3 Highly Shorted Stocks Insiders Are Buying

04/18/2014 7:00 am EST


Macro conditions in China and elsewhere have excited short sellers in basic materials stocks and fundamental strength in these stocks may be indicated by insider buying. If fundamentals win out over macroeconomic pessimism, stock values may benefit from a short squeeze, writes the staff at Kapitall.com.

On the surface, Cliffs Natural Resources (CLF), a mining and natural resources company that produces iron ore and metallurgical coal, Ultra Petroleum Corp. (UPL), a natural gas development and production company, and United States Steel Corporation (X), a producer of flat-rolled and tubular steel products in North America and Europe, have little in common other than being in the basic materials sector.

Click to Enlarge

But all three companies do share one interesting common characteristic: a high percentage of their stock float is short while insiders are buying up shares. At Ultra Petroleum (UPL), the numbers of shares insiders bought has exceeded the shares sold in the last year by 3 to 1; at US Steel the ratio is 9 to 1; and at Cliffs the ratio is 1.5 to 1 in the last 12 months, but jumps to a whopping 35 to 1 in the last three months.

There are only two outcomes to this kind of situation. Either the insiders, who have more knowledge about a company's prospects in the short and long term, are foolishly about to lose their shirts, or short sellers are betting that something big and bad is about to happen to take the wind out of the self-confident insiders' sails. If the former, long-term investors may see stock prices rise precipitously if short sellers get caught in a short squeeze.

Three Case Studies
Cliffs Natural Resources (CLF) stock has been under a cloud since it announced it will delist from the Euronext Paris exchange on May 7. Moreover, their battle with activist investor group Casablanca Capital, which has proposed splitting up the company and spinning off several divisions, has put downside pressure on shares. But most worrisome is Cliffs’ dependence on steel exports—primarily to China—to prop up their bottom line.

Click to Enlarge

The story for US Steel (X) is similar. The company has increased its capacity, and healthy auto sales in the last year could be a boon to its bottom line. Green shoots in the domestic economy also bode well for the steel manufacturer (if they blossom). But China's recent slowdown has decreased Chinese domestic steel demand, and China's steelmakers are more than happy to export their surplus—made at a discount to US producers—to American markets.

Click to Enlarge

Finally, Ultra Petroleum (UPL), whose share float is 23.5% sold short, suffered when natural gas prices took a tumble in 2012. Not only did the collapse of gas prices result in a 27% drop in Ultra's revenue from the previous year, it also forced the company to write down over $2.9 billion in assets. In addition, Ultra's debt load makes some investors uncomfortable, even if the greatest portion of that debt isn't due soon.

Recently, however, the company acquired rights to drill in the Uinta Basin, which it hopes will double oil production to nearly 12,000 barrels a day. Arjun Sreekumar has argued recently that this acquisition "could exceed 500% [return on investment] at a wellhead oil price of $80 per barrel," removing the rationale for short sellers to stay short.

Click to Enlarge

Here, in the final analysis, the fact that these companies are in the same broad sector becomes important. If the macro environment shifts decisively in favor of growth (if, for example, both the US recovery is real and robust in 2014 and the Chinese economy doesn't tank) then the pessimism of short sellers vis-a-vis these concerns becomes untenable. Broad short positions like the ones presented here are likely to be covered in a short squeeze, which, in addition to the price boost offered by fundamental strength, will catapult prices higher.

There is a lot of risk and uncertainty in the cards, which is why the pessimists are playing such a daring hand. But long-term value investors stand to win by buying and holding Cliffs and US Steel, as these companies pay for your patience with respectable dividend returns.

By the Staff of Kapitall.com

Related Articles on STOCKS

Keyword Image
The Best Buys in Cybersecurity
12/08/2017 5:00 am EST

After weeks of sifting through hundreds of cybersecurity stocks on the market, I finally narrowed my...