Five Stocks Traders Are Betting Against (With Good Reason)

There are so many different styles of investors and/or traders out there, but there comes a time when all indicators come together in a “perfect storm” of sorts to create a very easy trading opportunity, a chance to short names that are out of favor, have weak fundamentals and technicals, and are seeing selling from both insiders and institutional investors.

I recently came across 5 stocks exhibiting these characteristics, and will short these names for the foreseeable future. I will provide a brief summary of each of the names and the fundamental, technical, and sentiment picture which includes short interest and options market activity.

1 – NCI Building Systems (NCS) manufactures and markets metal products for roofing and wall systems in non-residential construction. NCS at first glance may look cheap trading just 3.3x forward earnings, and 1.4x cash, but when you throw in the fact that earnings projections are still inflated and there will be substantial cash burn to pay back high amounts of debt, NCS could be in trouble in 2009. There is a high possibility of debt covenants being breached as steel prices remain volatile and the commercial construction outlook weakens.

On the charts, shares have been under significant pressure with shares being cut in half in just the past week. MACD is falling and Money Flow is coming out of the name, both bearish indicators with room to fall further. Shares are at all-time lows, so there is not really a support price objective, and the downside may be to zero when considering the other indicators.

Option traders are also betting against shares as large 2,000 contract lots of puts for June and September at the $5 strike were purchased aggressively at the offer on wide spreads, looking for a lot more downside in shares. I highlighted this intraday on 2/26 before shares tumbled another 20%. Short interest is at a level where more shorts could pile on, near levels from 10/15/08 where shorts added to positions, and interest has dropped from 4.82 million shares to 3.88 million shares (21% of the float) in 2009. Implied volatility is at 107, looking for large stock movements ahead of earnings on March 10, for which the company has already slashed guidance.

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2 – Rigel Pharmaceuticals (RIGL) discovers and develops small-molecule drugs for autoimmune diseases and cancer, with a phase 2 rheumatoid arthritis drug the furthest along. This is the drug in focus as shares were slammed on recent news of delays on partnership agreements. It is tough to fundamentally value Rigel, because it is more valued on hype and hope, as it lost $3.67 in the trailing twelve months.

RIGL had its lowest closing low on Friday, and with any continuation should test $4.76 lows from 11/21/08. There has not been a lot of volume in the name recently but Money Flow has turned sharply lower, and the technical picture is very weak.

Short interest is around 10.85% of the float, or 10.3 days to cover. This short ratio has been falling since 11/15/08 when the amount of shares short was around 5 million, as compared to 4.17 million now. It is currently at a level where shorts could come back to roost, as the technical picture worsens and safety concerns regarding R788 come about. On Friday one option trader took the offer on wide spreads for 2,000 of the June $5 puts where a huge open interest of 9,277 exists, dwarfing OI on the entire call side spectrum. Back on February 4th, shortly after restructuring announcements, more than 7,000 of these puts were bought, along with 1,000 March $5 puts which could be a level trader’s look to take out ahead of March expiration. Put volume has been substantially high the past 2 weeks, with 4 days where puts have traded far more than the average volume.

3 – Autonation (AN) operates as an automotive retailer, which includes parts, services, as well as finance and insurance products (the worrisome part). With auto sales at the weakest levels in many years, it is no wonder why traders are betting against Autonation, despite the backing of Eddie Lampert and Bill Gates. In the trailing twelve months, the company lost $6.85 per share, and currently has a quick ratio of just 0.28 showing that short term liquidity is in jeopardy, especially with a long term debt to equity ratio of 0.56.

The technical picture is bleak as well, with shares having significant resistance around $12.50, but also finding support around $7.50. If $9.50, the 50 day EMA and uptrend support line, breaks it would be the time to get short. Money Flow broke support and is dropping, while MACD has stabilized but could crack at any time. A massive triangle has formed, and with implied volatility near 85 we could get a substantial move in the near term.

Short interest is at 26.23% of the float, or 12.2 days to cover, but has fallen substantially since October 2008. However, the amount of shorts is still elevated and recent options activity suggests a short term plunge is coming. On 2.24/09 the April $7.50 puts traded 5,976 times versus open interest of just 2,515, with 90% of the volume flow at the offer, a bearish indication. On February 12th more than 10,000 of the April $10 puts were purchased, and the open interest shows that the positions remain open. The March $10 puts also saw massive buying in early February and the open interest remains, looking for a move down in March.

4 – Cheniere Energy (LNG) is involved in the development and operation of onshore liquefied natural gas along the Gulf Coast of the US. The company lost $6.40 in the last twelve trailing months, and is a very ugly fundamental picture, although it has $2.50 in cash per share on the books. With an average return on investment of -11.8%, that cash will not last for long.

From 2/5/09 to 2/17/09, shares of LNG ran into substantial resistance at $5 and have fallen back since. Even the recent move higher with crude rising has been accompanied by declining Money Flow, a bearish divergence. Shares were around $1 in October, and it looks like we could see a return there, especially with the signaling in the options market.

