and watch NRG evolve into the leader in distributed energy.



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