The Short Report

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By Andrew Nelson

Last week was another slow one on the Australian share market when it came to adding to, or covering short positions. Just four stocks saw their short position changed by more than one percentage point ((ppt)) over the week from the twenty fourth of April to the first of May. The trend was balanced, with two increases offsetting two decreases.

Nine stocks moved more than two ppt over the month to the first of May, with ASIC shorts data showing seven significant increases to short position and just two decreases. With quarterly reporting season winding down, most of the action was seen in resources and resources related sectors.

This week’s report leads off with DUET ((DUE)), with shorts increasing 1.62ppt from 1.3% to 2.92%. The FNArena Database shows sentiment for the stock slipped into the negative towards the end of last month after JP Morgan downgraded its recommendation to Sell from Hold on valuation grounds. The broker also expects DUET to only grow its asset base by 1.3% per annum over the next three years, which compares with a sector average of 4.6%. The main reason for the difference is the Dampier to Bunbury Natural Gas Pipeline, which JP Morgan expects to have no earnings growth in FY13 to FY15.

Drillsearch ((DLS)) is our next and last significant weekly increase, with shorts rising 1.28ppt from 2.42% to 3.70%. Sentiment is perfect for the stock on straight Buys in the FNArena Database. While brokers unanimously like the company’s prospects, there is a bit of expectation for some short term weakness. Macquarie said last week the stock offers value at current levels, although a successful convertible bond issue could result in some short-term share price weakness as holders look to hedge equity exposure. UBS thinks the stock may soon break out of the doldrums it's been stuck in because of the delays in the Bauer oil pipeline commissioning and a six month break in wet gas sales. UBS thinks increasing oil exploration activity and upcoming unconventional gas drilling will more than support the price in the meantime.

Shorts in Acrux ((ACR)) were down 1.25ppt from 6.95% to 5.70%. Macquarie actually upgraded to Hold at the end of April, noting Eli Lilly appears to be gaining traction with Axiron and rebates have moved to 54% from 68%. Macquarie does not think rebates will move below what established competitors offer, given the lack of differentiation in the market and that Axiron is a newer arrival. Nevertheless, the reduction in rebate suggested to the broker that Lilly is getting pricing traction with insurers. That being said, the broker did see a risk of earnings growth slowing given the flat trend recently and the cycling of tough comparables. Sentiment for the stock is positive.

Our last weekly mover is The Reject Shop ((TRS)), with shorts pulling back 1.23ppt from 8.21% to 6.98%. The company announced a $40m capital raising via a $30m placement and $10m share purchase plan. UBS thought the decision to firm up the balance sheet was reasonable, especially considering the relatively high operating leverage. The broker believes the action is more about de-risking than accretion, given the operational and execution risks involved in the current accelerated store roll out. Despite UBS’ guarded optimism, the sentiment for TRS is negative.

The biggest increase to short position on a monthly basis was booked by NRW Holdings ((NWH)), with shorts advancing 3.58ppt from 3.48% to 7.06%. Deutsche Bank downgraded its call to Neutral yesterday and CIMB cut its forecasts the day before. Deutsche thinks NRW Holdings is well managed with a strong project delivery and execution track record but the company is exposed to the slowing domestic iron ore sector and mining companies are focused on reducing costs, and they will continue to do so. The problem is, Deutsche Bank believes significant margin pressure will be the consequence. Just a few days before, Macquarie noted the company had received a $180 million contract from Rio Tinto ((RIO)) at the Nammuldi project. The broker thought this was a good start on another big site and follows the Roy Hill win. Macquarie acknowledged further share price volatility is likely until the iron ore market outlook stabilizes, but this should abate over the next year. Sentiment for the stock is positive.

Shorts in Troy Resources ((TRY)) advanced 3.41ppt from 0.48% to 3.89%. Next was Whitehaven Coal ((WHC)), with shorts up 3.08ppt from 6.73% to 9.81%. Citi downgraded its recommendation on the stock to Hold from Buy a couple weeks back after downgrading copper, aluminium, coal and gold price forecasts by anywhere from 5% to 15%. For WHC this added up to lower forecasts on the back of reduced coal price assumptions, which saw the price target trimmed on the lower earnings. The company did report in line quarterly results that were well enough received last week. Sentiment for the stock is positive.

Drillsearch is next on the monthly increase list, rising 3.08ppt from 0.62% to 3.70%. SAI Global ((SAI)) follows next, its short position advancing 2.63ppt from 3.89% to 6.52%. JP Morgan, for one, is cautious on the stock, having noted recently the regular occurrence of downgrades to guidance in the recent past. Sentiment for the stock is positive.

