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Why SolarCity Stock May Move Huge
Fundamentals
Solar City (SCTY) has earnings due out July 29th. This note will go over the expectations from that report and walk us through some good news, and some bad news surrounding the company. Ultimately we will be left with a very strong bullish thesis and perhaps an equally strong bearish thesis. We must note upfront that SCTY received a one billion dollar financing deal from Credit Suisse in April to accelerate the company's expansion plans.
SolarCity is the largest US residential solar installer, which is good news for them. The company has entered into several recent partnerships that have grown its geographic reach to Texas, Pennsylvania, New Mexico and New Hampshire. Further, Solar City has existing partnerships with DIRECTTV Nest Labs (a thermostat maker). The Motley Fool reported that SCTY also launched its power storage program with partner Tesla Motors (TSLA), making it available in all of SolarCity's current markets. With further expansion into California and Nevada, the growth story is compelling. Add to that a leadership position in the industry and the reality that we now must accept, solar is the future, no more arguments, period, and we have a raging bullish argument for this company that is fully founded on fact.
There are other facts, though. The fundamentals as of today are quite poor and the stock price drop of nearly 20% in the last year is evidence of that. Remember, the relationship between fundamentals and stock price is one of causation, not correlation. A stock price is the expected future free cash flow of a firm taken to perpetuity (forever), so a rising stock price must come from a belief that those expected free cash flows will grow.
SolarCity's mode of operation is pretty slick, actually, investing colossal amounts into capital expenditures (CapEx) (we'll see that in a chart, below) to build a customer base (that part is working) and then let that expense turn into two-decades of revenue streams from the leased solar systems. So, as a guiding principle, that strategy does make sense. But, keep in mind that the innovation in solar is actually holding it back. We know that solar conversion rates will increase so much in the next year, two-years, and so on, that large commitments for installations today are getting delayed as improvements are made. It's a fascinating pickle for the industry. It's guaranteed to grow. It's guaranteed to get better and converting sunlight into energy and at storing that energy. And therefore, it's harder to make sales today.
SCTY's revenue (TTM) has risen for seven consecutive quarters, and each time that has broken a new all-time high. Technicals | Support: 55.175 | Resistance: 58.1 
Swing Death Cross Alert: The short-term 10 day MA is now below the 50 day MA.
SCTY has a three bull (stock is range bound) technical rating because its trading above its 10- and 200-day moving averages, but below its 50- day moving average. We also note that the 10-day MA is below the 50-day MA ("swing death cross").
Let's look at the core elements that drive the SCTY's poor fundamental rating and then get into consensus estimates and what it will take for the stock to rise.
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Fundamentals Rating Summary |
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| METRIC | CURRENT | 1YR AGO | 2YR AGO | DIRECTION |
| Revenue (TTM US$ Millions) | 259 | 197 | 132 |  |
| Operating Margin (QTR) | 0.349 | 0.49 | 0.53 | FALLING |
| Net Income (TTM US$ Millions) | -53 | -39 | -143 | FALLING |
| Levered Free Cash Flow (TTM US$ Millions) | -1,340 | -793 | -445 |  |
| Capital Expenditures (TTM US$ Millions) | 1,319 | 785 | 475 | |
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| Stock Returns and Chart |
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Before we dig into the fundamental trends that drive the rating, let's look at a two-year stock chart with regression channel and 10-day momentum (on the bottom).
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Now let's examine the visualizations of the critical financial measures.
| METRIC | CURRENT | 1YR AGO | 2YR AGO | DIRECTION |
| Revenue (TTM US$ Millions) | 259 | 197 | 132 | |
There is some "very good" with SCTY. Revenue (TTM) has increased for at least five consecutive quarters (seven in this case) which triggers a "trend." Note that SolarCity has grown revenue by 31% year-over-year and 96% in two-years. Those are gigantic numbers. Any number over 20% year-over-year has an added impact on the fundamental (star) rating. We also note that the $1 billion from Credit Suisse will finance "commercial solar energy systems — including battery storage systems — for businesses, schools and government organizations across the U.S" (Source: SolarCity news release).
Revenue Estimates
The range for revenue estimates this quarter are [$85.4M, $95.1M], with an average estimate of $90.2M. If the company can reports a number at the higher end of the range, or dare we say near $100M, the stock could absolutely soar. Any revenue softness would be a catastrophe as this company's valuation is already at a staggering $5.4 billion with negative earnings and a price to Sales of over 21. That's crazy high.
In this market, there is a huge premium paid for growth (see Netflix), but there is punitive action taken on stock prices that miss growth (see TWTR last earnings release). This earnings release, in a hyper sensitive market environment could mean a massive (over) reaction to the revenue numbers SCTY posts along with the forecats which may be the most important part.
What do all these numbers mean?
SCTY's fundamental rating benefited these results:
1. The one-year change was positive.
2. The one-year change was greater than +20% (an extra boost to the rating).
3. The two-year change was positive.
Finally, the five+ consecutive quarters of an upward trend in revenue benefited the fundamental (star) rating.
Let's look at Revenue (TTM US$ Millions) in the chart below.
