Short sales on the TSX: What bearish investors are betting against

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Canadian stocks with exposure to the marijuana sector have been a favourite target of short sellers in recent months, but that is much less the case in the second week of May.

Many marijuana stocks recently slipping off tables of the most-shorted companies published by the Globe and Mail.

Taking their places were companies from a variety of sectors. Their appearance on the tables mostly reflects company-specific factors, similar to the companies topping the list this month: Badger Daylighting Ltd., Concordia International Corp. and Canadian REIT.

Monitoring short sales can be worthwhile. Short sellers borrow shares and sell them on the expectation the price will be lower when they buy and return them to the owner. So, if you own a stock they are targeting, you might want to review your reasons for holding. Or, with the current bull market getting long in the tooth and close to ending, you might welcome some ideas on what companies to short.

Table I below shows the 20 Canadian companies with the highest percentage of shares on loan as of May 8. Shares on loan serve as a proxy for short sales, and are supplied by global data firm IHS Markit. It collects the data daily from brokers in the securities-lending market.

Table I: Companies with the highest percentage of shares on loan (as of May 7)

At the top of Table I, with 22.7 per cent of shares loaned out, is Calgary-based Badger Daylighting.

It operates the largest North American fleet of hydrovac trucks (they use water jets and vacuums to excavate earth without damaging underground infrastructure such as pipes, tunnels and cables).

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Vocal U.S. short-seller Marc Cohodes has waged a lengthy campaign against the company. Short sellers, like Mr. Cohodes, see red flags in accounting practises, disclosure policies, management turnover and low barriers to entry.

In late March, Badger reported financial results for the 2017 fiscal year, highlights of which were a 23.5-per-cent increase in revenues to $499.2-million and a 127.5-per-cent increase in net profit to $69.5-million. It also announced an 18-per-cent dividend increase and stock buyback program.

Badger continues to expand into the U.S. market, where hydrovac methods are still relatively new. With its U.S. operations now a substantial component of operations, management sees a positive benefit in fiscal 2018 from the reduction in the U.S. federal corporate income tax rate to 21 per cent.

An Alberta Securities Commission investigation into short sellers’ allegations recently ended with no enforcement actions undertaken. Insiders have also bought shares over the past year.

Table II: The most expensive shares to borrow (as of May 7)

Table II shows the 20 Canadian companies whose shares are the most expensive to borrow, according to data from Interactive Brokers’ stock-lending facility. The cost to borrow is another way to gauge bearish sentiment since rising demand for loanable shares can pressure borrowing rates higher, especially when there are a small number of shares available for lending.

The cost to borrow the shares of pharmaceutical company Concordia International Corp. recently soared and now stands above 100 per cent, the highest rate on Table II. The company’s business model based on acquiring pharmaceutical companies and hiking their drug prices began to unravel in late 2015 when politicians around the world turned their attention to drug price “gouging.” Concordia’s debt-financed acquisition binge and dwindling earnings power resulted in a default on some interest payments in late 2017, followed by the recent announcement of a debt restructuring that will require unsecured debt holders to swap bonds for shares – which massively dilutes existing shareholders.

Table III shows companies with the largest increases in the percentage of their shares sold short over the past month. Canadian REIT heads the group with a whopping 664-per-cent jump. With the completion of the takeover of Canadian REIT by Choice Properties REIT effective early May, the short selling may have been related to arbitraging of market and conversion prices for units in the two REITs.

Table III: Companies with the largest increase in shares on loan (as of May 7)

Some caveats about short selling may be in order. Short sellers’ bets on falling prices don’t always pan out. And some short positions are for hedging purposes only. Lastly, if good news causes short sellers to unwind their trades in a hurry, a short squeeze may develop and drive prices up.

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