Shorts Are Piling Into These Stocks. Should You Be Worried?

Do short-sellers have McDermott International, Under Armour, and Clovis Oncology pegged? You be the judge!

Apr 28, 2014 at 5:02PM

The best thing about the stock market is that you can make money in either direction. Historically, stock indexes tend to trend upward over the long term. But when you look at individual stocks, you'll find plenty that lose money over the long haul. According to hedge-fund institution Blackstar Funds, between 1983 and 2006, even with dividends included, 64% of stocks underperformed the Russell 3000, a broad-scope market index.

A large influx of short-sellers isn't a condemning factor for any company, but it could be a red flag indicating that something is off. Let's look at three companies that have seen rapid increases in the number of shares sold short and see whether traders are blowing smoke or if their worries have merit.

Company

Short Increase March 31 to April 15

Short Shares as a % of Float

McDermott International (NYSE:MDR)

31.5%

25.4%

Under Armour (NYSE:UA)

84.4%

7.8%

Clovis Oncology (NASDAQ:CLVS)

63%

10.4%

Source: The Wall Street Journal.

Drill or be drilled
It's been rough sledding -- or should I say drilling -- for offshore oil and gas service contractors, with few feeling the pinch as hard as McDermott International.

McDermott is an EPCI service company, meaning it engineers, procures, constructs, and installs floating platforms and pipelines for offshore and subsea oil and gas projects around the world. As you may recall from previous discussions, the offshore industry faces a crisis from both ends at the moment. Many oil and gas exploration and production companies have cut their capital-expenditure budgets, leaving less money to be spent on offshore projects. Similarly, a number of offshore producers, seeing opportunity for many years in drilling projects, are introducing new rigs and creating a bottleneck of too many ships for too little demand. The result has been a negative trickle-down to contractors such as McDermott, which has missed Wall Street's earnings-per-share forecasts by a mile in each of the past four quarters.

The bet against McDermott makes sense from a short-sellers' standpoint. There's likely no overnight remedy to new equipment oversupply, nor will E&P drillers boost capex by billions of dollars at the drop of a hat.

Over the long run, however, assuming McDermott can survive this swoon, it could be in great shape to benefit from the global increase in the demand for energy, especially in emerging and industrializing nations such as China and Brazil. Over time, we should see demand largely outweigh the introduction of new offshore drilling vessels, which will be good for McDermott.

The biggest question mark surrounding the company is liquidity, and I believe McDermott decisively answered those concerns earlier this month when it announced a second-lien debt offering of $500 million. This extra working capital should give the company breathing room from skeptics, along with the ability to upgrade its infrastructure should it see fit to do so.

I would certainly suggest investors keep their expectations tempered on McDermott over the near term, with moderate losses extended possibly through 2015, but I also don't see extensive downside left in shares for skeptics to feed on.

Forget the sprint -- this is a marathon
If you needed any evidence that "buy the rumor, sell the news" still exists, look no further than performance apparel and footwear company Under Armour, which was throttled by investors after reporting what I can only describe as stellar first-quarter revenue and profit growth last week.

For the quarter, Under Armour delivered a 36% increase in net revenue, with apparel revenue rising 33%, footwear up 41%, and other accessories tacking on 43%. Direct-to-consumer (i.e., online) sales also rose 33%. In addition, gross margin improved 100 basis points to 46.9% as manufacturing efficiencies improved and higher-margin items were sold. This led to a favorable product mix -- no small feat considering that nearly every retailer was expected to report weak first-quarter results due to exceptionally cold weather within the U.S. Finally, adjusted earnings for the quarter increased 71% from the prior year.

But shareholders chose not to focus on that. Instead, they honed in on Under Armour's boosted full-year forecast for $2.88 billion-$2.91 billion in sales and $331 million-$334 million in operating income. While these figures suggest gains of 24%-25% and 25%-26%, respectively, that would be be a notable drop-off from the 33% revenue jump it just reported for the first quarter.

Is this a true cause for concern? I don't believe so.

G
Source: Under Armour.

Under Armour is one of the few retailers that really understand not only how to brand themselves, but which ambassadors to hire in order to make that happen. The company has also successfully expanded overseas into fast-growing emerging markets, thus reducing its reliance on the stable but slower-growth U.S. market. There's little doubt, as well, that Under Armour is among the leaders in performance apparel when it comes to innovative designs that engage consumers and keep them loyal to the brand.

In other words, even though Under Armour is valued at 41 times forward earnings, I believe its conservative growth estimates, key partnerships, and leading innovation set the company up for more long-term upside. Consider this your warning, short-sellers!

Put the champagne away
Lastly, we have Clovis Oncology, a volatile clinical-stage biopharmaceutical company attempting to develop therapies to treat cancer.

Clovis' current pipeline revolves around three products: CO-1686, a clinical-stage therapy for non-small cell lung cancer, or NSCLC; rucaparib, an experimental ovarian-cancer drug; and lucitanib, a clinical solid-tumor therapy.

The big news of late has been the exciting results from a phase 1/2 study involving CO-1686 in NSCLC patients with EGFR mutations and a dominant resistance mutation T790M. The early data showed the therapy to be well-tolerated, with just one of 62 patients dropping out due to adverse events. Of the 22 patients with an evaluable T790M mutation, 64% experienced a RECIST partial response, although it was still too early to determine the length of its median progression-free survival.

These are positive results, and I wouldn't take a thing away from optimists based on this early-stage data. However, investors have to keep in mind that Clovis is wholly clinical-stage and burning through its cash at the moment. It had sought to potentially sell itself a few months back and found no bidders, signaling that even in a risk-on environment other biopharmaceuticals felt the buying price was simply too high.

The other thing to keep in mind here is that most of Clovis' pipeline is fairly early-stage. There have been plenty of glimpses of promise, but nothing for shareholders to really sink their teeth into. In 2012, Clovis' most promising pancreatic cancer therapy, CO-101, flopped in a midstage trial, yet shares have quadrupled since that announcement. While I hope for the best for cancer patients suffering from NSCLC and ovarian cancer, I also don't see anything that would qualify Clovis for a $1.7 billion valuation -- at least not yet. As such, I believe short-sellers may stand a good chance of being correct here.

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Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool owns shares of, and recommends Under Armour. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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