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Shares fund managers believe are vulnerable to big falls include the likes of Cineworld, Royal Mail and Fevertree  
Thursday 23 Jun 2022 Author: Steven Frazer

Some of the UK’s best-known businesses are being targeted by hedge funds this year as investors’ nerves are shredded by inflation risks, rising interest rates and Russia’s war in Ukraine.

British retailers such as ASOS (ASC), B&Q-owner Kingfisher (KGF) and Currys (CURY) have seen short sellers make big bets that they will struggle as the cost-of-living crisis spirals, potentially leading to large share price falls.

Other targets include Royal Mail (RMG), Domino’s Pizza (DOM), Fevertree (FEVR:AIM) and Future (FUTR), the magazine and website publisher.



Cineworld (CINE), the world’s second-largest cinema operator, has been top of the list of the most shorted stocks since January.

The latest data from shorttracker.co.uk, a website which calculates short interest on UK stocks, shows Cineworld has 8.2% of its shares in the hands of shorters, who profit when share prices fall, including 2.42% held by New Holland Capital and Whitebox Advisors’ 2.38%, the two largest bets against the company.

Tempting as it might be at a time when many shares are under pressure, shorting is not really an activity which is accessible or suitable for most investors, however it is definitely worth keeping tabs on the list of most shorted stocks.

If you already own stock in any of these businesses, or perhaps think they might represent buying opportunities at current valuations, it is worth considering why they might be in the sights of the shorters.

After all, these specialists are taking on big risks if they hold these positions. The most someone can lose when buying shares in the hope they go up in value is the entire value of their initial investment. Yet if someone is short selling a stock and it goes up in value – rather than down as they hoped – then in theory there’s no limit to the level a share price can rise. That means the losses could be significantly more than the initial investment. For this reason, shorting stocks is not suitable for most retail investors.

How shorting works

HOW SHORTING WORKS

Short selling or ‘shorting’ is a process where investors seek out companies who they believe could suffer a falling share price. They are effectively betting the company risks financial distress or issues bad news that triggers a share price decline.

The short seller pays a small fee to borrow stock owned by an existing shareholder, typically a large financial institution such as a pension fund, then sells it at the current market price.

Presuming the stock falls as anticipated, it means the short seller can buy back the same number of shares as originally borrowed for a cheaper price, give the stake to the original lender, and pocket the difference.

For example, say a short seller borrows 100,000 shares at 100p each in the hope the share price will fall. They sell the stake worth £100,000 and wait. Let’s say the stock declines to 85p after three months. The short seller buys back 100,000 shares in the market at a cost of £85,000, gives these shares to the original lender, and they make £15,000 profit on the deal, less any fees.

WHY GO SHORT?

As discussed, even if you don’t partake in short selling, it is also worth establishing why others are betting against a stock. It could help you avoid companies which you previously thought were good, or make you alert to problems which lead you to reassess whether you still want to own those shares.

This year, there have been several times shorters have called it right. Since the start of 2022, Cineworld’s shares have lost 30% of their value. In fairness, you could say the same about any number of stocks this year. But what sets Cineworld apart is that at 2.89p, the stock is trading at an all-time low, valuing the one-time near-£10 billion company at just £320 million.

Many companies that rely on consumer spending will be feeling nervous as pressure mounts on household budgets. In the current environment, how many of us can justify doing up the spare room, buying a bigger fridge or spending cash on takeaways?

It should come as no surprise that FCA data indicates that short sellers are looking to exploit weaknesses that the cost-of-living crisis will create for consumer stocks.

Several businesses which prospered during the pandemic have also drawn short interest – the hypothesis being that either the pandemic pulled forward future business leading to growth rates which will be hard to sustain post-Covid or simply that they were more of a fad or temporary beneficiary of things like lockdown restrictions.

Royal Mail remains a favourite of shorters, some of whom believe the 500-year-old postal service faces an existential crisis. The company is seeking to radically overhaul its business after the pandemic accelerated an existing trend toward e-commerce that sees it deliver more parcels and fewer letters.

But with a heavily unionised workforce pushing aggressively for higher pay, costs are rising fast, putting Royal Mail’s pace of operational savings under threat.

Investors might wonder why people are betting against Tullow Oil (TLW) despite rising oil prices, with 2.8% of its stock in the hands of short sellers. It’s certainly true that rocketing oil prices have provided a vital boost to cash flow following a dismal period during the early stages of the pandemic.

Tullow’s shares have risen in price by nearly 9% this year versus the FTSE 100’s near-6% decline, yet its strained balance sheet, despite refinancing last year, means it has not been able to capitalise on the higher commodity price environment in the same way as many of its peers.

All of this said, just because short sellers have held the upper hand on many stocks through 2022, that doesn’t mean they will continue to do so down the line.

A LESSON FROM TESLA

Elon Musk’s electric cars-to-renewable energy company was once the most shorted stock on the Nasdaq market as investors queued up to bet against the electric automaker.



In early 2020, short interest on Tesla (TSLA:NASDAQ) was estimated at around 20% of its entire float as it was targeted by high-profile short sellers like Jim Chanos, who made his name on shorting Enron, David Einhorn, who made his name shorting Lehman Brothers before its 2008 collapse, and Michael Burry, whose bet against the US housing market before the financial crisis was dramatised in Hollywood blockbuster The Big Short.

