The share price of Inghams Group Ltd (ASX: ING) is rallying recently in anticipation of a good profit result next week but short-sellers are reported to be increasingly eager to target the stock.
The stock has jumped 7% since the start of the month while the S&P/ASX 200 (Index:^AXJO) (ASX: XJO) is up 1%, but some experts have told the Australian Financial Review that it’s only a matter of time before the stock goes into a nose-dive.
They claim the stock is a classic private-equity (PE) blow up. PE firm TPG owned the poultry producer before listing it on the ASX in 2016. PE-backed initial public offers (IPO) tend to have a bad smell about them as many of these companies have left investors nursing big losses after around two-years following their market debut.
You only need to think about Dick Smith, department store Myer Holdings Ltd (ASX: MYR), retirement facilities operator Estia Health Ltd (ASX: EHE) and personal and hygiene products supplier Asaleo Care Ltd (ASX: AHY).
Not all PE-backed listings have turned out to be disasters, but it still pays to beware of PE firms bearing IPO gifts.
In Ingham’s case, the AFR reports that there is an increasing chance Inghams belongs to the dark-side of PE-IPOs as it has undertaken asset sales, aggressive cost-cutting, factoring of trade payables (where the company sells its invoices to another firm at a discount to the invoiced amount to receive the cash up front) and the exit of its chief executive Mick McMahon.
This reporting season will be McMahon’s last before he heads for the exit and many are expecting him to go out on a high. It’s what happens next that is exciting short-sellers who are borrowing stock to sell on market in the belief that they can buy it back later at a lower price.
These bearish traders think the stock is set to fall because TPG still owns 32% of the stock and it’s only a matter of time before it sells the rest.
This is on top of McMahon’s 3.4 million shares that are tipped to hit the market. PE firms seldom hang on to their shares past escrow and the smart money that buys into a PE-IPO knows to exit before the PE firm does.
The other issue is the rising cost of chicken feed. The drought has caused the price of wheat (a key ingredient in feedstock) to double over the last year and it’s estimated that feedstock can account for as much as 60% of the total cost in a facility like Inghams.
There are substitutes for wheat and Inghams hedges its wheat contracts, so this may not be an immediate issue for the company.
Nonetheless, it adds to the bearish sentiment as it is unclear if Inghams has much power in passing on higher costs to its two key customers – Woolworths Group Ltd (ASX: WOW) and Wesfarmers Ltd’s (ASX: WES) Coles.
As I have written before, there is a growing probability of another bruising price war between the supermarkets and that could leave suppliers like Inghams squeezed between the retail giants.
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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Wesfarmers Limited. 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 Scott Phillips.