Shorts in Monadelphous ((MND)) increased 2.14ppt from 9.35% to 11.49%. UBS said yesterday it believes Monadelphous' end markets have deteriorated further, predicting an earlier-than-expected decline in earnings, i.e. FY14 rather than FY16. The broker has upgraded FY13 earnings forecasts by 1.5%, but reduced FY14-15 by 18%.

The last big monthly increase was posted by Alacer Gold ((AQG)), with shorts increasing 2.05ppt from 3.82% to 5.87%. Last week’s March quarter production report was fairly well received by most, although JP Morgan cut its call to Underweight. The broker was concerned that low recoveries are persisting at Copler despite the solid result achieved through high grades. There were continued declines in grade at Higginsville and unit costs escalated across all assets. The broker is also cautious about delivery of the $60m in savings the company is forecasting and the medium-term operational turnaround, noting the profitable Copler is subsidising the Australian assets. Sentiment for the stock remains positive, with most other brokers either liking, or not disliking post the result.

Metcash ((MTS)) saw its short position come off 2.3ppt from 11.56% to 8.50%. Sentiment for the stock is neutral. Lastly, shorts in Iluka Resources ((ILU)), retreated 2.19ppt from 16.79% to 14.49%. Two weeks back was a busy time for the stock, with brokers pouring over March quarter numbers. The consensus judgment was positive, with comments from BA-Merrill Lynch summing up the situation well. The broker noted March quarter production numbers were in line, with sales revenue especially pleasing given the prevailing weak conditions. There was no pricing update, but the broker assumed the market believes that prices have stabilised. Zircon demand is starting to turn positive and the broker expected titanium prices will also soon turn. Sentiment for the stock is positive.

There wasn’t much in the way of change to the Top 20 most shorted list except for a few position swaps. The biggest was Metcash ((MTS)), which moved from eighth place to fourteenth.
 

Top 20 Largest Short Positions

To see the full Short Report, please go to this link

IMPORTANT INFORMATION ABOUT THIS REPORT

The above information is sourced from daily reports published by the Australian Investment & Securities Commission (ASIC) and is provided by FNArena unqualified as a service to subscribers. FNArena would like to make it very clear that immediate assumptions cannot be drawn from the numbers alone.

It is wrong to assume that short percentages published by ASIC simply imply negative market positions held by fund managers or others looking to profit from a fall in respective share prices. While all or part of certain short percentages may indeed imply such, there are also a myriad of other reasons why a short position might be held which does not render that position “naked” given offsetting positions held elsewhere. Whatever balance of percentages truly is a “short” position would suggest there are negative views on a stock held by some in the market and also would suggest that were the news flow on that stock to turn suddenly positive, “short covering” may spark a short, sharp rally in that share price. However short positions held as an offset against another position may prove merely benign.

Often large short positions can be attributable to a listed hybrid security on the same stock where traders look to “strip out” the option value of the hybrid with offsetting listed option and stock positions. Short positions may form part of a short stock portfolio offsetting a long share price index (SPI) futures portfolio – a popular trade which seeks to exploit windows of opportunity when the SPI price trades at an overextended discount to fair value. Short positions may be held as a hedge by a broking house providing dividend reinvestment plan (DRP) underwriting services or other similar services. Short positions will occasionally need to be adopted by market makers in listed equity exchange traded fund products (EFT). All of the above are just some of the reasons why a short position may be held in a stock but can be considered benign in share price direction terms due to offsets.

Market makers in stock and stock index options will also hedge their portfolios using short positions where necessary. These delta hedges often form the other side of a client's long stock-long put option protection trade, or perhaps long stock-short call option (“buy-write”) position. In a clear example of how published short percentages can be misleading, an options market maker may hold a short position below the implied delta hedge level and that actually implies a “long” position in that stock.

Another popular trading strategy is that of “pairs trading” in which one stock is held short against a long position in another stock. Such positions look to exploit perceived imbalances in the valuations of two stocks and imply a “net neutral” market position.

Aside from all the above reasons as to why it would be a potential misconception to draw simply conclusions on short percentages, there are even wider issues to consider. ASIC itself will admit that short position data is not an exact science given the onus on market participants to declare to their broker when positions truly are “short”. Without any suggestion of deceit, there are always participants who are ignorant of the regulations. Discrepancies can also arise when short positions are held by a large investment banking operation offering multiple stock market services as well as proprietary trading activities. Such activity can introduce the possibility of either non-counting or double-counting when custodians are involved and beneficial ownership issues become unclear.

Finally, a simple fact is that the Australian Securities Exchange also keeps its own register of short positions. The figures provided by ASIC and by the ASX at any point do not necessarily correlate.

FNArena has offered this qualified explanation of the vagaries of short stock positions as a warning to subscribers not to jump to any conclusions or to make investment decisions based solely on these unqualified numbers. FNArena strongly suggests investors seek advice from their stock broker or financial adviser before acting upon any of the information provided herein.

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