Livewire | Where the short sellers have it wrong

By Ben Rundle | Portfolio Manager at NAOS Asset Management

In September of last year, I nominated a stock on Livewire where I felt the short sellers had it wrong. The stock I chose was Flight Centre Travel Group (ASX: FLT), as I felt industry dynamics were improving, the company was undergoing a cost out program, and FLT also had a very strong balance sheet. Recently Livewire reached out for an update on the progress, and to nominate another stock where the short sellers may have it wrong.

Where did the short-sellers go wrong on Flight Centre?

Pleasingly, the FLT share price has risen considerably over the past 12 months, but the main reason for the performance to date is due to internal improvements, rather than an improving industry backdrop. Domestic and Global airfares still remain depressed which is great for the consumer, but has resulted in a tough operating environment for the business.

"The key lesson here is that it is dangerous to be short a company where management has a strong track record, the balance sheet is in good shape and the company generates healthy cash flows"

Interestingly, the short interest in FLT hasn’t changed over the past 12 months, and still sits at around 7% of the company’s register. However, it is important to make the point that as management holds approximately 50% of the stock, this 7% is actually the equivalent of 14% of the available free float; making it a more dangerous position to be short.

The Flight Centre story today looks less compelling than it did 12 months ago as the valuation is now higher and therefore the upside is much more limited. The company is also subject to a new round of issues, namely the accusations of underpaying its staff. With that said,

"FLT has proven to be a dangerous short in the past and we still think this is the case today."

The company is still working on internal cost efficiencies which should contribute to earnings growth in the near term, and any improvement in the operating environment would be an added bonus to earnings. We currently rate FLT a hold and while the short sellers may make money in the short term, we would be cautious of being short FLT over the longer term.

Where do the short sellers have it wrong today?

Another company which has an elevated level of short interest is Super Retail Group (ASX: SUL). Whilst it is no secret that the consumer sentiment is low, the valuation of SUL isn’t pricing in much in the way of a recovery. Internally, there are a number of levers that SUL could pull to drive earnings. To start with they are seeing less promotional activity in sports this year versus last year. They have now completed the transition from Amart to Rebel and have undergone a period of store rationalisation in BCF, along with increasing private label sales which drive a higher margin.

Recently SUL announced the acquisition of Macpac, which currently has 30 stores in New Zealand and only 24 in Australia, despite it being a larger market. We believe the Australian market is underpenetrated and an opportunity exists to not only convert the existing Ray’s stores to Macpac, but to also add new stores to the network. Ray’s currently makes an EBIT loss, so exiting this business will help to drive margin growth.

"SUL has a capable and well aligned management team with the founder of the business still owning a ~30% stake and other directors currently buying shares on-market"

We think it is dangerous to be short a company that has a reasonable valuation, a well aligned management team, good cash flows and a runway for earnings growth. Despite the well-publicised issues around consumer sentiment, we believe there is a margin for safety at the current share price.

Read further insights by the NAOS team on The Importance of Corporate Culture Investing or A Case for Concentrated Investing.

Important Information: This material has been prepared by NAOS Asset Management Limited (ABN 23 107 624 126, AFSL 273529 and is provided for general information purposes only and must not be construed as investment advice. It does not take into account the investment objectives, financial situation or needs of any particular investor. Before making an investment decision, investors should consider obtaining professional investment advice that is tailored to their specific circumstances.

Published Livewire: 12 September 2018