Share market investing offers the opportunity to make money from both positive and negative outcomes.  While the majority of investors focus on finding stocks likely to rise in price – the positive outcome – the technique of short selling affords the chance to make money when the price of a stock falls.  The average investor is often advised to avoid short selling, since the risk of loss is theoretically infinite as the short seller will eventually have to cover the rise in price.  In contrast, the inherent risk for “long” positions (betting on positive outcomes) is limited to the price paid for the stock and only realised should the company go out of business.

Because of the risks involved, conventional wisdom tells us short sellers are often highly skilled at researching stocks.  But short sellers can be wrong and therein lays the opportunity for bargain hunters to benefit.

As evidence, one only need look at electronics retailer JB Hi-Fi Limited (JBH), in seventh place in the most recent Top Ten Shorted Stocks List.  JBH is one of only two stocks to make the list that has maintained positive average annualised rates of total shareholder return (dividends plus price appreciation) over 1 year (11.8%); 3 years (7.3%); five years (8.1%); and 10 years (26.9%).  The other stock to make that claim is mining services provider Monadelphous Limited (MND).  Here is the full Top Ten Shorted Stocks List, ordered by short percentage.

Company

(CODE)

Share Price

52 Wk % Change

Forward P/E

5 Yr Est P/EG

2 Yr Est Earnings Growth

Dvd Yield

2 Yr Est Dividend Growth

Gearing

Cochlear Ltd
(COH)

$59.01

+6%

23.89

4.16

+5.3%

4.3%

+0.4%

70%

Monadel-
phous Group Ltd (MND)

$16.86

+5%

12.58

-2.31

-12.6%

7.6%

-6.4%

13%

UGL Limited
(UGL)

$6.99

-37%

9.58

0.85

+11.4%

5.6%

-16.7%

67%

Metcash   Ltd
(MTS)

$2.94

-22%

10.41

(Current)

-15.6%

7.7%

-30.6%

0

News       Corp
(NWS)

$18.27

+19%

37.29

-4.19

-64.5%

0

Acrux    Limited
(ACR)

$0.775

-80%

7.05

0.22

+146.6%

10%

+9.1%

0

JB Hi-Fi  Ltd
(JBH)

$18.03

+19%

13.36

1.65

+7%

4.7%

+8.2%

14.98%

Reject      Shop Ltd
(TRS)

$9.08

-44%

11.79

1.49

-=1.4%

3.8%

+2.1%

0.35%

Myer   Holdings     Ltd
(MYR)

$2.07

-26%

10.35

-7.29

-4.4%

7.9%

-6.5%

32.9%

Sundance Resources
(SDL)

$0.10

+18%

+25.7%

13.67%

 

JBH has spent considerable time sitting atop that list in the past few years as short sellers piled on as mounting low-price foreign competition and the rising Aussie dollar threatened the company’s profit margins.  Some investors with high risk tolerance looked instead at the company’s enhanced online presence, expanded product offerings, cost cutting, and new store openings, and thought otherwise.  A five year price movement chart for JBH appears to show those investors bested the shorts over time.

Based on the numbers in our table, it appears a Bull case for JBH could still be made for the near future, with low debt, modest but positive growth rates and a solid fully franked dividend yield expected to increase.  Analysts appear to agree with an analyst consensus Overweight rating on JBH, with 5 analysts with a Buy recommendation, 2 at Overweight, and 6 at Hold.  

What of the other stocks in the table?  Let’s see which, if any, represent opportunities for Bullish investors and which should be left to the Bears.

Few would deny that Cochlear Limited (COH) is still the global “Rolls Royce” of hearing implants, a market expected to grow substantially with Baby Boomer retirement and increasing government involvement in health care.  The case against Cochlear rising is simple.  The company has been losing market share since the disastrous 2011 recall of one of its flagship implant product lines.  The 2014 Half Year Results released in February showed a sickening 73% drop in net profit.  In addition, Cochlear issued yet another downward revision of forward guidance.

One of Cochlear’s principal rivals, Swiss based Sonova, owner of implant provider Advanced Bionics, has seen revenues increase 54% year over year to March 2014.  Reviewing the forward estimates in our table and the company’s high gearing, how could one possibly make a Bull case for investing in Cochlear at this time?

