Contrarian investors occasionally troll the ASX Top Ten Short List for investment prospects. Although there is some validity to the belief short sellers are often “the smartest people in the room”, the shorts do make mistakes and therein lays the profit opportunity.
If the share price of a heavily shorted stock begins to rise the shorts have to start thinking about covering their position. (Shorting means you borrow stock at a given price and later buy the shares to cover what you borrowed. When the stock price continues to drop, shorts make money; but when it goes the other way, the risk is infinite.)
In the last few weeks seven stocks in the Top Ten Short List have reported earnings. Here we investigate the results as well as sharemarket reaction. Below are the seven stocks, listed by total percentage of short interest.
See table at the end of the article.
Although headquartered in New York, News Corporation (NWS) remains an ASX traded company with a global reach, including substantial presence in the US, the UK, and Australia. NWS began trading as an independent entity in June 2013 following the split of the old News Corp, into a Publishing Company (NWS) and a Movie and Television company, Twenty-First Century Fox Inc. (ASX: FOX). FOX is set to leave the ASX and trade only on the US NASDAQ exchange.
ASX listed NWS remains a diversified media company but it is the declining fortunes of print media around the world that appears to have aroused the interest of the shorts. The new company operates about 130 different newspapers around the world but also has a presence in Cable Network Programming, Book Publishing, and Digital Real Estate Services.
On 07 February News Corp released its Q2 results, which were lukewarm at best. The 4% drop in revenue largely due to lower advertising sales from the News and Information segment confirmed the short view on the decline of print media. However, given the fact the company as it is now constituted did not even exist one year ago, interpreting the loss of revenue is problematic. Analysts were surprised at the reported $0.31 earnings per share, besting the consensus estimate of $0.20 per share. Investor reaction was positive. Here is a one month chart for NWS showing the uptick in share price following the announcement:
Although the company’s bloated Forward P/E and dismal 2 Year Earnings Growth Forecast seem to support the shorts view, some major analysts disagree. Macquarie stands alone among the big broking houses with an Underperform rating, although increasing its price target from $15.85 to $18.00 following the earnings release. Citi and Credit Suisse maintained Buy recommendations and both raised price targets ($23.50 at Citi and $20.26 at Credit Suisse.) The shorts may be proven right on this one, pending the company’s ability to grow its other businesses in light of declines in print media.
Hearing implant manufacturer Cochlear Ltd (COH) has had a volatile run since the disastrous product recall in September of 2011. The concern of share market participants at that time was the recall opening a window for Cochlear’s competitors to gain market share. That has come to pass. Worries about declining margins accompanying a loss of market share seem to be the bedrocks of the short’s view of Cochlear.
Cochlear reported Half Year results on 11 February and the lone bright spot for shareholders was the 2% increase in dividends. Revenues declined 5% and Net Profit after Tax (NPAT) dropped 53%. There were extenuating circumstances such as a patent case and approval delays, but these did not dampen share market disappointment with the result. The profit loss before the lawsuit provision was actually 73%. The share price dropped almost 10%. Here is the chart:
Four broking houses have Sell, Underperform, and Reduce recommendations on Cochlear following the earnings release. Credit Suisse, Citi, and CIMB Securities lowered price targets while UBS raised its target to $48 from $47 even though the Sell rating was maintained. Deutsche Bank, BA-Merrill Lynch, and JP Morgan upgraded Cochlear to Neutral while at the same time reducing price targets. JP Morgan noted the result did show “strong underlying growth.”
The market share loss appears to be real, but contrarians can take heart from the example of US based Apple Inc. Like the Apple iPhone, Cochlear implants are still viewed as the “Rolls Royce” of the industry. Apple has lost market share to its Android-based smartphones but its outsized margins remain largely intact. The bull case for Apple is simple. Profitability is more important than market share. Cochlear’s margins have slipped, but like Apple’s are still solid. According to Reuters, Cochlear’s operating margins on a trailing twelve month basis (TTM) stand at 13.31%, besting the Sector’s 3.7% but slightly trailing the Industry level of 14.7%. In addition, Cochlear’s Return on Equity (TTM) of 21.29% beats both its Industry (8.6%) and its Sector (19.10%).
Engineering and Property services provider UGL Limited (UGL) is another Top Ten Short List stock making the shorts look very smart. The share price dropped around 12% following the 17 February release of Half Year results and has fallen further. Here is the one month price movement chart:
Although operating revenue showed a 7% year over year increase, underlying net profit and earnings per share (EPS) dropped 2.5% and 2.9% respectively. The company is planning to split into two separate entities – Engineering and Property Services – and the underlying result included one-off costs associated with the upcoming demerger. Factoring out those costs, the profit result was up 13.5%. Ignoring that was easy for investors as the earnings release also included lowered forward guidance and an announcement the dividend would be cut. The demerger is not expected to be fully complete until FY2015, although selling off the Property Services division prior to that time is a possibility. However, some major broking houses are expressing concern finding a buyer could be impeded by UGL’s weak balance sheet. Gearing as of the most recent quarter was close to 66%. Although company management sees positive future results from Australian infrastructure developments, the analyst community as a whole is siding with the shorts on UGL. Not one of the big houses has a Buy rating on UGL, with five at Neutral or Hold and three at Sell or Underperform.
