SolarCity (SCTY, Financial) has recorded impressive revenue growth over the last few years. But the company’s growth story is flawed as the company’s inability to generate a profit and huge debt will come back to haunt SolarCity in the coming quarters. Hence, I would recommend investors to stay away from the stock at current levels.
With growth comes debt
SolarCity’s growth is grounded on the idea of popularizing solar energy. Solar companies have to capitalize a lot of cash in its projects to fund growth. It doesn’t matter whether you are solar system installer such as SolarCity, SunPower installing setup on roofs across the country or a producer like Yingli Green Energy —Â these companies need wealth to build capacity.
Given that, the capacity being figured out will yield good results for over 10 to 20 years, either from gathering payments from clients or by selling products like solar panels. It is must for every company to undergo thorough various operations to produce innovative and up-to-date products to stay in the market. Therefore, most of the solar companies are spending a lot of money at once to make a long-term payoff, and generally that means increasing a lot of debt to fund operations.
Debt does not necessarily have a negative impact on the growth of companies, but the solar sector is different than most businesses. With the investment tax credit expected to expire in 2016, installation growth could slow down considerably and this would make it difficult for SolarCity to pay off its current debt. The company is still burning cash and is far away from turning a profit.
Need of more customers
SolarCity is facing many challenges to improve its position in the solar industry. The company has witnessed a slowdown in growth as evidenced by its latest quarterly report and forward guidance. With the ITC set to expire by the end of 2016, SolarCity will need to add as many clients as possible this year. I don’t believe the company will be able to add enough clients, however, to generate cash to pay off its debt over the years.
Hence, SolarCity longs should hope for an extension in the ITC or the company will suffer big time. Falling costs may have helped the solar industry until now, but things will change once ITC expires and SolarCity, because of its high debt, will feel the full force of it.
Conclusion
After the post-earnings plunge, SolarCity has staged an impressive turnaround, with the stock up almost 30%. Short covering and insider buying from Elon Musk at Tesla (TSLA) may have been a big driving factor for the recent rally. But the company’s long-term prospects are dim. The expiry of ITC and slowing growth are big red flags that should convince investors to stay away from the stock.
