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

By Sean Williams - Sep 30, 2013 at 6:00PM

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Do short-sellers have these stocks pegged? You be the judge!

The best thing about the stock market is that you can make money in either direction. Historically, stock indexes have tended to trend up 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, even with dividends included, between 1983 and 2006, 64% of stocks underperformed the Russell 3000, a broad-scope market index.

A large influx of short-sellers shouldn't be a condemning factor for any company, but it could be a red flag from traders that something may not be as cut-and-dried as it appears. Let's look at three companies that have seen a rapid increase in the number of shares sold short and see whether traders are blowing smoke or if their worry has some merit.

Company

Short Increase Aug. 30 to Sept. 13

Short Shares as a % of Float

Delta Air Lines (DAL 5.55%)

135%

5.1%

DaVita Healthcare Partners (DVA -0.55%)

95.4%

3.5%

Eldorado Gold (EGO 3.49%)

75.1%

1.6%

Source: The Wall Street Journal.

Is one company's pain another's gain?
If you thought the U.S. Department of Justice's stamp of disapproval on the pending US Airways (NYSE: LCC) and AMR merger only affected those two companies, think again. Rival Delta Air Lines' shares have been rallying nearly nonstop since the deal, which would have combined two of the five largest U.S. airlines and potentially given Delta much stiffer competition, was shot down. The DoJ's stance, however, means more of the status quo in the airline sector, where Delta has enjoyed success recently. The deal isn't dead yet, but for now Delta shareholders appear pretty convinced that it is.

But there are other concerns Delta shareholders should keep their eyes on. The Federal Reserve's decision not to draw down its quantitative easing in September has been viewed as an economic confidence booster by some. However, when the Fed does decide to "taper," there's a good chance economic growth may slow, which could adversely affect Delta's growth prospects.

Another concern would be rising fuel costs. Turmoil in Syria has pushed oil prices near their highest levels in two years, thereby bumping jet fuel prices higher as well. Fuel is the primary expense of most airlines, so Delta could struggle if oil prices continue to rise.

While Delta is certainly in better shape than many of its large peers, I understand why short-sellers have piled into this stock, and I feel they have a chance of being correct over the long run.

Pumping profits
When it comes to health care stocks, the new mantra appears to be to "blame Obamacare." One of the main reasons the Patient Protection and Affordable Care Act is being put into place is to reduce long-term health costs. And one of the primary ways it does so is by reducing the reliance of private businesses on government-sponsored care like Medicare and Medicaid. Should the Center for Medicare and Medicaid Services go through with its recommendation to slowly reduce payouts, it could negatively impact kidney dialysis centers like DaVita Healthcare Partners, which relies partially on government-sponsored payouts.

Then again, DaVita also has two factors working in its favor that short-sellers would be wise to pay attention to. First, DaVita isn't going to sit on its laurels, and it plans to use partnerships to expand its reach. Just two weeks ago the company announced a merger between its DaVita Healthcare Partners subsidiary and Arizona Integrated Partners in order to expand its geographic reach to Arizona and, as is common with most mergers, help reduce competitive costs.

The second factor short-sellers need to be aware of is that the baby boomer generation is aging, which should result in a greater need for dialysis over the coming decade. Even if government payouts are down, the sheer volume increase in patients would help push DaVita's profits higher. While there could be some near-term downside in DaVita's share price because of Obamacare, the long term still looks bright for this company.

Can you dig this?
This certainly looks as if it'll become the first year over the past 13 that gold prices will fall. Short-sellers have piled into gold miners like Eldorado Gold in anticipation of a further drop in the price of the yellow metal once the Federal Reserve pares back its monthly bond-buying program. They also point to the rising all-in sustaining costs of running a mine. However, rather than lumping all miners together, short-sellers would be wise to consider where individual companies operate.

Eldorado Gold, for example, operates in overseas markets such as China, Eastern Europe, and Brazil. Labor costs are relatively low in these regions, and mines are pretty accessible, leading Eldorado to some of the lowest production costs among its peers. In the second quarter, Eldorado's cash operating costs actually fell $2 per ounce year over year to $478 per ounce as gold production increased by 31%. Furthermore, Eldorado is scaling back its capital-spending forecast to $430 million from $670 million in order to reduce expenses and add to its bottom line.

If short-sellers really want to target gold miners, they should instead be looking at higher-labor-cost regions like Africa where all-in sustaining costs really don't make much sense, even now. Gold Fields (GFI 4.72%), for instance, delivered sustaining cash costs of $1,240 per ounce in Q2, which would barely make the company profitable based on current gold prices. Even with a vastly reduced capital-expenditures budget, there's no guarantee that Gold Fields can maintain profitability.

If I were a short-seller, I'd suggest re-evaluating my negative stance on Eldorado and instead redirect it toward a region that's really struggling with costs like Africa.

Foolish roundup
This week's theme really comes down to long-term business viability. Historically speaking, the airline industry has been a poor capital investment, while gold can be hit or miss depending on the company and the current shape of the economy. DaVita Healthcare, on the other hand, looks like a smart play as baby boomers age and quality of dialysis care improves.

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Stocks Mentioned

Delta Air Lines, Inc. Stock Quote
Delta Air Lines, Inc.
DAL
$31.20 (5.55%) $1.64
Eldorado Gold Corporation Stock Quote
Eldorado Gold Corporation
EGO
$7.11 (3.49%) $0.24
DaVita Inc. Stock Quote
DaVita Inc.
DVA
$77.50 (-0.55%) $0.43
Gold Fields Limited Stock Quote
Gold Fields Limited
GFI
$9.54 (4.72%) $0.43

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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