On Friday, traders bought 825 of the April $2.50 puts in Cheniere, versus prior open interest of just 50, and 75% of the volume taking the offer as traders were urgent to get these low dollar puts. Friday was the highest put volume in more than a month, as LNG only averages 147 puts trading per day. The only substantial call volume lies in the January 2010 $2.50 calls, which is likely players selling LEAPs to collect premium for a company headed south. LNG has 13.26% of the float short, or 16.4 days to cover on this low volume traded stock. The CEO of the company recently sold 70,000 shares of the company’s stock in mid-January, showing a lack of confidence in the company.

5 – Steak and Shake (SNS) operates restaurants in the US, mostly down South, which may be just where shares are headed. SNS is a restaurant stock with a lot of debt, with a current ratio of just 0.79 and long term debt to equity of 0.50. With negative profitability ratios and declining sales, it is a matter of time before the stock falls off.

Steak and Shake has struggled to get above $7 per share which can be seen as a possible neckline for an inverse head and shoulders pattern. Money Flow and MACD are falling off, and shares have sunk below its 20 and 50 day EMAs causing a symmetrical triangle breakdown. If $5.50 support cannot hold, shares should re-test the lows seen in November near $3, which coincides with how the option traders are playing this one.

On 2/25/09 I noticed that 1,000 March $5 puts traded on SNS, more than 100x the average volume for a thinly traded optionable stock. Much of the action occurred offer-side, making it bearish flow. 2% of the float, 32 days to cover, are short in SNS as a lot of traders are betting against the burger company. Short interest has been climbing, but is still off highs seen in October of 2008 which preceded a fall from $8.50 to $3.

Charts courtesy of FinViz and Short Interest Graphs courtesy of Schaeffers Research.

Disclosure: Currently no positions, but considering a short stake in each of the names.

Comments

[H.J. Huneycutt:]

How do you conclude SNS has "a lot of debt"? Their LTD appears to be fairly low --- about 4.2% of their total equity. Their liability-to-value ratio is 46%, which is relatively low by restaurant standards and most of it is "obligations under leases." Current ratio and quick ratio are bad, but they had positive free cash flows their past quarter.

Most of their assets are real things with value (property and equipment); very little Goodwill and Intangibles on their Balance Sheet. Even after subtracting those "fake assets" (as I call them), their book value is $9.23. Then, to top it off, they are the type of restaurant that you occasionally find people writing entire pieces about on how much they long for their food; so it's not like they are any old fast-food joint.

I'm not saying the short-term outlook is good (for any restaurant), but I don't think your assessment of the fundamentals meshes with reality on this one. There are probably better short targets out there in the restaurant sphere.


I do agree on LNG. They have an *UGLY* balance sheet and natural gas prices are not coming back up any time soon.

Mar 02 09:09 PM

[James Wilson:]

FREE MARKETS ; FREE MARKETS !!!!!!!!

Destroy all the survivors !!!!!

RIGHT !

Mar 02 10:03 PM

[Whitehawk:]

I agree on LNG. It has a massive amount of debt and while it has recently benefitted from an analyst upgrade I doubt it can sustain its levity where it is compared to others that have the same poor fundamentals. I got out of it a few weeks ago and was lucky to have made a small profit. Wish I could say the same about a few other names I own, that actually have better fundamentals!

Mar 03 02:03 PM

[Whitehawk:]

I would add two names to a short list: GS and IBM. Not the most obvious, but (a) GS will be under increasing pressure due to the influence it posed in getting paid back on CDS contracts by AIG with gov't money and (2) IBM's guidance and earnings are lofty and due for a correction.

Mar 03 02:15 PM

[Hogan:]

Glad to see you are shorting SNS based on that logic - hopefully others do too and I can get another chance to buy more shares at $3.00. Heck please drive it to $1.00 and then I'll buy more.

Mar 04 05:51 PM

[Jeffrey Moore:]

are you still considering shorting SNS?

Mar 17 08:07 PM

[Missing_Link:]

Whitehawk, I can see plenty of reasons why you might want to short GS (I tried to do so myself once in April), but shorting IBM at this point is just nutty. Why would you short a company with a PE of 11.25, strong dividends, historical EBITD margin over 20%, etc, etc?

Your short recommendation in IBM is based on the assumption that because earnings are so high, they must come down, and that will make the company overvalued. But that hasn't happened yet!

I'd prefer to wait for the earnings to come down first, THEN see how much they came down, THEN see if they actually fell enough to make it a short target.

I'm a rampaging bear right now and I'm furiously buying ETFs and shorting everything I can. IBM is one of the few companies I'd actually consider BUYING in this insanely overbought market. Its earnings would have to come down tremendously to make it a good short target.


On Mar 03 02:15 PM Whitehawk wrote:

> I would add two names to a short list: GS and IBM. Not the most obvious,
> but (a) GS will be under increasing pressure due to the influence
> it posed in getting paid back on CDS contracts by AIG with gov't
> money and (2) IBM's guidance and earnings are lofty and due for a
> correction.

May 17 11:13 AM