This Top Short-Seller Still Sees Huge Opportunities Despite The Market

The industrial sector rallied almost 14% in October, but short-sellers quickly increased their bets against the sector as prices rose. According to S&P Global Market Intelligence, investors boosted short interest in the sector to 3.08%. However, one well-known short-seller prefers consumer discretionary stocks over industrial names.

In a recent interview with ValueWalk, Spruce Point founder and CIO Ben Axler updated some of their recent shorts. He also shared the industry where they’ve been looking for their next shorts.

`Tootsie Roll

Two of Spruce Point’s newest shorts are Tootsie Roll and Broadridge.

The fund made a successful short call on Tootsie Roll in 2017, and Axler now sees a 20% decline from its current stock price. He believes the recent stock price performance reflects excessive enthusiasm about permanent sales increases during the recent historic Halloween season. He also thinks pent-up demand from the reopening of trick-or-treating after COVID-19 drove Tootsie Roll’s record Halloween sales.

“Despite record sales, Tootsie Roll’s earnings per share did not match record performance,” Axler explains. “We believe the company is hampered by manufacturing inefficiencies and rising input costs that will weigh on future earnings results once sales normalize in the coming quarters.”

Broadridge

On Broadridge, the company’s recent earnings results underscore Spruce Point’s concerns. Broadridge’s “closed sales” metric is a leading indicator of future business, and he pointed out that this metric declined for the quarter and year over year.

Expectations for adjusted earnings per share lagged the consensus number by four cents. However, Ben feels the real story is Broadridge’s operating cash burn, which surged 51% year over year. Among other problems, he also highlighted the decline in growth in the company’s “prized” Global Technology and Operations segment — the second consecutive quarterly decline.

Broadridge also disclosed an SEC regulatory change which will result in $30 million of recurring revenue starting in FY25,” Axler adds. “Lastly, capitalized and deferred client conversion and start-up costs on the balance sheet reaccelerated by 10.3%, but the company claims they will moderate. We continue to have concerns about the economic viability of the UBS wealth management platform development cost.”

Spruce Point believes Broadridge should cease capitalization and start expensing further costs. This would result in a debt covenant violation.

Figs

Axler also highlighted their short position in Figs, a healthcare fashion company that makes medical scrubs. He believes the company is an example of a company that wouldn’t have gone public if it weren’t for the pandemic.

“Figs came public because they had a good story to tell,” he explains. “They were serving healthcare workers needing more fashionable scrubs. Given that healthcare workers are working long hours, they want to make a fashion statement and be comfortable. They could sell at a premium. It was a nice story. The company had been around a while. We think, obviously, the market environment with COVID made for a great backdrop.”

Figs reported soaring sales during the pandemic, but the short-seller believes the company is lagging new competitors in the space. He said dozens of other companies jumped into the market for premium scrubs with similar styles and colors.

“It’s a fickle industry with few long-term sustainable advantages,” Axler adds. “It’s hard to patent-protect intellectual property in the fashion space. We believe the company exaggerated its addressable market. They claimed a $12 billion market, but we think it’s closer to $5 billion.”

He pointed out that hospitals generally buy scrubs for their surgeons and medical staff. They won’t buy premium scrubs because their doctors and nurses have to change after every surgery and throw their scrubs away.

Axler also thinks Figs is overstating its margins by about 20% and that it misclassified some of its expenses, artificially boosting its gross margins. He sees Figs shares falling to $5. The stock was once trading at $30 to $40 a share but now is down by about 75% year to date.

After looking carefully at its inventory levels, the short-seller also thinks Figs is losing money. He pointed that the company’s inventory ballooned to over 300 days of inventory, adding that its revenue rates are declining as its inventory grows. Thus, he expects Figs’ margins to come down in the future.

Generac

Axler also highlights Spruce Point’s short of Generac, which makes backup portable power devices and residential generators for standby power. He said the position has been “slowly working,” although it hasn’t worked as fast as they would like it to.

The Spruce Point founder noted that generators sit outside the home in case of a blackout or natural disaster, at which point they kick in and power the home. He thinks Generac has also benefited from COVID, which had millions of people working from home, and the unprecedented power outages in Texas a few years ago.

The strong demand sent Generac into a backlog, but when it started increasing its capacity, so did its competitors. Ben thinks demand for generators has slowed and that Generac will be left with too much capacity. He also highlighted how ESG concerns are driving a pivot from generators that use diesel or other fossil fuels that aren’t environmentally friendly to those that use alternative energy.

“We think the company is in over its head because it’s not in its core competency,” Ben explained. “They made acquisitions that are problematic and are not living up to their growth expectations… We think Generac has substantial downside, over 50%. It’s taking a little time, but we do think our thesis will play out.”

He added that backup generators cost $7,000 to $10,000 or more and are very discretionary. While a generator is nice to have, it’s not a must-have item, which is bad news in a recession.

Looking elsewhere

Aside from the shorts he highlighted, Spruce Point is also looking elsewhere for additional shorts. Axler sees a sizable bubble in financial technology and thinks many tech stocks are still overvalued despite this year’s plunge. He said lots of money has gone into fintech in recent years.

“We’re looking at companies that claim to be financial technology companies but are a step behind the curve. For instance, we think lot of old technology companies will be disrupted by newer technology companies,” Ben explains. “IBMIBM
is an old company that’s been around a while, and employees leave to start new companies. The startups start to pressure those old-line companies, so we’re looking at recent innovations in technology and finding companies we think might be claiming to be technology leaders but that are losing their technology edge, so they aren’t what they say.”

Michelle Jones contributed to this report.