Real Goods Solar: Riding High On The Promise Of Inflation

| About: RGS Energy, (RGSE)

As a follow up to my Sept. 16 article, "Real Goods Solar Shines Among Peers", I, now, need to warn investors that the recent move in the shares of (RSOL), from a closing price of $2.38 on the day of publication of my article, to a high of $4.64, set on Oct. 21 (a 94.9 percent move), has been too high, too fast-in my opinion. In the event of a setback from this impressive move, it should not be misconstrued as evidence of a stock peaking-out on its way to a blow-off top and subsequent collapse, not by a long shot-again, in my opinion, as I will explain later in this article.

As the latest example of a stock gone unleashed, any student of the market will tell you that history is replete of instances of stocks like RSOL, moving from rational levels, to irrational levels, to bizarre levels, and then, to some more easy gains courtesy of the madness of crowds.

Who knows? Maybe RSOL has only reached level 2 of the "irrational level" stage in this recent rally and has two more levels of insanity left in it. There are some very hurt shorts who've gotten fooled by this stock. Be careful. Don't become tempted to join them; there are some mighty forces behind the stock volume of RSOL, and it's not coming from mom-and-pop investors.

Brief Summary of RSOL's 1,000 Percent, 11-Month Rally

RSOL's primary business model focuses upon the residential, commercial and utility solar energy construction, engineering and procurement within the continental United States. The company provides several financing and leasing plans for its compete solar system, as well as a billing plan for electricity used, without any obligation to pay for the solar system.

With income metrics such as a profit margin of -54.6 percent, an operating margin of -16.8 percent, a debt-to-equity of 388.27, and a current ratio dangerously close to one-to-one, those seeking a compelling explanation for the remarkable move higher in RSOL since my Sept. 16 article won't find one that make sense from a fundamental analysis point of view.

For example, the Mercury Solar Systems deal did nothing for the stock. On Aug. 9, RSOL announced its intentions to acquire Mercury's business and the $10 million cash that comes with the company's balance sheet. Along with scooping up a competitor, RSOL needs cash, badly. Sounds like a good thing.

But, what was the investor reaction to the news? Initially, RSOL closed up approximately 10 percent for the day. But, as trading resumed, the stock dropped 30 percent throughout a 15-day trading period.

Prior to the announcement, the stock showed no sign of traders buying on rumors or leaks surrounding the deal. There was no pump-and-dump signature in the price action. The stock just wasn't going to change its course to the downside. But the overall trend since Nov. 2012 has been up! Strange.

And taking the analysis back to RSOL's Nov. 2012 intraday low of approximately $0.40, one would think that today's $4 stock must have been driven by material changes in the prospects of the company in the areas of improving top-line or bottom-line metrics; meaningfully expanding market share; or improving anything else about the business. But, alas, you won't find one overarching reason that warrants a move of this magnitude throughout an 11-month time period.

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So, what's really driving RSOL?

Thesis overview

As Wall Street continues to levitate from unprecedented and incrementally larger central bank "liquidity", the asset-price inflation trade had emerged as the theme for the bulls following the monetary policy response by the Fed to debase the US dollar in the wake of the NASDAQ collapse of 1999. Oil prices soared to a high of $147. Gold soared to $1,930. Real estate, too. And solar stocks, outperformed them all, with the darling of the solar sector, First Solar (FSLR), for example, making a nearly 1,500 percent return within 18 months of its IPO of Nov. 2006.

In contrast to FSLR's meteoric rise, RSOL launched its IPO within days of FSLR's high (of $317 in May 2008, from $20 in Nov. 2006) and weeks from the catalyst for the global financial meltdown-the bankruptcy of Bear Stearns in March 2008 and subsequent collapse of the entire global financial system the bankruptcy caused, soon after. In hindsight, the spring of 2008 was the most inopportune time for any IPO to launch, and RSOL got it all wrong from the beginning.

Following the crash, capital for small-caps with no earnings was hard to come by. Banks didn't lend much to consumers and small business, which was all good, anyway, because consumers and many small businesses didn't want to borrow (though, of course, some did). As a result, RSOL suffered from its capital-intensive business model and a reluctant consumer, who was too busy paying down debt and conserving cash due to widespread economic uncertainty. Shares of RSOL dropped from a high of $9.25 in May of 2008, to a low of $0.40 in Nov. 2012.

In short, money was reduced to a trickle for RSOL. The company managed to hang in there, however, though its management did opine about the economic conditions throughout its SEC filings of fiscal 2010-12.

For example, somewhere in RSOL's 2012 Annual 10-K, it reads:

Adverse overall economic conditions that impact consumer spending could impact our results of operations. Future economic conditions affecting disposable income such as employment levels, consumer confidence, credit availability, spending on housing, business conditions, stock market volatility, weather conditions, acts of terrorism, threats of war, and interest and tax rates could reduce consumer spending or cause consumers to shift their spending away from our products. While many economic indicators have improved recently, activity in many areas of the general U.S. economy remain sluggish. If the economic conditions continue to be adverse or worsen, we may experience material adverse impacts on our business, operating results and financial condition. The ongoing financial crisis and the loss of confidence in the stock market has increased our cost of funding and limited our access to some of our traditional sources of liquidity, including both secured and unsecured borrowings. Increases in funding costs and limitations on our access to liquidity could have a negative impact on our earnings and our ability to drive our growth strategies. In addition, the deteriorating general economic conditions in the United States have caused a drop in consumer spending in general, and discretionary spending in particular. These dynamics may also adversely impact the solar sector.

