CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 69% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 69% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

Tesco shorts crushed not extinct

Article By: ,  Financial Analyst

Tesco’s ongoing revamp is leaving fewer and fewer places for bearish traders to hide.

That partly explains the stock’s massive jump on Wednesday on robust results.

Not that there’s any doubt Britain’s leading retailer has turned a decisive corner. Few can argue with a 60% leap in gross operating profit, matching the most bullish market forecasts, despite steady-to-lower half-year revenues.

But it’s also true that Britain’s biggest supermarkets have been under unprecedented short-selling pressure for around two years.

Short positions in Tesco big enough to require regulatory disclosure (typically multi-million pound bets by hedge funds) are now lower than the dark days of 2014.

But at 3.58% of outstanding shares, Tesco shorts are a persistent fly in its ointment.

The stock’s surge to 2-year highs—extending to 13.6% higher at the time of writing—points to potential close out of more of these positions, perhaps in a hurry—AKA ‘short-covering’.

If so, once the effect of forced buying has passed, the shares could pull back.

That could bring the real test of the wider market’s view of ‘Tesco turnaround phase II’, announced today.

Whilst sentiment has undoubtedly been buttressed by its robust half-year performance, the stock remains within touching distance of prices around 210p that have contained the shares for 18 months and slippage is not out of the question.

 

Signs abound, however, that shareholders’ trust has been won back.

Plans for an aggressive ramp in capital spending—funded by more cost cuts—have been absorbed smoothly, though the group has not missed an opportunity to flag to investors—including on Wednesday—threats still posed by a strenuous competitive environment.

Holding pension top-up payments at £270m a year, despite the widening deficit, softens that blow, whilst CEO Lewis’s bullish 3.5%-4% margin target is a considered bet—with a 3-year timeline.

 

Even so, there’s little sign that Tesco’s margin for error has increased in 2016.

For instance, Morrisons and Asda recently slashed hundreds of prices further, in a price war that is no less intense, whilst deflation has even begun to erode sales growth at Aldi and Lidl.

Tesco has found a sweet spot of low-priced quality that is attracting shoppers back enough to bring a third consecutive quarter of underlying sales growth.

 

But it is still only the fourth-cheapest supermarket in Britain, according to a report by The Grocer, released in May.

 

In a fickle and demanding era of consumption, there’s no telling when the balance for shoppers could tilt back to ‘cheaper’ from ‘cheerful’.

At some point too, Tesco’s (and Sainsbury’s) negative shareholder returns (for two years in a row) could still shift investor favour to rival Morrisons.

Or even to elsewhere in the increasingly homogenous retail sector.

 

There are fewer reasons to short Tesco as its turnaround passes a critical test with flying colours. But considerable challenges remain.

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