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Two contrarian short ideas

September 28, 2013 | About:
Federico Zaldua

Federico Zaldua

2 followers
I few days ago I published an article with contrarian long equity ideas – see the article here. Here I will make the opposite case. I am looking for two stocks that the market is generally optimistic about and make a short case for both of them. Shorting stocks is dangerous because, as the market goes against you, the shorts become a larger portion of your portfolio. That said, shorting could be a very profitable alternative to hedge yourself from general market movements. Let's take a look at my two short equity ideas.

Not just a matter of price



While second quarter results came below expectations, the market keeps on believing on Pinnacle Entertainment's (PNK) case since the stock has gone up by 24% during the last 12 weeks. As I mentioned before, results were disappointing: Pinnacle reported adjusted EBITDA and EPS of $72.7 million and $0.21 versus the consensus of $75.1 million and $0.23. On top of poor results, investors should not ignore the continuously weak industry fundamentals and the fact that the company is investing a significant amount of capital in a new racino in Ohio (River Downs) which should yield low returns (since the market is over-supplied).

Most importantly, the company looks expensive. Pinnacle trades at 2014 8.8 times EV/EBITDA and 23 times earnings. Besides, the company pays no dividends. I believe Pinnacle is over-valued and I can not see a clear case for its current premium valuation.

Unjustified premium





Yes, real estate in the US is poised to be an out-performer going forward and the economy lodging segments are showing strong improvements but, since Choice Hotels (CHH) operates a pure franchising model, it has less direct upside to the lodging recovery than real estate owners such as Hersha Hospitality (HT).

Obviously, the market does not agree with my views on the company. Choice Hotels is up by 27% year-to-date (ytd). My view on the shares is reinforce when I see Choice Hotel's rich valuation level and high leverage (its net debt stands at just below 3.4 times EBITDA). The company trades at the stunning price of 2014 14.3 times EV/EBITDA and 21.5 times earnings.

It is true that, thanks to a lower tax rate, the company has been able to beat consensus estimates for the second quarter (Choice reported EPS of $0.48 versus consensus of $0.46) but Choice Hotel's valuation still seems extremely rich. Even when I take into account the SkyTouch project that may provide let the company unlock a technology revenue stream. That said, SkyTouch will require considerable investments and there are no assurances that other hotel groups would start using it since there are other technologies that are fully comparable.

Bottom line



I am convinced about the rich valuation of Pinnacle and Choice but when you sell a stock you always need to think carefully. Indeed, some smart investors are long on the companies that I am recommending to sell. While Ron Baron is long Choice Hotels, Mario Gabelli and Jean-Marie Eveillard are both long on Pinnacle.


Rating: 1.0/5 (1 vote)

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