Short Sellers Target Sainsbury as Tesco Revival Looms Large

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Coming up short

Sainsbury and Morrison are the two most shorted stocks in the U.K. benchmark index

If you think things are tough for Tesco Plc, consider the main rivals of the U.K.’s largest supermarket.

Also under siege from discounters Aldi and Lidl, J Sainsbury Plc and Wm Morrison Supermarkets Plc now face in Tesco a wounded competitor prepared to sacrifice profit if it means winning back customers and restoring its dominance.

Their predicament hasn’t gone unnoticed by short sellers -- stock pickers who seek to make money by borrowing shares, selling them and buying them back at a cheaper price. Sainsbury and Morrison are the most shorted companies in the U.K.’s benchmark FTSE 100 Index, with short interest equivalent to about 13 percent of their outstanding shares, according to data compiled by researcher Markit Ltd. Only 0.6 percent of Tesco’s shares are on loan from financial institutions to short sellers.

“Heavy shorting makes large shareholders question their investment strategy,” said Charles Allen, an analyst at Bloomberg Intelligence. “Many of those shorting Sainsbury probably feel there’s still room for estimates to fall.”

Tesco’s results last week showed what’s influencing investor thinking. While a record loss and spiraling debt grabbed the headlines, Tesco increased grocery volume in the last quarter compared with a year earlier, the first time it’s done so in more than four years. And with Chief Executive Officer Dave Lewis only just starting his turnaround efforts, the pain for his main competitors may only just be beginning.

“If Tesco is growing volumes, then someone should be losing,” said John Kershaw, an analyst at Exane BNP Paribas. “There isn’t enough superstore growth to go around.”

Next week, Sainsbury reports annual results and Morrison will issue a first-quarter trading update. Sainsbury rose 0.7 percent to 270.2 pence at 11:10 a.m. in London, while Tesco was up 1 percent and Morrison was down 0.3 percent.

Price War

At a press conference last week, Lewis said sales growth will continue to be his priority as he seeks to take the initiative in a price war between supermarkets.

For mainstream rivals, that was the most worrying development from Tesco’s results, said Richard Marwood, who oversees about $4.5 billion in assets at Axa Investment Managers, including Tesco and Sainsbury shares. “The pessimism around Sainsbury stems from a feeling that a price war could potentially impact the company more, due to its slightly higher price point.”

Sainsbury’s record of nine consecutive years of operating profit growth is about to come to a halt, with analysts projecting the company will post a 17 percent drop in the earnings measure next week.

A recovering Tesco will be “very problematic” for Sainsbury, David McCarthy, an analyst at HSBC, said in a note Thursday. “We remain unconvinced that Sainsbury has the strategy to overcome its relative scale disadvantage versus Tesco.”

CEO Mike Coupe has forecast that the grocer’s superior quality and value would see sales outperform peers, yet Sainsbury shares, trading at 12 times the company’s estimated 2016 earnings, are the cheapest in the industry.

“The market is telling you that Sainsbury’s margins aren’t sustainable,” Kershaw said.

That’s music to the ears of Sainsbury’s short sellers. They include hedge funds Lansdowne Partners U.K., Marshall Wace and Odey Asset Management, all of whom declined to comment for this story. Sainsbury also declined to comment.

Sainsburys and Morrisons are stuck between a recuperating Tesco and the discounters, according to Bruno Monteyne, an analyst at Sanford C. Bernstein. “They have to live around what’s happening and react accordingly,” he said.

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