Will Obama Coal Plant Restrictions Boost Solar City?

Aug. 5.14 | About: SolarCity Corp. (SCTY)

Summary

The Obama Administration’s environmental policies will lead to the shutdown of large numbers of coal-fired power plants.

Utilities will have to increase electric bills to cover the cost of replacing coal with other power sources.

Solar companies like Solar City stand to benefit because more and more customers will be looking for lower-cost alternatives to the grid.

Theoretically, Solar City’s business model could give it a lot of float.

Questionable finances put Solar City on much shakier ground than many investors realize.

The Obama Administration could be giving solar panel makers like Solar City (NASDAQ:SCTY) a helping hand in a most unexpected way. By hitting utilities with tough new restrictions on emissions from coal-fired power plants, Obama might be giving home and business owners an incentive to go solar.

The incentive would be higher electric bills caused by utilities that need to cover the cost of replacing old coal-burning power plants. Generating companies have already announced plans to shut down coal-fired boilers at 84 power plants, Bloomberg reported. Bloomberg also predicted that coal-burning boilers, which produce steam to generate electricity, at 146 more power plants are likely to go offline in the next few years because of the regulations.

Naturally, utilities will pass the cost of switching to other power sources, usually natural gas, onto customers in the form of rate increases, which can really add up. The Washington Post reported that electric rates in Pueblo, Colorado, have risen by 26% since 2010 because the local utility, Black Hills Energy (NYSE:BKH), switched from coal to natural gas almost overnight.

That, of course, gives customers a huge incentive to switch to rooftop solar, which is Solar City's specialty. The wave of power plant downs comes just as Solar City is undergoing a major wave of expansion.

The expansion includes an ambitious scheme to manufacture enough solar panels to generate one gigawatt of electricity every year. That will be done by increasing the size and capacity of the factory owned by solar panel maker Silevo, which Solar City bought in June.

Solar City Has Possibility of Float

Solar City has also demonstrated an impressive ability to raise money through financing. The company just issued $204.5 million in "Solar Asset Backed Notes," securities backed by solar panel leases. The issue, similar to mortgage backed securities, could be a real game changer for the solar panel industry if it works out.

The securities issued in two bundles, a $160 million round of Class A notes with a 4.026% interest rate and a $41.5 million round of Class B notes with a 5.45% interest, demonstrate that Solar City's leases could generate float. Float is Warren Buffett's term for revenue that a company takes in that doesn't have to be immediately spent. The revenue adds to the bottom line without increasing expenses. Buffett's classic example of float is insurance policy premiums.

If the Solar Asset Backed Notes work as planned, Solar City could be sitting on a lot of float. The notes will apparently be used to pay for the Silevo expansion, which is designed to manufacture more solar panels to create more leases. More leases are supposed to lead to more float, or at least that's the business plan.

What Solar City is banking on here is that its impressive revenue growth will keep up. Solar City reported that its TTM revenue rose from $123.43 million in June 2013 to $163.84 million in December 2013, or an increase of $60.41 million in six months. December 2013 was the newest revenue figure I could find for Solar City at Ycharts.

The expansion plans are well timed given President Obama's war on coal and its promise of higher electric bills and more demand for solar electric systems. Yet Solar City is still on some very shaky ground here.

Solar City's Questionable Finances Are Similar to MREITS

The whole arrangement reminds me of mortgage backed real estate investment trusts (MREITS) or, worse, the infamous mortgage backed securities that helped trigger the great market meltdown of 2007. MREITs such as Annaly Capital Management (NYSE:NLY) are known for their incredibly low share values and big dividends.

On August 1, 2014, Annaly was trading at $11.19 a share but reported a TTM dividend yield of 11.17%. In contrast, Solar City isn't currently paying out a dividend because it has a net income of -$55.79 million.

Like MREITs, Solar City has some very questionable financial arrangements that my fellow Seeking Alpha writers at Prudent Research have done an excellent job of exposing. Prudent noted that Solar City is facing an investigation of its pricing by the U.S. Treasury Department and two class action lawsuits from investors that allege "accounting errors" in financial statements.

Solar City has a unique opportunity in an expanding industry, but its potentially shady and shaky finances should give investors pause. The company is taking on a lot of debt based on an unproven business model that might not be legally viable. Even the increasing electric bills created by the war on coal might not be enough to save Solar City from its leasing arrangements.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.