Should Bellamy’s Australia Ltd and Blackmores Limited worry about the short sellers?

Credit: Blackmores

When a company’s shares explode more than 500% in a single year, they’re bound to receive some attention from the doubters and hedge funds out to prove that their gains are unsustainable.

That’s what appears to be happening to both Bellamy’s Australia Ltd (ASX: BAL) and Blackmores Limited (ASX: BKL) right now. The share price of Bellamy’s Australia soared as much as 900% during 2015, while Blackmores was the top performing share from the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) for the year, rising 519% after hitting a high of $220.90.

However, it’s been a very different story so far in 2016. Bellamy’s shares have fallen 24.5% since the beginning of the year and Blackmores has lost 20.3%. Shares of the a2 Milk Company Ltd (Australia) (ASX: A2M) have also fallen nearly 30% from their high achieved late last year.

What’s happening?

A report from The Australian Financial Review today highlighted that shares of both Bellamy’s and Blackmores have become the targets of hedge funds who believe that “China’s love affair with brands from Australia will become unsustainable”.

It said that short interest in Bellamy’s has climbed to 5.76%, while Blackmores has 8.8% of its shares shorted on March 10. While that data was compiled from Bloomberg, data from ASIC shows much lower short positions of 3.87% and 4.01% respectively, as at 11 March 2016.

Indeed, the products of both companies (Bellamy’s primarily produces organic infant formula, while Blackmores is a vitamins company that has recently expanded into the infant formula space) have been in hot demand. Australian sales still make up the bulk of their transactions, although both admit that many of the sales made locally are then shipped to Chinese residents via “grey markets”.

This is partially due to the lack of trust many Chinese residents have of home-grown products, exacerbated by a number of high-profile health scares related to foods grown locally. Thus, many are happy to pay a premium for goods from Australia and other Western countries that they know they can trust.

This trend resulted in booming sales and earnings for both companies, which was reflected by their soaring share prices through last year.

While there is little doubt about their growth prospects, (The AFR noted that of all the researchers covering the two companies, none advise selling them), there are those in the market concerned about their valuations.

What does this mean?

Now, it’s worth noting that companies with high valuations and expectations for huge growth are particularly vulnerable to news which could impact their future performance.

One such factor that has likely been considered by investors recently is the potential for China to crackdown on those ‘grey market’ transactions that I mentioned above, which has the potential to hurt sales for both companies, at least in the short term.

Then, there is also the risk that growth slows down faster than what some in the market are expecting, which could see their share prices fall considerably further than their current levels.

However, so far, both companies have done everything they can to justify their current valuations and further earnings growth is expected in the coming periods. Strong results could also force short sellers to cover their positions which could see share prices rebound strongly.

To be clear, I’m not saying that will happen, but it does have the potential to.

Foolish takeaway

Investors do have reason to be cautious of the companies’ shares based on their high valuations. However, sometimes you need to pay a higher price for high-quality businesses, which both Bellamy’s and Blackmores appear to be.

While I think investors would be wise to limit their exposure to either company (for the sake of full disclosure, I sold some of my Bellamy’s shares at around $11.50 a share), both could also be worth a closer look by long-term investors – particularly if their shares fall any further from here.

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Motley Fool contributor Ryan Newman owns shares of Bellamy's Australia. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. You can follow Ryan on Twitter @ASXvalueinvest.

The Motley Fool Australia owns shares of Bellamy's Australia. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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