Monadelphous Group (MND) is an engineering firm serving the resources, energy, and infrastructure sectors through three operating divisions – Engineering Construction, Maintenance and Instrumentation Services, and Infrastructure. On the surface the company seems well-diversified but some of its core markets – Iron Ore, Mineral Processing, Coal, Oil and Gas, Power, and Water – have seen cutbacks in expansion plans and operating costs. The short case appears to be based largely on dwindling revenue as the mining boom fades. The share price decline of around 33% year over year supports that view, but Monadelphous Group’s 18 February Half Year Earnings release contained some surprises, to the delight of shareholders. The market reacted positively. Here is a one month chart for MND:
Despite the tough times for mining service providers, MND’s revenues dropped only 1% and NPAT came in at a record level for the company – $87.1 million, representing a 10.1% year over year increase. The company did reduce its dividend 3.2% but still sports a healthy fully franked yield of 8%. Monadelphous also reported $700 million in contract awards and extensions during the period.
The analyst reaction to the earnings release was less enthusiastic. The lone upgrade came from Deutsche Bank going from Sell to Hold with a target price increase from $13.96 to $15.64. Citi, BA-Merrill Lynch, JP Morgan, and UBS remain at Sell, Underperform, and Underweight. The belief appears to be earnings have peaked and will deteriorate in the second half. Of those four broking houses, only UBS is positive on MND, stating its Sell recommendation is based on valuation grounds with the stock price outstripping the UBS price target of $12.10. Contrarians might be inclined to focus instead on MND’s current trailing twelve month P/E of 9.57 and Forward P/E of 12.28.
Nickel miner and explorer Western Areas Ltd (WSA) probably earned its spot on the Top Ten Short List over concerns about commodity prices and demand, although some experts are now anticipating better days ahead. The company is the largest producer of nickel in Australia and has exploration assets in Finland. The share price was already rising prior to its 18 February Half Year Earnings release, largely due to a rising prices for nickel on the London Metal Exchange. Here is the chart:
On 10 February the company raised guidance for the full year 2014 and coupled its 18 February Half Year earnings release with the announcement of a capital raise to reduce debt. The earnings were mediocre, with a 10% decline in revenue along with a solid 29% increase in NPAT. Perhaps the biggest disappointment for investors was the cut in dividends from $0.02 per share in the previous corresponding period to $0.001 per share.
Following the release, Deutsche Bank downgraded the stock from Buy to Hold, due to the capital raise. Citi’s downgrade was from Neutral to Underperform for the same reasons. However, four of the big houses run contrary to the short argument with Buy (BA-Merrill Lynch and UBS), Overweight (JP Morgan), and Outperform (Macquarie) recommendations, with JP Morgan labeling WSA its “preferred pure play in nickel.”
What can you say about JB Hi Fi (JBH)? After what seemed several lifetimes on the Top Ten Short List, the shorts finally let go as the JBH share price rose close to 60% over the last two years, and JBH fell from the list. Now the shorts are back and JBH, while up over 40% year over year, has seen about a 16% decline in share price since the start of 2014. The stock rose following news of the JB Hi Fi earnings release, but has fallen back since. Here are some of the highlights from the earnings report:
• Revenues increased 6.8%
• NPAT up 10%
• Earnings per Share rose 9%
• Gross Margin increased 0.11%
• Dividends increased 10%
The numbers speak for themselves. Of particular note is the increase in margins. Admittedly that is a small rise but it was concern over dwindling margins in the face of cutthroat pricing wars that sent JBH to the short list in the first place. In light of disappointing earnings from other retailers, JB Hi Fi pre-announced its earnings to the market on 28 January with the official release coming on 03 February. Here is a price movement chart for JBH for the last three months:
The shorts are unlikely to let go of this one. Citi, the only major broking house with a Sell recommendation for JBH, makes the case. In their opinion, sales growth in critical electronics categories are due to slow down, but operating costs will not. The Citi analyst foresees negative comparable store sales by 2015.
Bradken Limited (BKN) is another mining service provider the short have their eyes on.
Bradken boasts 59 facilities offering manufacturing, sales, and service in Australia, New Zealand, the US and UK, Canada, South Africa, South America, and China. Its markets include energy, mining and construction, and rail and transit. Bradken’s customers are primarily producers, not explorers. Despite that fact the company has had a tough year, with Full Year results reported back in June of 2013 showing a 10% drop in revenue along with a 4% decline in NPAT.
On 11 February Bradken announced Half Year 2014 results. The earnings release had nothing but bad news for shareholders and good news for the shorts – revenue down 17.2%; NPAT down 18.4%; dividends per share reduced 25%, and forward guidance below analyst consensus estimates. The one month chart shows the additional beating doled out to an already beaten down stock.
The analyst reaction was less severe. Although price targets were cut by most major broking houses, not a single one downgraded Bradken shares. JP Morgan maintained its Overweight recommendation and Credit Suisse kept its Outperform rating. Deutsche Bank maintained a Hold recommendation, but the rationale provides strong support for the short position. DB believes “picking a bottom for Bradken is difficult and more downside risk is in the offing.”
Short Interest %
Share Price (52 WK % Change)
2 Year Earnings Growth Forecast
5 Year Total Shareholder Return (Annual Average Rate)
Monadelphous Group Ltd
Western Areas Ltd
JB Hi Fi Ltd
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