Beyond Meat Shows the Risk of Short Selling a Stock. 5 More Stocks to Watch. - Barron's

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The Beyond Meat short squeeze that burned bearish investors got Barron’s thinking—are there other stocks poised to do the same? It’s hard to say, but we found five stocks, including Zillow and Hormel Food, that wary short sellers (or aggressive traders) should watch.

A short sale means borrowing stock an investor doesn’t own and selling it—a bet that the borrowed stock will decline so it can be purchased back (and returned) at a lower price in the future.

Beyond Meat (ticker: BYND) was a very popular short for bearish investors ahead of the company’s inaugural conference call on June 6. So popular, in fact, industry data provider S3 estimated half the free float of stock available for trading was sold short, more than 12 times the short-selling activity of a typical stock.

Excessive short interest raises the risk of a short squeeze—when stock prices “melt up” as short sellers rush to buy stock to cover those bearish bets.

That’s what happened to Beyond Meat stock’s short sellers. Shares rose more than 100% after the alternative-meat company reported earnings, cracking $200 a share briefly on Tuesday. On the earnings call, management indicated 2019 full-year sales would be $210 million, about 2% higher than Wall Street was expecting. The incredible reaction to that news cost short sellers up to $1 billion.

Shares of Carvana (CVNA), Zillow (Z, ZG), Snap-On (SNA), Hormel Foods (HRL), and Ubiquiti Networks (UBNT) have some characteristics similar to beyond Beyond Meat. All five are heavily shorted, unpopular stocks based on Wall Street ratings, and most are expensive relative to peers. That sounds like a recipe for stock declines, but, as Beyond Meat has shown, unexpected good news can also generate a painful squeeze.

Some might wonder why Tesla (TSLA) doesn’t appear on this list when more than 33% of the free float of stock available to trade is sold short, about 8 times higher than a typical stock. But the 44 million Tesla shares sold short represent less than three days of average trading volume, and more liquidity lowers the chance of a violent short squeeze. (Higher daily trading volume makes for a very large door for short sellers to exit through.) These five stocks have high short interest, but less liquidity than, say, Tesla.

Carvana

Carvana is an online car dealership that became a publicly traded company in April 2017, selling shares at $15. The stock has shot up 340% since then, and trades for about 2.7 times estimated 2019 sales. Carvana isn’t profitable yet, and more than 33% of its free float of shares available for trading have been sold short. High valuation and competition from existing car dealers are two reasons bears have targeted the company, but Carvana has its bullish analysts and investors too. It is actually the most popular of these five stocks—about half of the analysts covering the company rate shares Buy.

Ubiquiti Networks

Ubiquiti Networks, which sells networking equipment and software, is less popular on Wall Street. No analysts covering the stock rate shares Buy, according to Bloomberg, and 29% of its free float of shares available for trading have been sold short. That is a significant chunk, but amounts to about 4 million shares (out of 71 million total outstanding) because company founder (and owner of the NBA’s Memphis Grizzlies) Robert Pera holds almost 80% of all Ubiquiti stock. Ubiquiti has been a go-to target for short sellers since prominent bear Andrew Left from Citron Research in 2017 suggested the company was fraudulent. Pera, however, has defended the company’s business practices.

Zillow

Zillow, the online realty site, is nearly as unpopular as Ubiquiti on Wall Street, with only one Buy rating out of seven analysts covering the company, according to Bloomberg. About 20% of Zillow’s free float of the combined A- and C-Class shares available for trading have been sold short. Susquehanna Financial Group analyst Shyam Patil believes the housing market is slowing, and Zillow is earning less on each home advertised. Zillow’s stock is very volatile around earnings. In November, the stock fell 27% after the company cut revenue guidance. The stock recovered all those losses by February, and jumped 5% after reporting earnings in May.

Hormel Food

Hormel Food makes canned chili, among other products. About 16% of its free float of shares available for trading have been sold short and only one of 13 analysts covering the company rate shares Buy. The packaged food company trades for about 22 times estimated 2020 earnings and yields 2%. Hormel, however, buys a lot of pork, and hog prices have been volatile because African swine fever is threatening up to 20% of hog populations in Asia. That epidemic is putting Hormel earnings estimates at risk, according to JPMorgan analyst Thomas Palmer.

Snap-On

Snap-On is an industrial company selling tools to car mechanics. About 16% of its free float of shares available for trading have been sold short. The company doesn’t only sell tools, it extends credit to its mechanic customers. Bears see that as a risk to earnings if the car business slows down. The stock once traded for more than 20 times earnings, but its valuation multiple is closer to 13 times estimated 2019 earnings now. There hasn’t been a dramatic drop in the stock as the price-to-earnings ratio has contracted. Instead the stock has been range bound for the past few years.

Even though short sellers have flocked to these stocks, the bears don’t seem to be profiting all that much from their positions. The average gain in the five stocks year to date is more than 38%, far better than the 13.5% gain of the Dow Jones Industrial Average. Only Hormel is performing worse than the market, dropping 4.5% so far in 2019.

For a short squeeze to happen in this group, but there has to be a catalyst first, like earnings for Beyond Meat. All five companies have reported numbers recently and won’t report again until after the second quarter ends.

Carvana presents at an investment conference, but those events don’t usually generate much drama. Hormel’s fortunes are tied to the health of pigs in Asia, and news about the epidemic could come at anytime. So besides Hormel, it appears short sellers have a few weeks to consider what to do.

Write to Al Root at allen.root@dowjones.com

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