Canadian stocks with exposure to the energy and marijuana sectors face headwinds as 2018 progresses, according to short-interest data collected in the second week of March by The Globe and Mail. A number of stocks in other sectors may also be at risk.
When a short sale is made, a broker borrows shares and sells them on behalf of the short seller. The latter hopes to profit by later buying the shares at a lower price and having them sent to the owner's account to close out the trade. Academic studies have found that heightened short-selling activity tends to foreshadow lower stock prices.
Table I shows the 20 Canadian companies with the highest percentage of shares on loan as of March 13. The data for loaned-out shares serve as a proxy for short sales and are provided by research firm IHS Markit. It collects the data from prime brokers in the securities-lending market on a daily basis. This is a different collection point-and-time interval than other providers of short-sales data, such as TMX Datalinx.
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On Table I, the percentage of shares sold short averaged 15.2 per cent. This is an increase from the average of 12.5 per cent for the previous month's table.
Turnover was higher too, with 8 new companies on Table I in March. They are: Peyto Exploration and Development Corp., AGT Food and Ingredients Inc., Cardinal Energy Ltd., Bonterra Energy Corp., Dirtt Environmental Solutions Ltd. Ritchie Bros. Auctioneers Inc., Painted Pony Energy Ltd. and Gluskin Sheff + Associates Inc.
Many of these new companies, as well as a number already present on the table, have exposure to the energy sector in western Canada, where the lack of pipeline capacity to external markets has generated a supply glut. As a result, prices in Alberta's AECO natural-gas market are trading below the industry's average cost, pushing firms to retrench. Peyto Exploration, for example, slashed its dividend and capital budget by nearly half earlier this year. Such industry cutbacks may continue throughout 2018.
Table II shows the 20 Canadian companies with the highest cost to borrow shares, based on data obtained from Interactive Brokers. When short sellers bid up borrowing costs for shares, it is usually a sign of rising bearish sentiment.
Half of the companies are from the marijuana sector. The level of bearishness seen in last month's table thus remains in force, if not more so. The 21st and 22nd most expensive stocks to borrow (not shown on the table) are two more Canadian marijuana companies: industry leader Canopy Growth Corp. (18.0 per cent) and Cannimed Therapeutics Inc. (17.8 per cent), respectively.
Most marijuana companies have negligible revenues and remain unprofitable. Yet, their shares have been substantially bid upward in anticipation of the legalization of marijuana. With such high expectations built into their stock prices, it would not take much in the way of disappointing news to bring valuations down.
However, true believers who own marijuana stocks can benefit from the high costs to borrow their shares. That's because some brokerages will transfer a substantial portion of short-sellers' interest payments to the owners of shorted shares.
Interactive Brokers, for example, offers the Stock Yield Enhancement Program, where half the payments to borrow shares are passed on to shareholders, provided they meet certain conditions. With the annual borrowing cost for many marijuana stocks ranging from 20 per cent to 55 per cent, the income received can be considerable.
A general caveat about short selling may be worth mentioning. While studies have found a link between short sales and stock declines, it is just an average tendency. Sometimes, there will not be a drop in price within a reasonable period of time. Moreover, short positions are not always bets on falling prices but put in place on occasion for hedging purposes. And, if good news emerges for a company and causes some short sellers to unwind heir trades, a short squeeze may develop and drive prices higher.