Why Does Goldman Sachs Like SolarCity?

Goldman Sachs recently upgraded SolarCity (NASDAQ: SCTY  ) to conviction buy with an $80 price target. Not long after the upgrade, SolarCity's stock rallied to a record high. Brian Lee, the Goldman analyst for the rooftop solar company, said that he expects SolarCity to achieve 50%-60% volume CAGR through 2016.

He estimates that SolarCity has an intrinsic value of at least $40 in the no-growth scenario through 2016 and believes that the expansion of the solar asset-backed security market is a very positive catalyst. Access to affordable financing is the rate limiting step for many considering rooftop solar. The expansion of securitization financing should allow SolarCity to grow faster while saving the company money in interest payments. Mr. Lee estimates SolarCity's securitization capacity to be around $340 million in 2014 and $700 million in 2016.

Elsewhere in the rooftop sector, the investment bank also has a buy rating on SunEdison (NYSE: SUNE  ) , and a neutral rating on SunPower (NASDAQ: SPWR  ) .

Strong 2014 trends
The rooftop solar sector is currently riding on very positive trends that should continue in 2014. Goldman forecasts that rooftop sector will grow around 45% a year until 2016. 

Large corporations, such as Wal-Mart and Costco, are aggressively adopting rooftop solar. Those large corporations have the scale and access to low cost financing to make rooftop solar economics work. Non-residential consumers such as companies, non-profits, and public agencies are expected to add 7 GW of additional capacity by 2018. 

SolarCity, SunEdison, and SunPower should all benefit as that nonresidential growth continues. 

As those companies grow, they should achieve greater economies of scale to cut soft costs, such as labor and systems design, which currently constitute anywhere between 52% and 64% of total installation costs.  

In addition to falling soft costs, solar panels prices are projected to continue falling as solar cells become more efficient and manufacturers realize greater economies of scale.

The bottom line
In my opinion, SolarCity's recent rally is due to traders using the Goldman upgrade as a pretext to squeeze shorts rather than institutions buying because of the upgrade. 25% of SolarCity's float is short. The shorts have to cover part of their position when the stock price goes higher to manage risk.

On Wall Street, trading is similar to the game of Liar's Poker. Traders establish positions in the early phase of bubble stocks and take profits on the way up. Traders judge bubble stocks based on how good the overall story is -- meaning how big the end markets are, what catalysts lay ahead, and the overall market sentiment. 

In SolarCity's case, the story is a very good one. Power company utilities sell $400 billion in electricity every year. Utilities have not changed very much since Thomas Edison's time. The renewable energy sector is clearly disruptive to utilities, and various factors such as government support and concerns over global warming will all but ensure that the sector reaches its potential.

Upcoming catalysts look good. New financing deals as well as new commercial company contract wins are likely to come into play. Finally, sentiment is extremely bullish. SolarCity had a great 2013, with its stock rallying over 400%. I think traders and long-term investors both agree that SolarCity has a lot of promise and that the underlying trends give SolarCity a chance at disrupting the utility market.

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