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SolarCity is likely to see a strong growth in revenues.

We believe the company's retained value is significantly overstated and is likely to be adjusted down.

Due to low barriers to entry in the core markets and increasing panel prices, there is significant risk of increased competition and lower gross margins.

SolarCity Inc. (NASDAQ:SCTY) is set to announce its Q1 2014 quarterly results on May 7th. While the company has been on a tear in terms of revenue growth, we are highly skeptical of its retained value and its core profit margins.

As far as Q1 earnings go, here is the guidance SCTY has provided March 18th (with less than 2 weeks left in the quarter):

  • GAAP Operating Lease and Solar Energy Systems Incentive Revenue: $27 million-$29 million
  • GAAP Solar Energy Systems Sale Revenue: $23 million-$27 million
  • GAAP Operating Lease and Solar Energy Systems Incentive Gross Margin: 40%-50% (Including impact of amortization of intangibles from recent M&A and new O&M department)
  • GAAP Operating Expenses: $70 million-$75 million (including $3 million in amortization of intangibles)
  • Non-GAAP EPS (before Income (Loss) Attributable to Noncontrolling Interests and Redeemable Noncontrolling Interests): ($0.70) - ($0.80)

Given the timing of the guidance, we expect SCTY to do well on all the mentioned metrics. In other words, any surprise is likely to be mildly on the upside.

Outside of these guidance items, there are other areas where investors need to pay special attention. In particular, here are some key metrics that we will be looking for:

  • Retained value: We believe the company's assumptions behind retained value are unrealistic, and will be looking for the company to either justify these metrics or adjust them.
  • Cash sales: With the cost per watt prices of solar installations going down, we expect sales to increasingly be cash. We saw this dynamic in SunPower (NASDAQ:SPWR) Q1 results, and we believe SCTY will be no exception. Cash sales have lower margins and no retaining value component.
  • Panel price increases: The company will also likely be slightly disadvantaged starting Q2 from the rising Chinese panel prices. The increased solar panel prices may offset other cost reductions somewhat.
  • Market share: With low barriers to entry and increased availability of financing options in its core markets, we believe SCTY market share may be near its peak. Chances are high that SCTY market share may flatten or trend down going forward. On the other hand, further increase of market share indicates the company's momentum is stronger than our expectations.

Given the price momentum behind the stock in the last year and the risk of restatement of retained value, we believe SCTY investors face the risk of a big valuation compression in the stock price.

Our sentiment: Avoid

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.