The Short Report

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This story features RIO TINTO LIMITED.
For more info SHARE ANALYSIS: RIO
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Andrew Nelson

With the holiday break approaching and given signs of economic improvement in China and the US, short covering in the Australian market has continued to pick up pace as the year draws to a close. The sector affected most by this year-end covering is the Resources sector, while short positions in Retail and Materials stocks continue to build.

Short positioning in Rio Tinto ((RIO)) is at a record low at 2%, having  fallen all the way from 6.5% in the beginning of the year. Meanwhile, shorts in other sector names such as Alumina ((AWC)), Discovery  Metals  ((DML)), Independence  Group  ((IGO)), Lynas  ((LYC)), Mirabela Nickel ((MBN)) and OZ Minerals ((OZL)) have  also  been  covered  to a lesser extent over the past few months.

Conversely, David Jones ((DJS)) and Harvey Norman ((HVN)) continue to see their already significant short positions extended, although analysts at CIMB note Metcash ((MTS)) is  largely  to blame for the overall increase in the Staples sector, with short interest increasing 2.82 percentage points (ppt) from 6.72% to 9.54%, posting the biggest short position increase in the Australian market over the course of the last month to 4 December.  The stock remains positively regarded in the FNArena Database, with two Buys five Holds and a Sell call. One of the Buys was posted by Credit Suisse, the broker upgrading its view on valuation grounds, believing the stock is just too cheap. BA-Merrill Lynch sit on the Sell side, noting rising costs and a continued loss of share to major retailers is a trend that is expected to continue.

Short  interest in the Capital  Goods sector has also continued to buck the covering trend, doubling in the past six months on steady increases in Bradken ((BKN)) and UGL ((UGL)). The building interest in Bradken sees it sitting at the number two spot for monthly short interest, its position rising 2.06ppt from 4.74% to 6.80%. Despite the shorting, the stock remains well regarded in the FNArena Database, with five Buy calls and two Holds recorded. Declining visibility in the order book and an expectation for a further softening in capital products demand over the next few months are likely taking a toll.

While there were only two significant (+/- 2%) monthly increases to short positions, there were four stocks that saw their position covered significantly. The biggest bit of covering was seen by Lynas Corp, whose short position has pulled back 4.95ppt from 13.14% to 8.19%. The stock remains positively regarded in the database, with two Buys, two Holds and a Sell. One of those Buy calls is from Macquarie, who upgraded from Sell a couple of weeks back noting the first rare earth ore from WA has landed at the LAMP in Malaysia and is ready to be fed in. The stock currently trades at a 66% discount to its consensus price target.

Lynas requested a trading halt yesterday to provide the company to comment on media reports suggesting the Malaysian government had insisted the company export its radioactive waste. The reports risked implying the LAMP temporary operating licence would thus again be revoked but an announcement from the company has since confirmed there is not threat at this stage.

SingTel ((SGT)) has also seen a busy bout of covering over the past month, its short position down 4.3ppt from 7.09% to 2.79%. Analysts seemed to have relaxed a bit since the in-line quarterly last month, with Credit Suisse upgrading to Buy on a more positive view on the group’s Bharti business in India. Sentiment is high, with the database showing four Buys and three Holds.

Next on the monthly decrease list is Fairfax ((FXJ)), whose short position has pulled back by 4.03ppt from 16.08% to 12.05% despite a broadly negative view on the stock. The database shows four Sells versus two Buys and a Hold, although there is 10% upside to the current consensus price target. Credit Suisse, who re-initiated coverage on Fairfax with an Underperform rating two weeks ago, notes the company needs to generate additional revenue streams to support its flagging publishing operations over the medium-term.

Mesoblast ((MSB)) is our last significant monthly mover, its short position coming off 3.37ppt from 6.29% to 2.92%. Analsyst sentiment remains positive, with the database showing two Buys, one Sell and one Hold and more than 29% upside to the consensus price target. BA-Merrill Lynch noted last month there is likely to be significant upside from phase III trial of the company’s Congestive Heart Failure treatment when it is eventually undertaken.

Significant moves on a weekly basis were even fewer, as traders look to wind down activities ahead of the holiday break. Not a single stock saw it’s short position increase by 2ppt or more from 27 November to 4 December. The biggest weekly increase was a 1.51ppt lift in Metcash from 8.03% to 9.54%. Fellow retailer JB HiFi ((JBH)) also rates a mention, its short position advancing 1.45ppt from 21.55% to 23% over the course of the week. The move has further cemented the stocks number one position on the Top 20 most shorted list, with a big gap of daylight between it and number two, Myer ((MYR)) at 14.98% shorted.

The biggest weekly decrease in short position was booked by Fairfax, down 3.58ppt from 15.63 to 12.05. The move sees the stock drop from the number two to number five spot on the Top 20 list. Next in line is Mesoblast, its short position pulling back 3.50ppt from 6.42% to 2.92%.

The was one compositional change to the Top 20 list, with Boral ((BLD)) falling off from the number 20 spot to be replaced by Linc Energy, which joins at number 19. There were a couple of other decent sized position changes other than Fairfax. Metcash rose from number 14 to the number 9 spot, while Lynas Corp went the other way, going from 9 to 14.

As always, CIMB has been keeping an eye on short position movement in order to find a few good trading ideas. This week the broker looked at Qantas ((QAN)), noting short positions continue to be covered and are now at their lowest level since August 2012. CIMB Transport analyst, Mark Williams, expects to see a strong rebound in earnings in FY13, given FY12 was affected by industrial action d a number of cost-saving initiatives. The stock remains the broker’s top pick in the Transport sector.

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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