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Community Health Systems (CYH), Alcatel Lucent SA (ADR) (ALU): Shorts Are Piling Into These Stocks. Should You Be Worried?

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The best thing about the stock market is that you can make money in either direction. Historically, stock indexes have tended to trend up over the long term. But when you look at individual stocks, you’ll find plenty that lose money over the long haul. According to hedge fund institution Blackstar Funds, even with dividends included, between 1983 and 2006, 64% of stocks underperformed the Russell 3000, a broad-scope market index.

A large influx of short sellers shouldn’t be a condemning factor for any company, but it could be a red flag from traders that something may not be as cut-and-dried as it appears. Let’s look at three companies that have seen a rapid increase in the number of shares sold short and see whether traders are blowing smoke or if their worry has some merit.

Company Short Increase July 31 to August 15 Short Shares as a % of Float
Weight Watchers 64.6% 18.5%
Community Health Systems (NYSE:CYH)   60.9% 3.7%
Alcatel Lucent SA (ADR) (NYSE:ALU) 43.6% 0.7%

Source: The Wall Street Journal.

Trimming the fat
If you thought the technology sector was notoriously cyclical, then you obviously haven’t paid attention to the nutrition/gym sector, which tends to cycle from up to down and back again about two times each year. My gripe with nutrition-oriented companies is that brand loyalty is practically nonexistent. No one seems to care how they get weight-loss results as long as they come easily. Therefore, when expenses in their lives rise or a better deal comes along, those consumers tend to jump ship.

We saw this to a T in Weight Watchers’ second-quarter results, which were released at the beginning of last month. For the quarter, Weight Watchers reported a 2.5% decline in global engagement, a dip in EPS to $1.15 from $1.36 in the previous year, and reduced its full-year EPS forecast — although that was with good reason since it took a charge to refinance its debt to a lower interest rate.

Community Health Systems (NYSE:CYH)We have seen time and again from nutrition-oriented businesses that when consumer spending weakens or the economy shows even the slightest hint of uncertainty — be it from Syria, Obamacare, or rising mortgage rates — consumers tighten their wallets. Weight Watchers’ main course of action to improve shareholder value over the past decade has been in repurchasing shares. While that’s helped its recent EPS figure a bit, it doesn’t mask a recent lack of top-line growth. Until Weight Watchers can develop a way to improve customer retention, I suspect short sellers will retain the upper hand.

Risking too much?
With the Patient Protection and Affordable Care Act, known affably as Obamacare, set to go into full effect — at least from an individual mandate perspective — on January 1, numerous hospital and acute-care facility stocks have been trading higher. The reason is simple: If people are required by law to have insurance or face a penalty, it should help reduce hospitals’ doubtful provisions account relating to patients treated without insurance. But might shareholders be getting a bit ahead of themselves?

It’s quite possible, with Community Health Systems (NYSE:CYH) agreeing in late July to buy Health Management Associates Inc (NYSE:HMA) for $3.9 billion, that it bit off more than it can chew. With the deal, Community Health will inherit HMA’s $3.5 billion in outstanding debt to go with its $9.1 billion in existing debt. Furthermore, Community Health is financing its purchase with, you guessed it, more debt!

We also can’t note the positives for the hospital sector if we don’t point out that the individual mandate penalties in the first year are very small. Furthermore, the IRS issued guidelines recently, which noted that it will not go after individuals who owe the penalty but do not pay. Ultimately, the passing of the PPACA, at least over the next two years, may have little material impact on doubtful accounts at hospitals if people simply choose to take the penalty. With that in mind, at least over the near term, short sellers may indeed be in control of Community Health Systems (NYSE:CYH).

You must learn to walk before you can fly
On Friday, I declared it open season for network equipment makers. The reason behind my bullish declaration has to do with wireless service providers opening up their wallets in order to upgrade their 4G LTE networks. As this money cascades down the line, it winds up in the hands of fiber optic and fiber optic product manufacturers and, eventually, networking companies like Alcatel Lucent SA (ADR) (NYSE:ALU). But has Alcatel-Lucent already spread its wings prior to this clearance for takeoff? I believe so.

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