SCTY – Don’t Get Burned With Solar-Backed Bonds

by Charles Sizemore | November 18, 2013 10:42 am

The rumors of securitization’s death following the 2008 mortgage meltdown have been greatly exaggerated.

Mortgage-backed securities and collateralized debt obligations are back with a vengeance[1], despite their role in bringing about the worst financial crisis in 100 years. Wall Street also has found new income streams to securitize — for instance, we now have bonds that are backed by the monthly rent payments[2] thrown off by rental houses.

But in a truly new innovation, SolarCity (SCTY[3]), the installer of residential and commercial solar power systems, has issued bonds back by the lease payments[4] that home and business owners make in exchange for their solar power.

SolarCity is planning to raise $54.4 million in the issue, and Standard & Poor’s has given the bonds a rating of BBB+, which is investment grade, but just barely. (Why anyone still gives S&P’s credit ratings — or those of any ratings agency — any credence at all is another question for another day.)

Perhaps the most attractive feature of the SCTY bonds: They’ll be priced to yield 4.8%.

But don’t bother calling your broker — the current issue is only available to select institutional investors. Rest assured, though, if the issue is a success, more will no doubt be down the pike.

At first glance, what’s not to like? You’re getting a reasonably high yield from an investment in an industry that is making the world a greener, better place.

But I have some advice for you: Don’t even think about investing in these bonds or any like them … at least not any time soon.

If you want to be green, call up SCTY or one of its competitors and have a solar system installed on your roof. But don’t let your civic-mindedness lead you to make a bad investment decision. The bonds are unattractive at the yield on offer.

Solar power is a no-brainer as a public policy initiative, in my opinion. Had our leaders invested in it sooner, we could have avoided decades of massive trade deficits driven by energy imports. But SolarCity is not a profitable company, and neither are most of its competitors. Furthermore, this particular revenue stream — lease payments on solar systems — is new, has limited history, and to my knowledge, has never been tested in court.

And I haven’t even touched on political risk. Continued public embrace of solar energy depends heavily on tax incentives, which are subject to change depending on which party is running the show in Washington. You don’t want your investments at the mercy of a fickle government.

Finally, let’s look at alternatives.

I recently wrote a favorable article about REITs[5] in which I recommend Realty Income (O[6]), a conservative triple-net REIT that owns things like pharmacies and FedEx distribution centers.

Realty Income has been a dividend-paying and dividend-raising monster since going public in 1994. In 19 years, it has made 519 dividend payments and hiked its dividend 73 times, and it currently pays a dividend yield of 5.4%.

Yes, Realty Income is a stock and has equity risk, whereas the SolarCity bonds do not.

But answer me this: What seems riskier to you: a stock that has made 519 consecutive dividend payments, backed by a conservative property portfolio that survived the 2008 meltdown without a scratch, or a new bond issued by a young, unprofitable company and backed by an unproven revenue stream?

I don’t know about you, but I’m taking the REIT.

Yes, there is equity risk. But what of it? If you’re buying for the income stream, market movements are a tolerable nuisance.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he was long O. Click here[7] to receive his FREE 8-part investing series that will not only show you which sectors will soar, but also which stocks will deliver the highest returns. This series starts Nov. 5 and includes a FREE copy of his 2014 Macro Trend Profit Report.

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