- Limited/non-existent history of profitability (frequently a history of losses).
- Limited barriers to entry and prospect of increased competition.
- Overvaluation – P/E ratio above 50 or a P/Sales ratio greater than 7.
- Material share price outperformance vs. S&P 500 and Russell 2000 over past year.
The recent bounce in the overall market has once again created some enticing short sale candidates. In contemplating a short sale, I look for several characteristics including:
- Limited history of profitability (frequently a history of losses)
- Limited barriers to entry and prospect of increased competition
- Overvaluation - P/E ratio above 50 or a P/Sales ratio greater than 7
- Material share price outperformance vs. S&P 500 and Russell 2000
My first short sale candidate is Plug Power (NASDAQ:PLUG). While Plug shares are down 50% from their highs, shares are up 60% from recent lows (and up 15 fold over the past year). While Plug reported positive EPS for the second quarter which seemed to excite some investors, a quick look beneath the surface reveals that this was due to an accounting quirk. Core operations remain solidly in the red with a $6 million operating loss despite a more than 100% increase in revenue. It remains highly questionable whether Plug will ever become a profitable business. Some investors seem highly confident as evidenced by Plug's ~$1 billion market cap (= 15x 2014 estimated sales). The prospect for fuel cells in general remains questionable as does Plug's position in what may or may not be an emerging industry. I think Plug's shares are worth less than 1/3 of their current price (valued at 75% of 2015 estimated cash + 1x sales + $0.50 for NOLs). Given the high and volatile cost of borrow, my preferred method of gaining short exposure to Plug is by selling long-dated out of the money calls.
Grubhub (NYSE:GRUB) shares have soared more than 70% from their IPO price. While the company has an attractive model (generates 25-30% EBITDA margins) and growth (48% YoY in 2Q), I question the sustainability of the business given the myriad of current competitors (Eat24, CEO deliveries, Foodler, etc.) as well as pending encroachment of tech heavyweights like Amazon (NASDAQ:AMZN), Priceline (NASDAQ:PCLN) via OpenTable (NASDAQ:OPEN), and of course Yelp (NYSE:YELP). In addition, Square recently acquired Caviar and likely expand the company's reach beyond the high end market. I expect this to negatively impact Grubhub in a number of ways including: 1) pressure on commission rates charged to restaurants (2) increased advertising/promotional expenses to maintain its industry leadership position. Even assuming that Grubhub can grow its revenue 25% per year for the next 3 years while increasing EBITDA margins to 35%, this implies that Grubhub is trading at 20x 2017 EBITDA which I think is 25-30% too high. Further, should the future be less rosy (15% growth and 25% EBITDA margins), Grubhub would be trading at 33x 2017 EBITDA (or 2-2.5x fair value so 50-60% downside). With a fast approaching lock-up expiry (first week of October), Grubhub looks like a compelling short.
SolarCity (NASDAQ:SCTY) shares have surged over the past several months, rising 50% from their May lows, including a baffling 18% surge on the day the company announced the acquisition of solar manufacturing company Silveo. Did this $350 million acquisition of a volatile, capital intensive, commoditized business add $1 billion to SolarCity's intrinsic value? I suspect not. I attribute SolarCity's recent rise to 1) recent strength among momentum stocks (2) strong affinity for all things related to Elon Musk and (3) confusion about the value of SolarCity's 'retained value' which is essentially a DCF of the company's installed base which uses what I believe to be very optimistic assumptions. With new competitors emerging every month in the solar installation business and a looming tax benefit expiration (end of 2016), I think investor optimism could soon turn to pessimism. Should that happen, look out below! I think it is reasonable that SolarCity could trade for $15 per share (assuming a value of 2x 2016 estimated sales). Even this seems optimistic given the lack of profitability or cash flow.
Though recent optimism has driven the share prices of the aforementioned companies into the stratosphere, I expect that these stocks will materially underperform the S&P 500 over the next two years.
Disclosure: The author is short GRUB, PLUG, SCTY. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.