2 Reasons Not To Buy Eastman Kodak On 70% Stock Pop

Eastman Kodak shares are up 70% in pre-market trading today on a report that a federal agency found no wrongdoing in an investigation into a proposed loan to the former photography giant, according to CNBC.

In case you missed it, that investigation referred to a July 2020 announcement of a possible $765 million government loan to Kodak to make chemicals for hydroxychloroquine, an anti-malaria drug touted as a Covid-19 cure by the White House — which Anthony Fauci said is not effective against Covid-19.

The loan deal “unraveled amid questions about how Kodak disclosed the loan to investors, resulting in an SEC investigation,” noted CNBC.

Last July, I argued that there were three reasons to avoid the stock — Kodak’s poor performance and prospects, weak demand for hydroxychloroquine ingredients, and Kodak’s long track record of poor management.

I would still avoid Kodak shares because the stock probably popped because Kodak’s performance and prospects remain poor and the no wrongdoing report may be driving massive short covering today.

No Wrongdoing Found In Halted Loan To Kodak

Senator Elizabeth Warren called for an investigation into that now-halted $765 million loan to Kodak. The Wall Street Journal reported that the inspector general of the U.S. International Development Finance Corp. (IDFC), the agency that brokered the deal with Kodak, concluded that there was no wrong-doing.

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Specifically, the Journal reported that IDFC’s inspector general, Anthony Zakel, found “no evidence that employees of the agency had any conflicts of interest in the plans, nor did he find ‘any evidence of misconduct on the part of IDFC officials.’”

Kodak’s Poor Performance and Prospects

Kodak’s performance and prospects both look poor to me.

In the third quarter, Kodak revenue fell 20% to $252 million while its net loss soared from $5 million to $445 million, according to its earnings report. Kodak ended the quarter with $193 million in cash.

Jim Continenza, Kodak’s Executive Chairman and CEO said that things were under control. “As the pandemic continued during the third quarter, Kodak stayed focused on keeping our employees safe and serving customers while carefully managing our costs and cash. We continue to invest in leading-edge digital print technology and [won] eight awards recently in three prestigious print industry competitions.”

Since Kodak has not received the loan to make hydroxychloroquine ingredients and the Oval Office occupant who was touting the malaria drug as a Covid-19 cure should be leaving next month, it is unclear from Continenza what will drive Kodak’s revenues up in the years ahead.

Kodak Shares Are Heavily Shorted

One popular way to bet on poor prospects is to sell shares short. That means that an investor must borrow the shares from a broker, sell them at the current market price, and at some point in the future return the borrowed shares to the broker.

If a company files for bankruptcy, selling short works out very well. That’s because the short seller can buy back the shares on the open market where for some reason they continue to trade — often at a few pennies a share. If an investor sells short at, say, $10 a share and buys back the shares at 5 cents a share, she earns a profit of $9.55 a share.

On the other hand, if the shares go above the price at which she shorted the stock, the broker requires her to repay the loan immediately by buying back the shares in the open market.

That is bad news for the short seller who is then forced to buy back the shares at a higher price than they were sold — locking in a loss. What’s more, short covering creates a buying panic which means that the prices will keep rising as more short sellers place buy orders.

This comes to mind in considering the 70% pop in Kodak shares — 33.6% of whose available shares have been sold short, according to Morningstar.

Kodak stock has certainly been volatile on news that has ultimately not changed its fundamentals. As CNBC reported, days before the July announcement of the loan, Kodak shares jumped from $2 to $30 on heavy trading volume.

Following that rise, shares rose over 1,000% partly due to the stock’s popularity among Robin Hood investors. News of investigations into the deal sent the stock down below $10 and it finished December 4 at $7.53.

Still — if you take into account the pre-market gains in Kodak stock, it is up 180% so far this year — vastly outperforming the S&P 500 and the Dow Jones.

Sadly Kodak’s market value of $930 million is 80% below its 52 week high of $4.65 billion. Avoid this stock.

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