Yet it now looks like most of them have given up as short interest on Tesla has dwindled. In October 2021, Bloomberg reported the lowest short interest on Tesla since the carmaker listed on Nasdaq in 2010.

‘The percentage of stock borrowed by traders, a standard measure of short interest, has slumped to 1.1% of Tesla’s shares available for trading, according to IHS Markit,’ reported the financial news site, as Tesla consistently met or beat vehicle delivery numbers.

WHAT’S A SHORT SQUEEZE?

When short sellers rush to exit their bets against a company to prevent deeper losses, their purchase of shares to cover positions can propel its stock price sharply higher. That exacerbates the pain of those still short the company, potentially forcing them to cover their trades as well, creating what is called a ‘short squeeze’.

That appears to have been part of the story behind Tesla’s blistering 1,340% gain between the start of the pandemic to the stock’s $1,222.09 peak in November 2021. That the stock has come back sharply this year is more in line with most growth stocks losing favour during the current inflation squeeze rather than evidence of renewed short seller confidence, with short interest currently running at 3.22%, according to MarketWatch data.

IT’S THE DEBT THAT WILL GET YOU

Cineworld faces bigger challenges than simply getting bums on seats in its theatres as it grapples with spiralling debts that could strangle the company out of existence. Full year 2021 results, released three months ago, showed net debt widened by nearly half a billion dollars last year to $4.84 billion, 14 times the company’s equity despite raising around $425 million in liquidity. It reports in dollars because more than two-thirds of its theatres are in the US.

Cinema-goers returned to the screens in the second half of the year of 2021, helping Cineworld’s revenue jump 112% to $1.8 billion and allowing the company to return to an operating profit ($15.8 million versus 2020’s $2.3 billion loss). Yet you can see why shorters have been drawn to the stock.

Facing a possible rough $1 billion damages bill following its decision to walk away from buying Canadian chain Cineplex (a case it has already lost but is appealing) ups the ante that bit more.


Why are investors shorting these stocks?

Domino’s pizza (dom) 308.4p

Year-to-date performance: -33%

Amount of stock on loan: 3.6%

Number of investment funds with short positions: 5

Source:
Google Finance, shorttracker.co.uk, data as at 17 June 2022


Why it has attracted shorters

The company was a clear beneficiary of the pandemic when people were unable to go out to eat and so spending £20 on a takeaway pizza felt like an affordable treat to break up the monotony of lockdown.

Now people are able to dine out again Domino’s position looks less robust, and the cost-of-living crisis means £20 for a pizza is starting to feel like more of a stretch.

There are also concerns the group has reached saturation point and new sites will only cannabilise sales from existing ones. And while a row with its franchisees was resolved in December 2021 through a profit sharing deal, that relationship still feels fragile.

Why shorters might be wrong 

The company is cash generative and net debt (at around 1.5 times earnings as of the end of 2021) is at manageable levels. The resolution with franchisees should help drive growth and the company is buying back shares – with £24.2 million of a planned £46 million purchased as of 5 May. Domino’s is also good at coming up with marketing offers to keep driving sales volumes. [TS]


Future (FUTR)

Year-to-date performance: -56.7%

Amount of stock on loan: 1.6%

Number of investment funds with short positions: 2

Source:
Google Finance, shorttracker.co.uk, data as at 17 June 2022

Why it has attracted shorters 

The publishing company has grown rapidly in a relatively short period of time, driven by lots of acquisitions. Question marks have been raised around the remuneration policy and there have been claims the monetisation of the company’s online content through links to the websites of commercial partners is alienating readers. The weak economic picture could hit advertising and e-commerce revenues.

Why they might be wrong 

The company continues to deliver, recently confirming 2022 guidance (17 June) after a series of earnings upgrades. A deteriorating consumer backdrop may be a risk but the focus on specialist niches and hobbies with loyal fans means spending among its cohort of readers could be more resilient.

Future’s model of buying titles cheaply and plugging them into its existing platform to generate revenue from their content and brands has proved successful and there should be more opportunities because of the current economic uncertainty. The shares now trade on a 2022 price to earnings ratio of 9.7 times. The balance sheet looks robust with net debt to earnings of less than 1.5 times. [TS]


Kingfisher (KGF)

Year-to-date performance: -31.2%

Amount of stock on loan: 7.1%

Number of investment funds with short positions: 6

Source:
Google Finance, shorttracker.co.uk, data as at 17 June 2022

Why it has attracted shorters:

The B&Q-owner had a patchy track record before the pandemic and is now emerging from an exceptional period when it was one of the few areas of retail able to operate without too many restrictions. It benefited from a lockdown-induced desire among customers stuck at home to spruce up their surroundings. With that tailwind disappearing sales are falling, down 14.2% in its first quarter to 30 April 2022. The company faces supply chain issues and rising costs.

Why they might be wrong: 

A lot of people are still waiting for tradesmen to become available to do projects on their home, so the tailwind for home improvements could stay healthy for longer. There are also plenty of people midway through projects where they are doing the work themselves.

Fundamentally there is lot of pent-up demand from people who still want to upgrade their home and spending at Kingfisher’s stores could be more resilient than expected. The company is in the process of a £300 million share buyback and recently reiterated full-year profit guidance of around £770 million. [TS]

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