First, despite its market share loss, the company is still the global market leader.  Second, the company has invested heavily in new products, which have yet to bear fruit.  Key among them is the Nucleus 6 implant, which uses sophisticated computer technology in its sound processor to filter out background noise to better recognise speech only.  A stripped-down version of the Nucleus 6 has been approved by the US FDA (Food and Drug Administration), but that agency has elected to approve the device feature by feature, and the speech/background noise differentiation feature, known as automated scene analysis, has yet to be approved.  The Nucleus Profile Series, fully replacing the recalled Nucleus 5 line; has been approved for use in Europe along with the Nucleus 6.   Risk tolerant investors might take notice of the reported plans for the Chinese government to increase investment in public health as one sign the market for hearing implants could expand enough to benefit both Cochlear and its rivals.  However, it appears analysts are siding with the shorts on this one, as there’s a consensus Underweight rating on Cochlear, with 5 analysts at Hold, 1 at Underweight, and 5 with a Sell recommendation.  Here is a one year price chart for COH, showing the highly volatile movement in share price.

Monadelphous Limited (MND) is often painted with a broad brush as a “mining services” provider, but the company is more diversified than that, serving the energy and infrastructure sectors as well.  However, there is little question the pullback in mining expenditures and the volatility of the price of coal has combined to hurt this company.  Monadelphous has rewarded its shareholders well over the past ten years, with an average annualised rate of total shareholder return over the period of 35.6%, but the past five years have been challenging.  A five year price chart for MND shows the impact of the winding down of the mining expansion boom.

Monadelphous, along with other companies negatively impacted by the dwindling mining expansion, has been aggressively looking to protect its margins through both cost cutting and enhanced production efficiency.   In the price chart you can see the share price has been moving upward in recent months, this following the release of Half Year 2014 results showing a 10.1% increase in net profit after tax.  In addition, since January 2014 Monadelphous has announced an impressive array of new contracts in the gas and LNG sector.   Analysts apparently have their doubts as there’s a consensus Underweight rating on the stock, with 3 analysts recommending Selling the stock, 1 at Underweight, 4 at Hold, and only 1 analyst with a Buy recommendation.

UGL Limited (UGL) is another diversified services company whose share price has taken a beating year over year.  Yet the company has some impressive forward looking numbers with a Forward P/E under 10; a P/EG under 1; and an earnings growth forecast of almost 12% over the next two years.  The gearing is high and analysts apparently feel the current dividend yield is not sustainable, forecasting a 16.7% decrease in dividends over two years.

One of the company’s operating segments is DTZ, one of the world’s largest property services companies.  UGL has been trying to shed itself of this segment for some time, starting with demerger talks and progressing to an outright sale.  News of a lack of interest in bidders has hurt the share price.  On 02 June the company responded to market speculation that a $1.2 billion deal was in the works with private equity firm TPG, acknowledging discussions were in progress but stating ”there is no guarantee this process will result in a binding offer for DTZ and all options are still being considered, including a demerger of DTZ.”

The share price rallied a bit on the news.  Here is a one year price movement chart for UGL.

Analyst opinion on the future of UGL is mixed, but not overwhelmingly Bearish, notably a consensus Hold rating, with 3 analysts recommending Buying the stock; 2 recommending Holding the stock; and 4 recommending selling the stock.

Metcash Limited (MTS) markets and wholesales a variety of consumable products from grocery, fresh produce and liquor, to hardware and automotive parts and accessories.  The grocery segment operates the Independent Grocers of Australia (IGA) stores and competes with the likes of Woolies and Coles, a battle Metcash appears to be losing.  In March 2014 the new CEO announced a five-year transformation plan to secure the survival of the wholesaler and its independent retailers from the crushing competition with Coles and Woolworths in food and groceries and Bunnings and Masters in the hardware sector.  The Metcash share price has been in steady decline for the past five years.  Here is the chart.

The ambitious plan calls for capital expenditures between $575 and $675 million over five years, paid for out of working capital and a cut in dividends.  The expansion includes new stores and existing store updating; automating distribution centres, as well as enhanced digital technology. 

Apparently, several analysts remain unconvinced with a consensus Underweight rating on MTS; 6 analysts recommend Selling the stock; 3 recommend Holding; 1 recommends Buying; along with 2 analysts with an Overweight rating and 1 at Underweight.

