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

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 their worries have merit.

Company

Short Increase April 30 to May 15

Short Shares as a % of Float

Hillshire Brands (NYSE: HSH  )

209.1%

3.8%

Trex (NYSE: TREX  )

187.9%

19.7%

Pfizer (NYSE: PFE  )

14%

0.9%

Source: The Wall Street Journal.

Where's the beef?
No, this isn't an episode of The Jerry Springer Show, but it sure seems that way: Hillshire Brands -- the company behind such beef names as Jimmy Dean breakfasts, Ball Park franks, and Hillshire Farms -- is involved in something that resembles a bidding triangle.


Source: Nakeva Corothers, Flickr.

Hillshire made waves just weeks ago when it announced its intention to purchase frozen-vegetables giant Pinnacle Foods for $4.2 billion. While some Wall Street pundits applauded the deal, others thought it could take Hillshire too far outside of its usual stomping ground (i.e., meat products). That's when things got really interesting.

Last week, the No. 2 poultry producer in the U.S., Pilgrim's Pride, made an offer to acquire Hillshire Brands for $45 per share and assume its debt, with the contingency that it drop its takeover bid for Pinnacle Foods. Not to be outdone, Tyson Foods (NYSE: TSN  ) responded just days later with a bid of its own. Tyson's offer for Hillshire equates to $50 per share and would also be contingent on Hillshire walking away from its Pinnacle Foods purchase. At the moment Hillshire is trading more than 6% above Tyson's offer price on the expectation that Pilgrim's Pride may come back with a higher offer (or that someone else may enter the bidding war).

Short-sellers who dove into Hillshire Brands over the aforementioned two-week period have been burnt to a crisp. While I do eventually expect Hillshire's board to choose one of these competing bids and to walk away from its Pinnacle Foods deal, I also don't expect the offer for Hillshire Brands to head any higher.

At Hillshire's current value, Tyson and Pilgrim would be ponying up 26 times forward earnings and greater than 12 times EBITDA to get their hands on a business that's capable of 2%-3% organic growth. I understand there's value in Hillshire's brand-name product lines, as well as cost synergies that could be realized from combining its channel distribution with either Tyson or Pilgrim's Pride. But there also comes a point where the valuation simply becomes too frothy, and I believe we've hit it with Hillshire Brands. While I may not have the guts to suggest short-sellers place their bets here, I really don't see any additional upside potential to Hillshire Brands' share price from here on out.

Doom or boom?
The battle continues to rage on within the housing industry to decipher whether or not the sector can continue to grow or if it's merely biding its time before another major downturn.

On one hand, housing inventories are being held down in order to keep demand up and boost pricing. Higher prices tend to be a major motivator for home buyers since many (wrongly) view as a home as an investment than a place to live.

On the other hand, the wind down of QE3 could bring about higher lending rates since fewer long-term U.S. Treasuries are being purchased. Since bond prices and yields move in opposite directions I would expect that interest rates would rise over time. Given how fickle consumers have been toward the home-buying process when rates move even 25 basis points higher, I can only assume what the long-term outlook for the housing industry looks like when rates do begin to normalize.


Source: Trex.

That brings us to Trex, a leader in alternative decking and railing products. Trex has seen a nice rebound in its business thanks to a stabilization in U.S. home sales as well as remodels. But its past quarter certainly wasn't anything to write home about with net sales dipping to $100.6 million from $107.9 million in the prior year period as the inclement weather across much of the nation took its toll. The real question is can Trex continue its momentum beyond just the next couple of quarters?

To be honest, I'm not sure it can. One of the biggest concerns I've had with Trex for the longest time is that it's a highly capital-intensive business with single-digit operating margins. Weather-related impacts and consumer sensitivity to interest-rate hikes will make it extremely difficult for Trex to grow with any consistency over the long run, making its forward P/E of 19 already a bit risky. While it's certainly my possible my doom and gloom forecast could be wrong, the minimal upside potential in Trex would appear to favor short-sellers in the immediate future.

These boots were made for walkin'
The war may still be fought, but the battle is over for now after pharmaceutical rival AstraZeneca (NYSE: AZN  ) spurned three successively higher bids from Pfizer.

The last of Pfizer's bids reached as high as $119 billion (up notably from its first bid which didn't even reach $100 billion) and was aimed at combining AstraZeneca's premium diabetes and respiratory line with Pfizer's burgeoning cancer pipeline. On paper the deal would have made sense with the two possessing what the other needs. Further, the cost synergies of combining their two pipelines into one unit over many years could have generated billions in extra cash flow. Not to mention, had this deal gone through Pfizer would likely have moved its headquarters to the U.K. to take advantage of lower corporate tax rates in the country.


Source: AstraZeneca

Ultimately, at least for the next six months according to U.K. takeover rules, this deal is as good as dead. While that's bad news for AstraZeneca shareholders who should be ticked that management turned down such a lucrative offer, it's good news for Pfizer as it clears the way for the company to once again focus on its pipeline.

There is, perhaps, nothing more exciting going on with Pfizer than its breakthrough designated breast cancer drug hopeful palbociclib. Administered in combination with Femara in the phase 2 PALOMA-1 study, the combination delivered median progression-free survival of 20.2 months in estrogen receptor-positive, HER2-negative breast cancer patients compared to just 10.2 months for the control arm. With Pfizer using this study as the basis for its new drug application it could be experiencing the financial benefits of its breakthrough therapy shortly. Not to mention, it's a notable step in the right direction with regard to improving breast cancer patients' quality of life.

Despite this possible blockbuster on the horizon, patent woes are still likely to push Pfizer's top line lower for what looks to be at least the next two years. In that time the company has tightened its belt and repurchased shares in an effort to boost EPS, but its lack of growth really isn't fooling anyone. This leaves short-sellers with what looks like an easy bet against Pfizer.

But pessimists also won't want to forget that Pfizer pays out a premium 3.5% yield that'll make any short-seller think twice. As for me, I suspect Pfizer is likely range-bound until we get a better bead on palbociclib's future, which makes the company a below-average short-sale opportunity for pessimists.

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