Three stocks Monash is shorting, and the big opportunity investors are missing

I think you’d be hard-pressed to find anyone that doesn’t believe the market is volatile at the moment. We’ve seen dramatic rises in interest rates, falling share prices, falling currencies, and rising energy prices. And while volatility is often uncomfortable, savvy investors know that with volatility comes opportunity. 

Knowing there are opportunities is one thing. Knowing how to identify them and having the courage to pursue them is another.

Simon Shields, co-founder at Monash Investors, believes some of the best opportunities right now stem from companies undergoing structural change in all the chaos. Both in terms of expectations of positive change – or negative.

“If you’ve got a company that is going through a big change, either positive or negative, the market usually has problems pricing that change. That’s why you see these stock price changes that just seem to keep going up and up, or down and down.”

While most value investors are looking for purchases on the long side – and Monash is no exception – it is also taking short positions in these volatile times.

In the second part of our Expert Insights series with Simon, he discusses the market behaviours driving mispricing, three companies Monash is shorting despite a predominantly long exposure, and the big opportunity he believes the market is missing.

Edited transcript:

What market behaviours do you see today and what opportunities is this creating?

Let’s put this in perspective to start with.

Most of the time, the market prices most stocks pretty well. By that, I mean within 10-15% of what they’re worth. At the end of each year, we can look backwards and see that some stocks have done much better than the market. Some stocks have done much worse. The question is, can we identify those companies in advance? Some of the companies we can. Some of those companies we can’t because we can’t predict what was happening within the business. 

The reason why we could predict some of the companies in advance is by falling back on those reoccurring business situations or reoccurring patterns of behaviour. The one that stands out the most and has been the most consistent over time is what I call “underestimation of significant change.”

If you’ve got a company that is going through a big change, either positive or negative, the market usually has problems pricing that change. That’s why you see these stock price changes that just seem to keep going up and up, or down and down. A great example of that is when companies have a store roll out in Australia or globally. It could be you’ve penetrated new markets. It could be a new product. It could be a technological change, it could be a fashion change. There are lots and lots of reasons there can be large changes. Bringing that back to today, it’s easier to find those sorts of companies when there’s a growth spurt.

The tech boom was full of those sorts of businesses. We were going into a credit boom before the global financial crisis happened. There were a lot of companies that benefited from a substantial change in the way that credit was applied at the time. Today we’re going into a contraction. To some extent, there are still companies that are going through structural growth. Lovisa, for example, with store rollouts is structural growth. Johns Lyng (ASX: JLG) in the United States, to a lesser extent Australia, is going through a period of structural growth as it's acquiring new clients and applying a business model that is generally not applied in its industry. There are lots of companies out there with structural growth. What’s a bit different now is we’re getting cyclical growth opportunities as well.

Resources have one of the longer cycles of any industry. It takes such a long time to put in new capacity to expand brown fields – years and years. Typically in the case of oil, it takes four years for the price signal to be reflected in additional output that brings that price back under control. We think if anything, that time period is blown out at the moment.

Given where all the prices are today, there’s a wonderful opportunity in oil stocks. That’s an example of a very significant change that the market is just not pricing.

Your long exposure dropped to 40% in March and increased to 86% recently. Can you discuss what market signals lead you to change the exposure?

Most of the time, we assume the economy is just what it is. We’re not economists, we’re investors. We’re not trying to pick the slightest increase in interest rates or the fall in GDP, but sometimes things can be pretty extreme. When we went from a cycle of having ever lower interest rates to one where interest rates were staying up for the first time in ages, and also happening for necessities of life – petrol, food, utilities, rent, mortgages – that led us to make a forecast about what consumers were going to do based on how they have acted previously. Our forecasts changed for a lot of retailers.

For example, that lead us to see that we should be shorting these retailers, or if we owned them, to at least sell them as they weren’t meeting hurdles on the long side. As a result, our exposure fell from about 80% or so down to around mid-forties. That worked quite well for us. It meant we avoided some of the fall in the market. We didn’t avoid all of it because we still had exposure. It helped us outperform once prices had fallen.

Once we saw that consumer behaviour wasn’t as bad as we were expecting it to be, we revisited some of the business models at much lower share prices and found we could start to get that big upside again. That drove us back into those retailers – or at least to close out the shorts we’d been putting on.

The other thing was around great businesses that had previously been on much higher valuations. The likes of James Hardie (ASX: JHX), realestate.coms (ASX: REA), and IDP Education (ASX: IEL). For those companies, it was a great opportunity to go back in and buy where we hadn’t previously because they’d been too expensive.

Can you discuss your current shorting positions?

We don’t have a lot of shorting at the moment.

One activity that has been useful in the past is shorting a company when the management leaves unexpectedly. For example, yesterday the CEO of Costa Group (ASX: CGC) who had been in that role for 18 months and previously had been the chief operating officer for 3.5 years, left without an interim managing director lined up. It wasn’t a planned leaving. The company’s going through a difficult period. We’re found shorting a company when that sort of thing goes on tends to work out for us. It doesn’t work out every time. There are lots of reasons people leave. More often than not, there’s a good reason to go short on the company.

Another reason to short a company would be for structural reasons. We have a short on Flight Centre (ASX: FLT) at the moment. The travel industry is recovering to an extent because the covid lockdowns are passing and people want to travel again. Flight Centre is quite challenged by the dual effect of:

1. The way airlines are cutting back on travel agent commissions
2. The inflationary forces on its footprint because it’s a bricks and mortar retail concept.

A third stock is one we think needs capital raising. SiteMinder (ASX: SDR) has been burning through capital at the moment. If it has to raise more money, that dilutes the share price its currently trading at. So that’s another stock we’re shorting.

What do you believe investors are missing?

That’s a tough one because I don’t think investors miss all that much. I think most companies are fairly priced most of the time and the stock market is fairly priced most of the time. There are certain examples where it’s not, like when we went into COVID and the CDC signalled it was going to be a global pandemic (without yet calling it one). I think the market was mispriced at that time. We were able to take advantage of that. Most of the time, the market’s pretty good and the vast majority of companies within the market are fairly priced.

I do think in a more broad sense at the moment that a lack of investment into the oil sector is being mispriced by the oil sector. 

I think the market is a bit too short term in worrying about recessionary fears and interest rate rises. That’s providing an opportunity for some of those high quality companies to have lower share prices than is justified. The market is missing that.

Benefit at every stage of a cycle

Monash Investors Limited invest in a small number of compelling stocks that offer considerable upside and short expensive stocks that are at risk of falling. Want to learn more? Head to their website or visit the fund profile below for further information.

ETF

Monash Absolute Active Trust (Hedge Fund)

Australian Shares

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Equities

Three ASX stocks with a 60% payoff upside

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