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SIMON BROWN: I’m chatting now with Casey Sprake from AG Capital, where she is the market strategist. Casey, always appreciate the early morning time.
A fascinating report you put out on short positions in our market. For listeners out there, a ‘short’ is usually a hedge fund trader. They’ve borrowed stock. They sell it into the market with the expectation that it will fall, and they can buy it back at a lower price at a profit and then return it to the lender. In other words, sell high, buy low.
Casey, this is a regular occurrence in markets the world over, and in the South African case you’ve just started it. It’s supplied by the JSE, which is able to say what the size of short positions are on individual stocks.
CASEY SPRAKE: Yes. Good morning, Simon, from a sunny Windhoek in Namibia. But yes, as you mentioned, we released a piece this week. It stemmed off a conversation I actually had with our CIO, who had been, as you mentioned, watching this data via the JSE and sort of noticed this trend.
I think, just at a very high level, retail is of course a working capital business. So we noticed that when margins compress and stock stops moving, you’re not starting to get a scenario where you don’t just lose earnings, [but] the balance sheets of course start to fray. And that’s when shorts start to move in from hedge funds such as ours and other speculative capital.
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SIMON BROWN: Some of these numbers –maybe they’re not – to me look really, really chunky. You’ve Truworths, you’ve Spar, you’ve Dis-Chem – almost 25%, 20.8%, almost 15% of total free float has been borrowed. That looks like a chunky number to me.
CASEY SPRAKE: Yes. It’s starting to grow quite significantly. We can look more from the stairs’ top level, but I think it’s quite interesting if you start drilling down to specific names – because I think there are a lot of nuanced ones between the various names. It’s not just a simple short story.
For example, I think you mentioned looking at Spar. I think Spar is the clearest example of where market concerns are actually firmly grounded in observable fundamentals, seeing a counter with a history of elevated debt and complex international expansion that is really sort of destroying value.
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So in simple terms in Spar’s case the market is effectively saying that this balance sheet is too tight for the earnings power of the business, so you see some form of recapitalisation.
Maybe a rights issue or something similar is a realistic scenario.
So that’s why from that case I would say Spar screens as the most fundamentally justified short in that way.
But then, if you look at a name like Truworths, for example, that’s a slightly different story. It stands in a bit of contrast to Spar. That company is still showing positive profitability, but it carries a very large debtors’ book, which is effectively straddling that line between, I would say, almost a retailer and a financing company.
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So the market is short Truworths not just because I would say, P&L [profit and loss] has necessarily fallen apart, but more because it’s very nervous around a large debtors’ book. And that’s when this makes the shorting of it more sort of extra-relative, as you would say.
The big case is that this could go wrong, rather than this has already gone wrong, and that distinction is important when we talk about embedded value versus sort of outright distressed finance, et cetera. So there are nuances around the names.
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SIMON BROWN: That’s a great point, and they’ve all got a different story. My sense is there’s always a bit of short. We’ve got Woolies, we’ve got Pep, we’ve got Shoprite all at around two point something percent. There’s always going to be some short position. That’s what markets do.
But then there’s what’s called the ‘days to cover’. Now I’ve seen it across my trading career. You get what sometimes is called a ‘short squeeze’.
In other words, I don’t know. if something happens, a really good piece of news comes out from a heavily shorted stock, then [there’s] the scramble to the exit because for short sellers to close they need to buy, and they need that liquidity.
And in some of these cases days to exits are running at 20-plus days. Maybe I’m just a coward. That would scare me.
Read: Shoprite defies market slowdown with R136.8bn sales surge
CASEY SPRAKE: 100%. And that’s why it’s a space that you really need to sort of be careful around. You mentioned specifically the concentration and sort of ‘days to cover’.
So I’d say given the size of the short positions relative to your sort of average daily trading volumes, some of these names would take weeks to buy back if shorts needed to sort of cover.
So if you look – for example I’m thinking off the top of my head – in Truworths or so I think the current short interest equates to roughly 36 days of average traded volume. In Dis-Chem the figure is actually closer to two months. So that’s around 57 trading days, which makes any forced covering extremely highly price sensitive.
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So our CIO actually often uses the words, when it comes to derivatives trading, ‘the tail wagging the dog’ scenario. With these sorts of tools, looking at index futures, options or swaps or whatever, often we see, referencing these names, you can also create additional short exposure beyond the cash market. That really amplifies moves when positions are rebalanced – which is what I think you alluded to now.
SIMON BROWN: Absolutely. I’ve done a little bit of trading in my life, but these numbers are giant.
We’ll leave it there. That was a fascinating article. Casey Sprake market strategist, AG Capital joined from Windhoek.
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