MorningWord 11/25/14: Gonna Play $SUNE $SCTY

by Dan November 25, 2014 9:35 am • Commentary

With declining oil prices have come declining solar stocks.  There is much debate as to the actual correlation of the solar projects based on the price of crude.  Sitting on the Fast Money desk the last few weeks I have heard the CEO of SunEdison (SUNE), and just last night an analyst from Robert Baird (and there have been others) suggest that there is very little real association with the two data points.  I’ll take their word for it. But let’s see how solar stocks are trading if we see crude at $60 in the coming weeks/months.  And let’s have this conversation again if and when crude oil has nearly been cut in half from its 52 week highs and trading at multi-year lows.

Interestingly, the space has garnered some attention lately having little to do with the solar projects themselves.  Rather, interest has increased since SUNE’s decision to create two “Yieldcos”, publicly traded entities that essentially strip out cash flow from their most reliable solar projects.  Here is a succinct description of the entities and reasons why other players may pursue similar strategies, from

Here’s why SunEdison and the rest of the industry is so keen to pursue new finance options. Back in its 3Q13 financial results SunEdison calculated its current business model of building and selling solar projects yields about $0.74/Watt — but those assets’ true value could jump as high as $1.97/W if the company can find ways to enumerate and apply various methods: lower the cost of capital, apply various underwriting assumptions, and factor in residual value in power purchase agreements. That’s a startling 2.6× increase in potential value creation that SunEdison thinks it can unlock, and creating a yieldco structure to attract interest from the broader investor community is a big part of the answer.

In its 4Q results SunEdison puts more numbers to that value-creation equation: in the fourth quarter it captured an additional $158 million by retaining projects vs. simply selling them off. And by applying most of the 127-MW on its balance sheet with an estimated $257 million in “retained value” to this yieldco, the company says it has sufficient scale to unlock the true value of those solar assets.

Is this the equivalent of slicing up tranches of mortgages and repackaging them and selling a more complicated version of the underlying?  It’s hard to create something from nothing when all you’re doing is financial repackaging. I’m not totally sure what’s going on here but it is either a very gimmicky financial engineering (at a time when investors were getting worried about the health of the underlying), or it is a way for the companies to take advantage of low rates and high investor demand, and the trend is just getting started.

SolarCity (SCTY) has caught my eye lately as the stock had been banging along the bottom of its 52 week range near $50 but recently bounced 10% on SUNE’s announcement of its second YieldCo. (SUNE is up 37% since the Nov 17th).   At one point in March SCTY  was up 850% from its December 2012 IPO, but is now down about 37% from those highs.  Earlier this fall, the stock broke the uptrend that had been in place since the IPO, and as stated above has been flirting with key support at $50:

SCTY since Dec 2012 IPO from Bloomberg
SCTY since Dec 2012 IPO from Bloomberg

No matter what your directional inclination on the stock, traders should consider using options to define risk.  Thirty day at the money implied vol is about 49%, which seems high by most standards, but is nearing 52 week lows, and down from 52 week highs of about 90% from mid October:

SCTY 1 yr chart of 30 day at the money IV from Bloomberg
SCTY 1 yr chart of 30 day at the money IV from Bloomberg

Now, YieldCos are only one potential method of financing solar projects.  SCTY’s difficulty is that the company is focused on residential and small-scale commercial projects, which are more difficult to package into a YieldCo when compared to utility-scale projects.  (For a full explanation of YieldCos for solar, check out this article.)

In any case, the mere suggestion of financing alternatives like YieldCos, or new expansion such as SUNE with wind power obviously has the potential to cause swift rallies in the sector.  I suspect SUNE’s almost 40% rally in a week would be enough to cause at least a portion of the 32% short interest to cover, causing a massive short squeeze.

As for SCTY, looking out at listed expirations, the choices are a bit slim with the two closest in 2015 being Jan and April. That is a bit disappointing as Jan seems almost a bit too short-dated to play for this type of an unexpected announcement, while April seems like an eternity.  But with the stock around $57, out of the money call spreads look like an interesting way to play a speculative stock given the precarious technical set up and high short interest.  One trade that looks interesting would be the Jan15 60/70 call spread offered at about $1.90.  Break-even at $61.90, with max gain of $8.10 at $70 or higher, a level the stock was trading at in mid September.