The collapse of construction services company Carillion was one of the biggest UK stock market stories last year. Beginning 2017 at a share price of around 235p, the stock ended the year under 20p, before ceasing trading early in 2018 after the company went into liquidation. It was a nightmare for shareholders, with those invested in the company losing their entire holdings.
Beware the shorters
Yet, at least some of those losses could have perhaps been avoided if investors had paid more attention to the amount of shares being shorted by hedge funds during the year. To recap, shorting is the process of betting on a company’s share price to fall. Hedge funds and other sophisticated investors will short a stock if they believe there is something fundamentally wrong with it. If the stock falls in price, they profit.
As I mentioned several times last year, the number of Carillion shares being shorted last year looked dangerously high at times, suggesting there was something seriously wrong with the company. When short interest is high in a stock, it can pay to be very careful as often the shorters have identified a problem that the rest of the market hasn’t spotted yet.
With that in mind, today I want to warn you about another company that the short sellers are focusing on right now. Could this Neil Woodford-owned stock be about to blow up like Carillion did?
Large short interest
The company I’m referring to is FTSE 250-listed construction firm Kier Group (LSE: KIE). According to IHS Markit data, short interest in Kier has jumped from around 10% a month ago, to 18% last last week, making it the third-most shorted stock on the London Stock Exchange. BlackRock Investments, GMT Capital Corp and Marshall Wace, who all made short bets on Carillion, are among those to short the construction group.
Clearly, many sophisticated investors believe the company could be in trouble: “The shorts have smelled blood and they have progressively moved on from one contractor to another and see if they can make some money,” says Cenkos Securities analyst Kevin Cammack.
While it’s too early to tell if the shorters will get it right with Kier, I do think it’s worth being cautious towards the stock at this stage.
Apart from the short interest, there are other red flags that suggest the stock could be a dangerous holding. For example, its dividend yield is above 7% at the moment, suggesting that the market has doubts over the sustainability of the payout. Operating margins are also extremely thin, and return on equity is low.
Kier is due to report its full-year financial results this Thursday and investors can expect to hear more about the company’s efficiency and streamlining programme that it announced in July. While the group noted recently that it has made “good progress” in identifying potential cost savings, I don’t think the shares are worth the risk at present, given such a high level of short interest. As such, I’ll be steering clear of Kier Group for now.
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Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.