Thursday, 24 June 2010 08:49

Non-Financial Companies to Short in 2010

For those who are new to my writings and research (those who follow me should skip down to the next section), I have had relatively strong results in ferreting out weak companies which the sell side, the ratings agencies and the media consider "buys", "conviction buys", and AAA/AA credits - only to collapse, be acquired on the cheap or fall into bankruptcy less than a year later. Despite the painful rides necessary to ride out volatile markets that absolutely ignore fundamentals, in the end broke is broke and insolvent businesses tend not to last very long. The list of companies called out as insolvent against the rating agencies/sell side analysts/super smart billionaire investment crowd include:

These calls provided 5 quarters in a row of phenomenal returns (see performance) until the massive market melt-up of 2009 where we saw fundamentals get thrown down the sewer drain while math and common sense were turned on their respective heads. Well, guess what boys and girls... Methinks math is back and it may be here to stay for a while.

The Latest BoomBustBlog Research

Continuing our Bankruptcy Search Series (see BoomBustBlog Bankruptcy Search: Focus on British Petroleum and Collateral Damage and The BoomBustBlog Pan-European Sovereign Debt Crisis Bankruptcy Search) I am moving on to the broad, non-financial sector in the US. Please keep in mind that this is a list for bearish investors who wish to take short positions, and thus does not aim to find the absolute weakest companies but strives to find the companies whose share prices will drop the farthest on a risk weighted basis. The share float, share price, market cap, (over)valuation, cash flows, revenue growth, interest coverage, net debt, etc. can (on a cumulative basis) trump outright insolvency – particularly if the market has already priced such in. In essence, we aim to find the next unpublicized financial collapse that can be primarily captured with short equity positions and options, although CDS investors can definitely benefit from the list as well.

After completing the first round of shortlisting in the non-financial sector, we shortlisted 7 companies using the following process:

  • Step 1: Retrieved data for a list of 1,415 companies with a market cap of more than $200 million and share price of more than $15
  • Step 2 – Excluded 516 companies with negative net debt, due to the relative strength of their balance sheets
  • Step 3 – Excluded 211 companies with positive average sales growth in 2009-2011 as well as positive sales growth in last FY and FQ due to improving fundamental conditions. We added back in 17 companies with interest coverage less than our required benchmark, assuming that those improving conditions failed to stem the debt service bleeding.
  • Step 4- Excluded 41 companies with small floats
  • Step 5 - Selected 161 companies which either had interest coverage less than our benchmark in 2009 or have net debt to market cap of more than 1.0x (insolvency based on market pricing).
  • Step 6: Of the selected 161 companies, the 31 companies with the weakest interest coverage were then shortlisted. These 31 companies were analyzed individually by hand based on various financial, operational metrics, and 9 companies were selected for trend analysis. At this point, database scans become inaccurate and you need a seasoned, educated eye to peruse the footnotes of the filings and releases to catch the BSFP (BS in the fine print).
  • Step 7: Based on a trend analysis and the debt maturity schedules of these 9 companies, two companies - DIN US Equity and OTT US Equity were excluded owing to relatively stable earnings stream,  no major debt maturities in the near-term and the debt largely carrying fixed rates of interest
  • Step 8: We have analyzed 6 companies out of the final shortlisted 8 comps and following are the key findings of these companies. Two comps are airline companies and their earnings stream is largely influenced by oil prices. Since the dynamics of this highly leveraged sector is different from most normal manufacturing businesses, we are looking deeper into these companies to come up with some empirical conclusions (this study has been completed and will be released as a follow-up analysis).

This is a snapshot of the initial 1,415 company initial scan along with solvency metrics for each company.

Non-Financal Short Scan List

This is presented as a live, embedded spreadsheet and is available, free to all by clicking here (feel free to register as well, its free - register then choose the free subscription option). I urge all who may be bearish this summer to peruse the spreadsheet for it contains the pricing and major solvency metrics for over 1400 companies whose shares have skyrocketed over the past year. As some may realize, literally insolvent companies' shares have participated in that skyrocketing!

The following link reveals the key details behind the weak points of the six shortlisted and analyzed companies (for subscribers only): Non-Financial Retail Subscriber Short List

Pro subscribers can access an expanded list of 33 companies here and institutional subscribers can access the expanded list here.

For those of you who have not registered or subscribed, there is still a company of interest that I will share in case you feel Europe will blow up and the US will hit a double dip recession. This is not nearly a strong a candidate as any of the subscription analyzed companies, but it is worth discussion.

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Last modified on Friday, 25 June 2010 05:20

5 comments

  • Comment Link whiteshadow Thursday, 24 June 2010 16:16 posted by whiteshadow

    Mr . Reggie,

    good reading and learning form your post. I am still waiting to get in touch with you and to join your team. Even though I don't have much experience and just a student, I would greatly appreciate learning from you.

    For anyone else, if you need an intern, let me know. will work long hours and that too free. haha. m a good standing student.

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  • Comment Link shaunsnoll Thursday, 24 June 2010 16:02 posted by shaunsnoll

    anyone seen SHIBOR, check out SHIF1M index on bloomberg, chinese lending market is freezing up as we speak.

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  • Comment Link overthetop Thursday, 24 June 2010 15:58 posted by overthetop

    this is prob. why debt/fcff ragtio is so much stronger than ebit/interest expense

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  • Comment Link shaunsnoll Thursday, 24 June 2010 12:56 posted by shaunsnoll

    usually when you get a negative Z score in a screen it is because of this, so you can adjust this by just having the section of your altman z calculator adjust retained earnings to zero if you get a negative number. if a company goes bankrupt then their NOLs aren't real valuable :)

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  • Comment Link shaunsnoll Thursday, 24 June 2010 11:45 posted by shaunsnoll

    their huge negative retained earnings is skewing the Z score. I think you'd have to adjust for this, I don't know the company but I'm guessing that those are NOLs which actually would have positive value impact on cash flows.

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