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Warning Signals Abound but 99 Cents Shares Show Strength

Warning Signals Abound but 99 Cents Shares Show Strength


Staff Reporter

Short sellers are staging an all-out war against Los Angeles-based 99 Cents Only Stores and they appear to be losing.

Though the company has always attracted its share of naysayers, the number of shares “shorted” has reached an all-time high of 6.3 million, double the level of a year ago and roughly 10 percent of all shares outstanding.

Short sellers, who borrow and sell shares in a bet that the price will go down, have added to their positions against the discount retailer this month after four insiders, including the company’s chief financial officer, sold shares.

The insider selling has only added to other risk factors for 99 Cents Only Stores shares, including higher expenses from a major expansion into Texas and the belief that the dollar retailer, which now has a market cap of $2 billion, is simply overvalued in today’s market.

“Investors appear to be waiting for the moment when this stock is going to crash and burn,” said Joan Storms, an analyst with Wedbush Morgan Securities, who remains bullish on the company with a $41 price target. Shares of 99 Cents Only Stores traded at $34.76 at the close on Sept. 4.

Crunch Time

For short sellers, the day of reckoning may be near.

They acknowledge that many will start to get squeezed if the stock plows through technical resistance and rises above $36 a share. In July, the stock hit an intraday high of $36.22.

If that happens, short sellers will be forced to close out their negative bets by buying shares on the open market driving up the price further in a classic short squeeze.

As of last week, the short position in 99 Cents Only was equal to 12 days’ average trading volume in the stock.

Even so, recent sales by 99 Cents Only insiders have heartened short sellers.

Andrew Farina, the company’s chief financial officer, pocketed $2.6 million in August by exercising options valued at between $3.33 and $11.33 a share. Farina sold the shares at $33.40 each.

Jose Gomez, a vice president, exercised options in May and pocketed $1.2 million. Several directors and officers also have exercised options in the past few months.

Repeated calls to the company were not returned.

“There are a lot of red flags out there,” said Mark Hart, a short-seller and portfolio manager at Corriente Capital Management in Dallas. “Frankly, there’s a lot of skepticism among hedge funds about the strong performance of a low-end retailer.”

Short sellers have come out in droves against a number of retailers since the stock market began its recent rally in March. Among those is Hot Topic Inc. in City of Industry, which has become a popular target.

‘Crow sandwiches’

James McGinty, Hot Topic’s chief financial officer, recalled how the company got targeted by short sellers last year and the stock fell to $15 a share from $22 with a whopping 11 million shares trading hands one-third of the company’s float. (The company just completed a 3-for-2 stock split.)

“We hear from analysts every month about how the shorts are ticked off that our business is really good,” said McGinty.

Last year at a meeting of institutional investors, McGinty said one short-seller made a comment about having crow sandwiches delivered to the company’s chief executive.

“They can be very nasty because they’re betting against the company,” he said. “The best thing you can do is good business, month in and month out.”

For 99 Cents Only Stores, the buildup in short sales began with a planned expansion into Texas, which required that the company open a huge distribution center.

So far, 99 Cents Only Stores has operated in just three Western states California, Arizona and Nevada and has done spectacularly well by locating its stores in middle-income neighborhoods where it attracts both low and high-income customers. With fewer than 200 stores, the company is expanding rapidly and expects to open 38 stores this year, with more than a dozen in Texas.

In June, Eric Schiffer, the company’s chief executive, lowered earnings estimates for the second half of 2003 because pre-opening costs to recruit, train and relocate new managers were higher in Texas.

The company reported earnings of $14.8 million, or 21 cents a share, for the second quarter ended June 30, compared with $13.5 million, or 19 cents a share, in the year-earlier period. Sales rose 23.3 percent, to $207 million, while same-store sales in the quarter rose 9.8 percent. The company routinely posts gross margins of 40 percent or more.

One of the major assets for 99 Cents Stores its return-on-equity is among the highest in the retail industry, and it throws off an enormous amount of cash. The company has $150 million on hand, even after opening the Texas distribution center.

Michael Baker, an analyst at Deutsche Bank, said short-sellers have targeted the stock primarily because of its high valuation.

“This is a stock that has jumped 34 percent this year so the short position is going to grow,” he said. “It’s a combination of factors including the perceived risks as they move into Texas and insider selling, but those are offset by the strong prospects the company has.”

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