The medium-sized US grocer faces stiff competition and should be sold short.
Online food and grocery shopping has taken longer to emerge in the US than in other developed countries. This is because America’s sprawling suburbs present a logistical challenge to any would-be entrant, compared with countries with more densely populated urban areas. However, Amazon is trying to change this.
Last August it bought upscale retailer Whole Foods, which it is now using as a base of operations for rolling out its online delivery service. It has already announced same-day delivery to most of the largest cities, and is quickly expanding this to smaller cities across the United States.
While this may be good news for American consumers, it is bad news for US grocery chains who will now have to deal with a competitor who can offer both a greater selection of goods and greater convenience. Indeed, even if Amazon’s new project doesn’t end up stealing their customers directly, it could push prices and margins downwards, reducing their profits.
While all parts of the sector will be affected to a certain degree, mid-sized regional supermarkets are particularly vulnerable because they rely on local dominance rather than economies of scale to keep competitors at bay.
A sitting duck that’s worth shorting
One such chain is Weis Markets (NYSE: WMK). Weis is a chain operating 205 stores in seven Northeastern and Mid-Atlantic states (Pennsylvania, Maryland, New York, New Jersey, Virginia, West Virginia and Delaware); more than half of these stores are located in Pennsylvania where it has a 20% market share.
Its prices are generally around 10%-25% higher than competitors’, while it gets low ratings from consumer surveys. This means that it is vulnerable to competition, not just from Amazon, but also from low-cost chains such as Aldi, which is also expanding its offerings in the United States. Weis has also had several run-ins with the food standards authorities in Pennsylvania.
Despite these problems, Weis trades at 21 times current earnings, much higher than the sector as a whole. Revenue has grown by an average of just under 5% a year over the past five years – a solid performance, but by no means spectacular.
While the company has said that it will spend $100m in an attempt to keep the firm growing, most of the money will be put into overhauling and refurbishing existing stores, rather than opening new ones. Indeed, the company plans to close as many stores as it will open, so it’s hard to see how this will translate into significantly higher sales.
Overall, we think that you should short Weis at the current price of $44. While IG Index allows you to bet as little as £0.01 per $0.01 (or £1 per $1), we would suggest that you short it at £100 per $1 (or £0.10 per $0.01). In this case you should close your position if it gets to $53.50, which would give you a maximum downside of £950.
Trading techniques… split US government
On 6 November America goes to the polls in the mid term elections, voting for the entire House of Representatives and one third of the Senate. Some traders argue that the expected Democratic capture of the House will be negative because President Donald Trump will struggle to pursue his pro-business agenda. Others are more sanguine, noting that a Democratic victory could make it harder for the president to wage trade wars.
LPL Research has found that between 1950 and 2017 the strongest S&P 500 returns (18.3% a year) came from a Democratic president and Republican control of both the House and the Senate. Interestingly, the next strongest performance came from a Republican president with each party controlling one part of Congress (the most likely scenario in 2018), with annual returns of 15.7%.
The year of the presidential election cycle that you are in may be as important as the result. One theory argues that the first two years of a presidential term tend to produce poor returns, as politicians are more likely to implement painful measures. However, as the date of the presidential election gets closer, politicians become more cautious about doing anything that could hurt their chances of getting re-elected.
Although nominally independent, the Fed could also come under pressure from the White House to stimulate the economy before the election. Research by Charles Schwab found that while S&P performance was similar in the first, second and fourth years, market returns were typically double the average in the third year.
How my tips have fared
As you’d expect, the turbulent market conditions have hit our portfolio of long positions over the last fortnight. Of the six currently open, only Shire increased, from £43.67 to £44.86, thanks to Japan’s Fair Trade Commission’s approval of the Takeda bid, though it still needs approval from the EU.
The five remaining positions all declined, with Premier Oil falling by nearly 20% from 132p to 109p. Redrow fell from 561p to 500p, Greene King from 492p to 480p, Next from £54.26 to £50.51 and Saga declined from 137p to 130p.
The good news is that four out of our six short positions have declined. Bitcoin is now $6,387, compared with $6,579 a fortnight ago. After briefly rising to $379 on the back of better-than- expected subscriber figures, Netflix fell to $330 (down from $350) on the realisation that content costs are increasing too, forcing the company to borrow more.
Snap has also declined to $6.84 (from $7.48), while Just Eat has declined to 601p (621p). However, Tesla has risen to $261 ($251), while Twitter has also bucked the downward trend, climbing from $28.45
Added together our open long positions are now making a loss of £1,573. This is still more than balanced by our shorts, which are making collective profits of £2,229. If you take into account the losses of £427 from our closed trades, then you get an overall profit of £229.
We’re not going to recommend that you close any positions now. However, we are going to adjust some of the stop-losses on our short positions downward to lock in some profit. So the Bitcoin stop-losses will be cut to $7,750 (from $8,000), the Twitter stop-losses will be reduced to $40 (from $42.73), while the Snap one rises to $15 (from $17.85).