Though many risks confront any business, especially newly-minted publicly-traded companies such as RSOL, economic conditions have hounded the company's financials during fiscal 2010-12 time frame. Gross margins are shrinking due to competition [Wal-Mart (NYSE:WMT), especially, has entered the business], and the ease of entry from other competitors remains as a growing risk to its model.

Another meaningful risk includes the 30-percent tax credit subsidy from the U.S. government, which expires in 2017 (but, most likely will renew, in my opinion), along with other risks, could derail the company.

To the continued dismay of management, the U.S. economy hasn't produced much growth-no more than stall speed, in fact. Consumer confidence, jobs, retail sales and housing show no signs of true recovery.

It all sounds so gloomy. Doesn't it? But, read on. There is much more to know about RSOL than what has been reported about the stock.

RSOL's Rise Has More to Do with Gamesmanship than Financial Metrics

But, today, none of these risks to RSOL (or most other businesses) matter much to Wall Street. Good economic news translates to stocks going up on recovery hopes. Bad economic news means stocks go up because the recovery is at risk, and the Fed will have to do something about it via additional near-zero cash for hedge funds and broker/dealers to speculate with, in the hopes of raising consumer confidence through the 'wealth effect'.

It's my contention that the market has been taken over by computer algorithm "black boxes" and central planning by the Fed. RSOL is a prime candidate to take a ride along with other solar names as the pack of big and cheap-money players buy up baskets of sector stocks. Here's what I mean:

Take a look at RSOL's chart, with FSLR's price action superimposed on top of RSOL's chart action (see below).

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And to buttress my case that states hedge funds (and proprietary trading desks) are driving RSOL, I posit the follow question: What does First Solar Inc. have in common with Real Goods Solar , besides having the word "solar" in the name of their companies?

Both companies compete in two separate marketplaces. One is a upstream maker of solar panels, and the other is a downstream retailer of those panels, or other panels. There is no real likeness between the two 'solar' companies. Essentially, the two companies have as much in common as a cattle rancher and a regional burger joint.

Now, look at another comparison (below). The two-company comparison in this next example doesn't quite make the argument that RSOL and SunPower Corporation (SPWR) are fungible stocks. SPWR is a competitor of FSLR, not RSOL.

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Additionally, when looking at other solar names, the correlation appears again. The chart for SolarCity Corporation (SCTY) demonstrates, again, a similar correlation. Pick any solar stock, from any sector within the solar industry, and observe the canny correlation to RSOL (or any other actively traded solar stock), yourself.

The two examples, above, demonstrate clearly why the correlation between two data sets doesn't necessarily infer causation.

It Gets Better for the Bulls - The Shorts are "on the Ropes"

On Thursday, Oct. 17, the day following a resolution in Washington to the quasi government shutdown, all stocks, commodities (save oil) and metals, which had been the big movers prior to the onset of the global financial/sovereign crisis of 2008, soared, including, this time, RSOL, the new kid to the joy ride of easy central bank money.

But, what gave RSOL and added boost came from the heavy short position in the stock, accumulated throughout the 2010-12 doldrums.

The following chart, courtesy of Interactive Chart Analytics, shows approximately 55 percent of RSOL's float short the stock. As Wall Street's algos bought "everything solar" (along with precious metals and other so-called "risk-on" trades), the RSOL shorts must have panicked as they were squeezed quite rapidly, and in high numbers, out of their positions. The chart, below, suggests that the big move on Oct. 17 was heavily influenced by the shorts squaring their positions, and not primarily due to enthusiastic investors drawn to a compelling solar 'story' on a comeback trail.

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With slightly less than 20 percent of the float still short in RSOL, according to Interactive Chart Analytics' data, there might be an additional move higher if the algos want to take the remaining holdouts, as well. The risks for the shorts remain.


As Wall Street becomes more accustomed to trading predicated upon the Fed and its QE solution to a never-ending fragile, levered and dependent financial system, solar stocks will most likely be a over-weighted beneficiary of central bank largess, as they were prior to the Bear Stearns bankruptcy.

Moreover, the resolution to the budget standoff in Washington has decidedly convinced traders and investors that a business-as-usual to the colossal U.S. deficit spending and complimentary Fed "monetization" program will lead to further debasement of the U.S. dollar and much higher commodities prices in the near future.

Oil may soon soar again, even as global demand for the commodity remains tepid. Since the oil market is priced in U.S. dollars, a resumption to the decline in the purchasing power of the U.S. dollar will most likely be seen in the oil and precious metals markets during the remainder of the fourth quarter and into the first-half of 2014. Solar stock will most likely follow as they did during the 2006-8 buying frenzy. RSOL may outperform in this scenario, as its beta is clearly higher than other big-name 'solar' companies.

It appears to be no coincidence that, following an announcement on Capitol Hill to reopen government, all pre-Lehman Brothers trades are back in vogue.

Because RSOL is a Nasdaq stock with much institutional sponsorship, the stock's mirror-image performance alongside heavyweights FSLR and SWPR isn't coincidental; RSOL appears to have made the grade among the quants, and has been added into the solar basket as means of boosting octane to their portfolios.

RSOL's relative small size to FSLR (and the like) will provide a nice stack of volume when the risk-on (inflation) trade is back to full-swing. Considering the crazy p/e multiple expansion of the solar stocks in 2007-8, RSOL could conceivably reach back up to its all-time high of $9.25 without any meaningful developments from company.

So, yes, the so-called "liquidity" from the Fed may keep this grossly overbought market moving higher from the madness of the crowd, taking RSOL with it. Acquisitions, mergers and other easily financed deals could sweep RSOL to heights not yet appreciated.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in RSOL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.