Should I Buy SCTY Stock? 3 Pros, 3 Cons

by Aaron Levitt | December 5, 2013 11:12 am

Should I Buy SCTY Stock? 3 Pros, 3 Cons

Solar stocks[1] have been one of the hottest sectors this year. A combination of positive factors — including rising emerging market demand for panels and newly renewed subsidies — has helped push solar stocks to highs not seen in years. One of the hottest of these has been the baby of billionaire Elon Musk: SolarCity (SCTY[2]).

SolarCity185 150x150 Should I Buy SCTY Stock? 3 Pros, 3 ConsElon Musk — the brains behind electric car maker Tesla (TSLA[3]) — is the chairman of this residential solar installer, which has been one of the brightest solar stocks around. In fact, SCTY stock has surged 360% year to date. Given the growth potential of SolarCity, many analysts and SCTY stock investors have continued to bid up shares in a big way.

With that huge gain in hand, the question remains whether or not SCTY stock is a buy today for new investors. SolarCity stock certainly has the potential to outperform[4], yet it also carries some pretty big negatives.

Let’s take a look at some of the pros and cons of SCTY stock:

Pros on SCTY Stock

Expanding Operations: First things first, SolarCity isn’t like traditional solar stocks such as First Solar (FSLR[5]). SCTY doesn’t actually make panels or wafers, but installs these products for residential and small commercial clients. This means it isn’t really affected by the whims of solar panel pricing. In fact, a glut of panels can actually help SCTY stock. And as an installer, SCTY is expanding quite rapidly. During the third quarter, SolarCity managed to add 12,386 new customers — a whopping 92% surge year-over-year. Overall, that makes it the nation’s largest and fastest-growing solar installer. And more good news for SolarCity stock investors: SCTY expects that number to continue rising and recently announced plans to open ten new operations/sales centers in California to take advantage of the trend towards clean energy. Ultimately, those sales will translate into higher profits down the road for SCTY stock.

TSLA Benefits: Aside from sharing visionary Elon Musk with booming TSLA stock, SCTY is sharing something else as well — its technology. One of the biggest issues with solar power[6] is that it’s not a base load source of energy and doesn’t necessarily sync-up with user demand. Storage of energy is key … and SCTY may have found an answer. Using advanced battery technology from Elon Musk and Tesla[7], SCTY will now offer the ability for commercial enterprises to use its systems for storing energy and avoid paying “demand charges” in certain key solar markets. This proprietary system should help give it a leg up on the competition and add to its subscriber base — more good news for SolarCity stock investors.

Asset Securitization: One of main risks for SCTY stock has been its leasing business model. In an effort to help drive down costs for consumers, SCTY actually leases the panels and collects a fee each month. That put plenty of risk onto the SolarCity balance sheet. However, in another first for Elon Musk and crew, SCTY managed to launch a bond offering to investors that is backed by these lease payments. Think of the SolarCity bonds in the same vain as a mortgage-backed security. Essentially, it pushes some of the risk off of SCTY and onto the bondholders if customers default or miss payments. More importantly, investors ate up the offering and SolarCity is looking to complete more such deals in the future.

Cons on SCTY Stock

Zero Profits: Perhaps the biggest issue for SCTY stock and its shareholders is that it’s not yet profitable. Unlike FSLR and Canadian Solar (CSIQ[8]), SCTY produced an adjusted third-quarter loss of 43 cents per share. While that is still an improvement from last year’s Q3 loss of $2.60 per share, a loss is a loss. What’s more troubling is that SolarCity has estimated it will also experience a loss of 55 to 65 cents per share of SCTY stock for the fourth quarter. Analysts also extrapolate that the negative EPS will stretch out into 2015. Consistent negative earnings does not make SCTY stock quite as appealing as an investment. Plus, investors can bet on a profitable (at least on an adjusted basis) Elon Musk enterprise with TSLA stock.

Difficult To Understand Accounting: As we’ve said before, SCTY isn’t like most solar stocks. While it does install solar panels, SolarCity is more like a bank than FSLR[9]. That’s because the company uses asset-backed securities, variable interest entity investments, debt and tax credits/subsidies in order to create leases, notes and other items to generate its income and profits. Essentially, SolarCity has more in common with Bank of America (BAC[10]) than it does with CSIQ. Given this fact, some have called this solar stock a “black-box” of accounting, and it’s very difficult to understand for regular investors. A good general rule is “if you don’t understand it, don’t buy it.” That can apply for SCTY stock.

It’s A Story Stock: Everyone loves a good story stock. Add billionaire playboy in Elon Musk and TSLA with a hot new technology and you can get momentum of epic proportions. The problem is that almost all story stocks fade away at some time. SCTY stock has been prone to these issues already. Shares of SolarCity stock fell nearly 15% when it reported earnings a few weeks ago. Volatility has been the general trend for shares of SCTY and the company tends to rise and fall rapidly. When the bottom falls out — either through another economic recession or another equity raising by the firm — SCTY could plummet big-time. That means long-term SCTY stock holders could be left holding the bag.

Verdict on SCTY Stock

So what’s the verdict on SolarCity stock? Well, it depends.

Yes, SCTY stock has been one of the best-performing solar stocks on the market today. Driven by increasing sales and a strong relationship with Elon Musk and TSLA, there are plenty of positives. However, some of the negatives at SolarCity are big red flags. Overall, SCTY stock is proving to be quite a risky investment.

All in all, SolarCity is making one heck of a trade. But investors need to understand what they are buying before adding shares of SCTY stock.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

Endnotes:
  1. Solar stocks: http://investorplace.com/2013/11/solar-stocks-fslr-spwr-csiq-yge/
  2. SCTY: http://studio-5.financialcontent.com/investplace/quote?Symbol=SCTY
  3. TSLA: http://studio-5.financialcontent.com/investplace/quote?Symbol=TSLA
  4. potential to outperform: http://investorplace.com/2013/12/sol-stock-solar-stocks/
  5. FSLR: http://studio-5.financialcontent.com/investplace/quote?Symbol=FSLR
  6. solar power: http://investorplace.com/2013/11/solar-stocks-csiq-fslr-yge/
  7. advanced battery technology from Elon Musk and Tesla: http://investorplace.com/2013/12/tsla-stock-scty-elon-musk/
  8. CSIQ: http://studio-5.financialcontent.com/investplace/quote?Symbol=CSIQ
  9. FSLR: http://investorplace.com/2013/10/solar-stocks-fslr-earnings-preview/
  10. BAC: http://studio-5.financialcontent.com/investplace/quote?Symbol=BAC

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