Positive investor sentiment towards Japan, but shorts active in select stocks

Japan’s government has reported that “difficulties continue to prevail” following the March earthquake but there are “some positive signs”. They predict a moderate recovery in the second half of 2011 and some quantitative models show Japan’s equities to be somewhat attractive to own at present. The Japanese Equities Long-short Ratio reached an annual high of 12.28 on 14th July. This denotes that there are over 12 times more longs than shorts in the market as institutional ownership in the region is close to annual highs. Average short interest in large cap’ stocks across the region is at a low of 1% of total shares outstanding. However, there are several stocks displaying negative investor sentiment and we look at some of these: Elpida Memory Inc (TYO:6665), Penta-Ocean Construction Co (TYO:1893), Kohnan Shoji Co Ltd (TYO:7516), Juki Corp, Construction Machinery Co and Geo Corp.

Top 3 Most Shorted Stocks

Semiconductor stock, Elpida Memory Inc (TYO:6665), which produces chips for companies including Sony Ericsson has experienced negative investor sentiment prior to the announcement of a planned rights issue and convertible bond. The new capital will be directed towards focusing the business on the smartphone and tablet markets. The stock already has a convertible bond in issue which is due to mature in four years. Short interest has held steady at 10% of total shares outstanding over the second quarter as the share prices continued to decline. However, the recent announcement has resulted in short interest surging to 15% of total shares outstanding as the share price fell to annual lows. Institutional investors increased holdings by over 50% over the year but sold on reaction to the fund raising. Almost all of the supply of shares that is available to be borrowed is currently on loan, which indicates an expensive and difficult to borrow stock.

Penta-Ocean Construction Co (TYO:1893), specialists in shoreline and river protection work, saw its share price surge in March to new annual highs as investors piled into construction companies. However, short sellers also reacted by building large positions. The previously thinly traded stock, in terms of securities lending, saw short interest jump from insignificant levels to highs of 18% of total shares outstanding and while the share price has declined over the quarter, short interest remains at levels far above those ahead of the disaster at 15% of total shares. There is limited supply making this an expensive and hard to borrow stock.

Kohnan Shoji Co Ltd (TYO:7516) has seen its share price rally in 2011 which has attracted short sellers to increase positions to new highs of 14% of total shares outstanding. This stock does have a convertible bond in issue which is due to mature at the end of next year. This could denote arbitrage whereby investors buy the bond and sell short the equity, evidenced as the amount of stock on loan is tracking share price. Institutional investors do not hold a large proportion of the total shares but have been bullish towards this stock increasing holdings by 166% over the past year.

Stocks reaching new annual short interest highs

Over the past month, there have not been a large number of Japanese stocks (with a market cap’ of greater than USD 300 million) reaching new annual short interest highs. When drilling down we see that the Retailing and Capital Goods sectors recorded the highest number of stocks with short interest reaching annual highs. Other than stocks mentioned above, those also hitting new highs include; Juki Corp (TYO:6440), Hitachi Construction Machinery Co (TYO:6305) and Geo Corp (TYO:2681)

Juki Corp: Short interest reached 13.5% of the total shares, as the shares declined from an annual high. Conversely, institutional ownership has increased 200% over 2011.

Construction Machinery Co: Short interest reached 9% of total shares outstanding as, the share price bottomed out over the past month.

Geo Corp: Short interest reached 7.5% of total shares. When coupled with low institutional ownership, we see that almost all the supply of shares that can be borrowed is out on loan. This stock may be subject to convertible arbitrage.