SunEdison Inc (OTC:SUNEQ) has been one of the worst stocks on the market since mid-2015, and the fall from grace has been spectacular. The company was once touting itself as the largest renewable-energy developer in the world, and now there are questions about its ability to stay solvent long term.
Like any stock that's fallen more than 90% in six months, there are some who think a turnaround is just around the corner. But for that to happen, SunEdison has to answer questions about its business and its balance sheet. Rather than look at potential upside, I think it's more prudent to look at where the downside risk lies, and see if there's a reasonable expectation that SunEdison can overcome those risks.
Will SunEdison make money selling projects?
When SunEdison launched its yieldco strategy, launching both TerraForm Power and TerraForm Global, it was predicated on the idea that the combination of companies would have a lower cost of capital than competitors. With that low cost of capital, SunEdison could bid aggressively to win projects, and the yieldcos could issue new equity and debt to expand asset purchases and grow dividends.
When both yieldcos dropped in 2015, their yields surged to double digits, making it impossible to execute on that strategy. SunEdison shifted and said it would sell projects to third parties, which would be lower margin. But we still don't know what SunEdison's margin profile will look like, because the strategy is only a few months old.
A gross margin of 20% would put the company among the industry's leaders, and show a turnaround could be around the corner. But considering SunEdison's aggressive bidding on projects, I think a gross margin of 10% to 15% will be more likely. And at that rate, it will have to grow more than it expects just to break even (as I showed here).
If SunEdison can't generate enough margin to show progress reducing losses, and show a path to profitability, the stock could fall rapidly. In the fourth quarter, analysts are expecting a loss of $0.69 per share; if the company comes up short of that, I don't think it will be a good day for investors.
Debt costs continue to rise
As SunEdison searched for ways to finance projects, it's gone from a position of strength to one of weakness. When its yieldcos had higher stock prices and lower dividend yields, it could drop projects down to either yieldco, generating cash at the sale, and dividends and incentive distribution rights long term. It could also sell projects to third parties if it made sense, or find partners for projects.
Today, the yieldco model is broken, and SunEdison has resorted to complex warehouse vehicles and third-party sales. But before it sells projects, it has to fund construction with cash or debt from the balance sheet. And that's why news of the company's new term-loan package at a cost of at least 11% is such a big deal. Competitors are paying less than half that for debt, and that cost advantage means they can bid more aggressively on future projects than SunEdison.
If SunEdison's financing costs continue to rise in 2016, it will likely spell doom for the company.
Growth prospects diminish
If SunEdison's financing costs are higher than competitors, it will be harder to win bids for competitive renewable energy projects. The problem is that SunEdison needs an increasing amount of volume, combined with high margins, to pay down $11.7 billion in debt. This creates a downward spiral for SunEdison. Margins go down, costs go up, growth becomes harder to obtain because competitors are able to win projects -- and on and on the cycle goes.
What investors will want to watch in 2016 is the company's contracted backlog trends. Third-quarter 2015 backlog fell from 6 GW to 5 GW a quarter earlier. SunEdison needs to keep backlog strong to maintain viability, and if backlog starts to drop, investors will put even more doubt in the company's future.
Lots of questions remain
Conditions are changing so fast at SunEdison that it's hard for investors to know what to expect. But we know that SunEdison is reporting losses each quarter, and investors are getting impatient about a potential turnaround. If margins, debt costs, or growth come up short of expectations, it could hurt the stock in 2016. Investors should be watching all three closely.