Why This Noted Solar Bear Suggests Adding To Short Position In SolarCity

• In a recent report, Axiom Capital Research analyst Gordon Johnson reiterated a Sell rating and $24 price target on shares of SolarCity Corp SCTY.
• He pointed out two negatives for the company: (1) the solar ITC extension/expansion deal seems increasingly improbable this year and (2) the “tradeoff for crude oil export ban doesn’t seem to be robust enough.”
• After discussions with a couple of contacts in Washington D.C., the firm recommended adding to the SolarCity short position.

After chats and prognostications from sell-side peers, analysts at Axiom have learned that there are four possible outcomes for the U.S. Congress’ handling of the solar investment tax credit (ITC) before the December 31, 2016 cliff. This is when the ITC for commercial projects will be trimmed from 30 percent to 10 percent, while the ITC for residential buildings will be reduced from 30 percent to zero.

What Republicans Say

Given the desire for many Republicans to eliminate the ban on crude oil exports out of the US, "solar/policy pundits have predicted that Democrats will successfully lobby their Republican counterparts to include some form of ITC extension in return for a compromise on US oil exports," the Axiom report said. This belief for the most part has been driving SolarCity’s stock upwards in the past few weeks. After discussions with two Washington D.C. contacts, Johnson shared his views on "how this dynamic may play out."

Related Link: Bernstein Says Wait For The Entry Point In Solar City; Starts At Market Perform

Axiom believes "both a long-term extension, as well as a change in the verbiage around 'connected/online' to 'construction started/commenced' is unlikely."

The analysts provided a few reasons to support this view. Regarding the inclusion of a long-term extension of the ITC in the December 11 budget, the firm's contacts have suggested "there is just too much pushback from Republicans at present."

What Democrats Say

While Democrats would love to see some kind of ITC extension, "the risk of losing too many votes to pass the budget is simply too high should a long-term extension of the ITC need to be pushed through, based on our contacts’ views." While the Republicans would be keen on seeing a lift on the ban for crude oil exports, "their opposition to a long-term ITC extension does not appear material enough to destroy the probability of this event eventually happening."

On the other hand, Axiom's contacts said the likeliness of a change in verbiage from "connected/online" to "construction started/commenced" is far higher -- although chances are this will not happen in 2015. "The reason centers on the reality that there are currently 50 tax credits that have expired under consideration. Yet, the solar ITC has not expired, making it difficult for Democrats to risk political capital on one area," Johnson explained.

Given SolarCity's recent stock strength off the probability of favorable ITC legislation, the analysts "see the potential for disappointment on the horizon." Thus, following their Washington D.C. checks, they would be adding to the SolarCity short position.

Based on the PTC precedent, where "(1) the credit was extended retroactively at the end of last year, and (2) the extensions were done after the credit expired," the analysts envision a potential extension of ITC for solar. Nonetheless, the likeliness of this happening this year is not particularly high.

Disclosure: Javier Hasse holds no positions in any of the securities mentioned above.