What next for ASOS shares?

Four institutional investors are hoping that ASOS (LSE:ASC) shares will fall in value over the coming weeks. If they’re right, they’ll make lots of money.

But I think the share price will go in the opposite direction.

A brief explanation

Each day the Financial Conduct Authority publishes a list of securities that are subject to short selling.

This is when an investor borrows a stock and sells it on the open market in the hope its price will fall and they can buy it back at a later date for less. The borrowed stock has to be returned to the original owner and — if all goes to plan — the short seller pockets the difference.

That’s the theory.

In practice, it could all go horribly wrong.

If the stock price rises then the short seller will lose money. As there’s no ceiling as to how high a share price could go, losses are potentially unlimited.

In early 2021, short-selling hedge funds lost nearly $20bn on GameStop. They expected the stock price of the videogame retailer to fall but, instead, it went up after thousands of individual, ‘retail’ investors thumbed their noses at the so-called professionals, and started buying.

Fashionable shorts

The latest publication of the most shorted stocks shows that 2.89% of ASOS shares are now owned by investors who they’ll fall in value.

Based on the company’s current market cap, this equates to around £13m.

But here’s why I think they’re wrong.

Good news

Last week, ASOS released a trading update for the three months to 31 May 2023.

It disclosed that, following last year’s loss, it expects to be profitable (£40m-£60m) during the second half of the current financial year.

A large cost-cutting programme is helping with £300m of anticipated savings.

Importantly, the gross margin is up 3.5 percentage points compared to the same period in 2022.

And with many of the group’s recent woes blamed on poor buying choices, it’s encouraging that stock is down by 15%.

Even so, it’s concerning that a company of this size bought more stock than it sold in 2021 and 2022. Any retailer — no matter how small their business — will tell you that inventory management is the key to cash generation.

ASOS’ chief executive has acknowledged that it’s time to get “back to basics“.

Bad news

But the company is still losing customers.

Excluding those in Russia, it had 24.1m active shoppers in the year to 31 May 2023 (2022: 25.6m). But the board doesn’t seem too bothered, claiming that the strategy of improving profitability over sales growth is starting to deliver results.

Another concern is the board’s admission that it’s “too early” to outline the company’s growth strategy.

And it’s unlikely that the company will pay a dividend any time soon.

What do I think?

Despite this, if I’d some spare cash I’d be buying ASOS shares, and not borrowing them to sell. I think the company has turned the corner and its emphasis on profitability over sales is the right one.

I believe all the bad news is now out in the open. It’s true that improved future earnings will be heavily dependent on an economic recovery, particularly in the UK where it generates 43% of its revenue.

But the company has re-financed its debt facilities and shouldn’t need to raise any more cash.

Long-term investors looking for capital growth will be hoping that ASOS sells lots of shorts this summer!