News Corp (NWS) has been trading on the ASX as an independent entity for less than a year.  The shares were officially admitted on 19 June 2013 after splitting off the entertainment segments into Twenty-First Century Fox Inc. (NASDAQ: FOXA).   News Corps now consists of a variety of media assets, including the Wall Street Journal and the New York Post in the US; the Australian; the Daily Telegraph, the Herald Sun, the Courier-Mail, and the Adelaide Advertiser in Australia; along with the Sun and the Sunday Times in the United Kingdom.  In addition, NWS has holdings in a variety of internet and cable assets, ranging from Fox Sports to REA Group.

Without a full year of financial information under the new organisational structure, interpreting reported results is difficult at best.  Given the uncertain future of the print media world-wide, conservative investors might want to adopt a “wait and see” posture on NWS.  Analysts, however, are enthusiastic – 6 with a Buy recommendation; 8 at Hold; and only 1 with a Sell recommendation.  Here is a one year chart for NWS.

Biotechnology Company Acrux Limited (ACR) makes a range of medicinal treatments applied directly through the skin, and one of those products, Testosterone treatment Axiron, is responsible for both the dramatic rise and the fall in the share price, down 80% year over year.  The rise began when Acrux announced a licensing agreement for the treatment with US based Eli-Lilly Inc. in 2010; and the fall began when ACR and Eli Lily filed a patent infringement suit against a competitive product in late 2013 and went over the cliff in January 2014 when it was reported the US FDA was reviewing Axiron and other testosterone treatments for possible cardiac complications. Here is a five year chart for ACR.

The FDA review followed the publication of two research studies, with the results of one hotly disputed by Acrux.  The stellar forward looking numbers for Acrux apparently assume continued Axiron revenue.  As yet there has been no decline, with Eli Lilly reporting Q1 revenues for Axiron sales of $39.5million, up from $37.1 million a year ago.  

However, the EMA (European Medicines Agency) is also reviewing the drug and the payment schedule to Acrux from Eli Lilly is in question.  Investors with high risk tolerance might be tempted by the following statement Acrux included in a 28 April 2014 Investor Presentation:

•    The FDA’s current view is that the benefits of testosterone therapy outweigh the known risks when used as directed in patients for whom the drug is indicated.”

Reject Shop Limited (TRS) is a discount retailer selling a wide variety of consumer goods in more than 300 company owned stores throughout Australia.  On 19 February the company’s Half Year results showed a 15.9% drop in profit along with lowered forward guidance and a slowdown in previously planned store expansions.  The market reaction was severe.  Here is a one year chart for TRS.

On 13 March shareholders got another shock with the surprise retirement of its CEO who had held the position for the last five years.  Most analysts line up with the shorts on this one, with a consensus Underweight rating and 3 Sell recommendations; 2 Holds; and only 1 Buy recommendation.

Myer Holdings (MYR) has a 100 year history in Australia with its 66 stores making it the largest department store chain in the country.  The company has been aggressively pursuing an “Omni-channel” distribution system with its improving online, digital and mobile platforms complementing brick and mortar locations.  

In January 2014 Myer issued an announcement confirming it had proposed a merger to David Jones (DJS) back in October 2013.  This approach followed on the disappointing Full Year 2013 Results for MYR showing an 8.7% drop in NPAT.  On 20 March Myer reported Half Year 2014 Results, with yet again a drop in NPAT, this time at 8.1%.  This sent the share price reeling but the prospect of David Jones as a savior evaporated.  South Africa’s Woolworth Holdings has stepped into the picture, with a $2.2 billion takeover offer for David Jones, which apparently is now in doubt according to latest reports.  Myer shares are down close to 30% year over year and the share price as of 04 June was $2.07, a scant 3 cents off its 52 week low of $2.04.  Here is a one year price chart for MYR.

The final stock on the Top Ten Shorted List is junior iron ore explorer Sundance Resources (SDL). The company has an exploration project in Central Africa, centered between the Republic of Cameroon and the Republic of Congo.  Regardless of the prospects of this project, the current volatility of the price of iron ore and the potential global oversupply would suggest SDL at the present time would be attractive only to the punters with nerves of steel.

However, 2 analysts cover the stock, and both have Buy recommendations.  The share price also spiked upward following positive announcements in October 2013 of plans to raise working capital. The share price spiked again following the announcement that the former CEO of Leighton Holdings had been appointed to the Sundance Board of Directors.  Long term investors with high risk tolerance may want to take a second look at this one.  Here is a one year price movement chart for SDL.

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.

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