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| METRIC | CURRENT | 1YR AGO | 2YR AGO | DIRECTION |
| Operating Revenues/Operating Expense | 0.349 | 0.49 | 0.53 | FALLING |
The single most disturbing part of SCTY's fundamentals is the trend in operating margins, in my opinion. This ratio (how much revenue is generated per one dollar of expense) must be at a minimum above 1.0 in order for a company to turn an operating profit. For the latest quarter SCTY showed a ratio of 0.35. That's simply terrible, and in English means that the company generates $0.35 of revenue for every dollar of expense. Again, this company is a growth story, but my goodness, it has a valuation of over $5 billion already. Growth or not, this is huge risk coming into earnings.
AS if the $0.35 wasn't bad enough news, it has dropped for four consecutive quarters and now sits at an all-time low. The best the company has ever reported is $0.75 (quarter ending July 2012), which is still really low in and of itself, but again, $0.35 is essentially unheard of. Growing revenue at $0.35 to the dollar of cost is hardly a business model that can be sustained. Counter point is that the mode of operation is costs now, and cash flow for decades to follow.
What do all these numbers mean?
One year ago Operating Revenues/Operating Expense was 0.49. In the last year we can see operating margins are decreasing and less than 1.0 for the most recent quarter (below the critical level).
SCTY's fundamental rating was affected from the operating margin numbers in the following ways:
1. The current value is below the critical 1.0 level (the firm generates an operating loss).
2. The one-year change was negative (lowers the rating).
Let's look at Operating Revenues/Operating Expense in the chart below with the total assets in the orange line.
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| METRIC | CURRENT | 1YR AGO | 2YR AGO | DIRECTION |
| Net Income (TTM US$ Millions) | -53 | -39 | -143 | FALLING |
Obviously, if a company spends $1 to generate $0.35 of revenue, earnings are going to be negative. Net Income over the trailing twelve months (TTM) for SCTY is falling. For the most recent trailing-twelve-months (TTM) the company reported net income of -$53 (million). Now, before we scream bloody murder, that number isn't "that bad." So far the firm has actually done a reasonable job of not totally destroying itself with unmanageable losses. But wait until we look at free cash flow.
EPS Estimates
The range for EPS estimates is [-$1.67, -$1.33] with an average estimate of -$1.57. I mean, those are all really bad at face value. i don't think EPS will have much of an effect on stoc price unless it's wildly outside this range. Revenue is the story here, as are forecasts for revenue moving forward. Watch those forecasts.
In our next chart we plot Net Income (TTM US$ Millions) in the blue bars and the we look at quarterly results in the gold line.
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| METRIC | CURRENT | 1YR AGO | 2YR AGO | DIRECTION |
| Levered Free Cash Flow (TTM US$ Millions) | -1,340 | -793 | -445 | |
Levered Free Cash Flow (FCF) (TTM US$ Millions) is a critical determinant of stock price since market cap is the present value of all future free cash flows. For SCTY the metric is trending lower and has seen new all-time lows for eight consecutive quarters. The most recent trailing-twelve-months show a FCF (TTM) number of negative $1.34 billion. These are unheard of negative free cash flow numbers with a company that is trading at 21x sales and it may be tumbling totally out of control. Look, the bulilsh thesis surrounds solar in general, and a leadership position in the industry for SCTY specifically. But these FCF numbers are not only atrocious, they are so big they pose legitimate concerns about the business moving forward as a going concern. Or do they?... Wait until we get to CapEx, next.
For our next chart we plot Levered Free Cash Flow (TTM US$ Millions) in the blue bars through time. Note that nasty trend.
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| METRIC | CURRENT | 1YR AGO | 2YR AGO | DIRECTION |
| Capital Expenditures (TTM US$ Millions) | 1,319 | 785 | 475 | |
So at this point one could wonder, "why is this stock not trading at zero?" There's actually very good reason.
Capital Expenditures (CapEx) (TTM US$ Millions) is trending higher meaning that for at least five consecutive quarters (in this case thirteen), it's been rising. CapEx in the most recent TTM for SCTY was $1.32 billion. That $1.32 billion is essentially exactly the level of negative free cash flow (-$1.34 billion). So we can see explicitly, that SolarCity is spending on CapEx at a huge rate and it's that phenomenon that is driving negative FCF, and nothing else. That's why the stock is not trading at zero, and in fact is trading at over $5.4 billion. You see, this is a tricky one to catch a proper valuation on.
CapEx is up 68% year-over-year and 178% from two-years ago.
In our final time series chart we plot Capital Expenditures (TTM US$ Millions) through time.
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Summary
The bullish thesis for SCTY surrounds a leadership position in the industry, growing revenue and an bet that investments today will give the firm a strong hold on leadership in the future and eventually generate very high margins and free cash flow. The expanding partnerships both domestically and internationally are big, and of course, we just can't forget the elephant in the room which is that Elon Musk (founder and CEO of Tesla (TSLA) as well) is a part of this company. His golden touch is factored into this company, and it well should be. All of those reasons are reasonable and bullish (although $5.4 billion valuation does seem a bit stretched, no?).
The bearish thesis for SCTY is also rather simple. While it invests in massive CapEx today, that investment in a matter of a few years (or less) could be obsolete. Building capacity to manufacture product is one thing, but the actual product itself is innovating so quickly, that a solar panel built today is essentially valueless in two-years. That's a tricky little dance.
Now you decide. Is SolarCity a winner or a loser?