The Shorts Of Whitney Tilson's Investor Letter

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After looking over hedge fund manager Whitney Tilson's investor letter, I analyzed his top ten long positions, and now it’s time to look at the short side of his portfolio. Tilson took over as the sole manager of his hedge fund in mid-2012, vowing to return to a more 'well-researched' and concentrated portfolio (check out Tilson's entire portfolio). Tilson said this about his plans..."I am pleased with the fund’s concentrated yet well-diversified long portfolio, which I believe will substantially outperform the market over time."

Two of Tilson's big short positions that he recently covered include Caterpillar (NYSE: CAT) and Chipotle  (NYSE: CMG)While I think a short on Caterpillar is a poor idea (see why I think CAT is a good investment), there might still be some value in shorting Chipotle. 

Last month Caterpillar posted EPS of $1.04, compared to the $2.32 for the same quarter last year; this came on a 7% drop in revenue year-over-year. The big miss was due to a previously announced goodwill impairment charge $0.87 per share. Despite this, the stock has showed resilience and is up 6% year to date. Billionaires Bill Gates and Louis Bacon both took new positions in Caterpillar during the third quarter (see Gates' newest picks). 

What will drive the equipment maker higher should be growing demand in emerging markets, as well as urbanization of under-developed countries. Caterpillar also appears to be quite cheap. The price to earnings-to-growth ratio for the stock is around 0.7, which is well below its major peers:

Price to Earnings to Growth

  • Caterpillar 0.7x 
  • Deere 1.2x
  • Cummins 1.2x
  • GE 1.4x
  • Joy Global 1.5x

As far as Chipotle goes, the stock saw same-store sales gain of 5% during the third quarter based on traffic growth of 4%. On the other hand, same store sales growth dropped 650 basis points on a year-over-year basis. Furthermore, same store sales growth is expected to further flatten in 2013, posting flat to low-single digit growth for the year.

When thinking about Chipotle, one of the best comps is other high growth-fresh food company Panera Bread.  Chipotle currently trades at 31.5x its 2013 earnings estimate, a premium of 55% to its peers, and well above other notable peer Panera. As well, the food company trades rich on a number of other multiples:

Chipotle:  EV/EBITDA 21x, P/E 36x, P/CF 33x 

Panera: EV/EBITDA 15x, P/E 28x, P/CF 22x 

Three of Tilson's four largest current short positions include InterOil Corporation (NYSE: IOC), K12 (NYSE: LRN) and Nokia (NYSE: NOK)Tilson started touting InterOil as a short back in 2010, where he said that he has never had more conviction, and put the stock as his largest bearish position. Tilson notes that after more than a decade of drilling, InterOil has "no proven or even probable reserves, just a lot of hype." Ari Levy of Lakeview Investment Group also has InterOil has a high conviction short (read more about the IFK presentation). Levy believes InterOil made misstatements to investors and agrees the company has no reserves. 

K-12 is a technology-based education company, and provider of proprietary curriculum and educational services for students in kindergarten through twelfth grade. K-12 did manage to post last quarter EPS of $0.24, compared to the $0.11 for the same quarter last year. 

K-12 currently operates well below historical standards, only further the short thesis.

Operating Margin

  • Trailing Twelve Months 5.0%
  • 5-Year Average 6.3%

Return on Investment

  • Trailing Twelve Months 4%
  • 5-Year Average 8.5%

Nokia is the struggling mobile phone maker that also has a poor outlook for the next few years. Wall Street expects the company to only grow EPS at 5% annually for the next five years. Nokia is looking to refocus, but is still in between the low-end and high-end of the mobile market, where the company is trying to better establish itself in emerging markets with low-end offerings. However, the mobile phone company is also trying to re-break into the high-end market with the Windows Phone. Margins for Nokia have also been under immense pressure of late…

Operating Margin

  • Trailing Twelve Months -1.4%
  • 5-Year Average 6%

Don't be fooled. Tilson's recent performance has not been stellar, but over the long-term his 110.6% return (since inception) has managed to beat all other indices including the Dow Jones. While looking at his current shorts, I also checked out his top five long picks here and six through ten hereAs far as the shorts are concerned, I don't think Caterpillar is a useful short, but Chipotle could be. Meanwhile, the InterOil short idea is worth pursing, while the K-12 short could go either way. Nokia has been rapidly losing market share, which may well lead to more share price depreciation. 

mhargra has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill and K12. The Motley Fool owns shares of Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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