Short-seller Jehoshaphat Research (JR) has accused Techtronic Industries (HK:0669) of defrauding its largest customer and strategic partner, Home Depot (US:HD). It lays out the case in its latest report after going short on HD stock in late February.

The Hong Kong-traded shares shed about 25% in the wake of the February short report and have bounced around in a range between HKD 87 and HKD 70 since then.

Last week’s report claims that Techtronic has been selling “fake” blemished products through its Direct Tools Factory Outlet (DTFO) to circumvent its exclusivity contract with Home Depot, amid its fraud allegations. However, a closer examination of the allegations highlight how there could be misleading arguments with questionable assumptions.

Techtronic denied the allegations in its June 6 response, emphasizing the small proportion of revenue derived from its factory outlet network.

Second Short

This is the second short report following an initial attack back in February which rattled the stock. In The latest update, Jehoshaphat appears to exaggerated Techtronics DTFO sales estimates, projecting figures of $1 billion to $2 billion, while the group reports actual total sales below $100 million. This significant discrepancy undermines the credibility of most claims made in the report.

Additionally, the short seller’s assumptions regarding DTFO’s profit margins and its contribution to Techtronics overall group EBIT seem unreasonable. The report fails to account for factors such as lower product prices, rental expenses, and additional operating costs associated with running a factory outlet business.

Commentary from market analysts said that it is unrealistic to expect exceptional margins for a factory outlet business, further undermining the validity of JR’s arguments.

Market Doubts

The latest report on Techtronic has had a relatively muted impact on the company’s share price compared to the first report, suggesting that investors may not fully believe the allegations made by Jehoshaphat. Short sellers aim to identify overvalued assets and release reports to support their claims.

However, for such reports to be effective, they must accurately analyze the target company and garner the trust of investors. The fact that Techtronics share price recovered after a brief decline indicates that the market has doubts about the veracity of the report.

Understanding Allegations

The short seller’s claim revolves around the alleged scam called “Blemishgate.” The report suggests that Techtronic is mislabeling Home Depot-exclusive brands as “Factory Blemished” to sell them through its DTFO channel, diverting these products from Home Depot and boosting TTI’s own profits.

While there may be instances where legitimate factory damaged products are sold through DTFO, Jehoshaphat tries to prove that this practice occurs on a larger, deliberate scale. However, conclusive evidence to support these allegations is lacking.

Techtronic has vehemently denied the allegations in the report, emphasizing the small contribution of its factory outlet network to its total revenue. It is important to note that TTI’s sales through Home Depot primarily focus on the Ryobi brand, while Milwaukee Tools remains its core contributor and growth driver.

The strategic partnership between Techtronic and Home Depot has been mutually beneficial, allowing for valuable customer feedback-sharing and product development. Techtronic’s limited exposure to online sales channels like Amazon also highlights its commitment to preserving the brand equity of its products.

Analyst commentary

Fintel’s forecast page highlights analyst coverage on Home Depot and Techtronic shares.

Daiwa Capital Markets Hong Kong analyst John Choi thinks that claims of DTFO being a competitor to Home Depot are highly exaggerated. The analyst thinks there will not be a financial impact on the Asia-traded shares under any scenario.

Daiwa maintained its ‘buy’ call and HK$120 target on the stock.

When looking at the consensus targets for these stocks, Fintel has a target price of HK$112.14 for Techtronic Industries implying 50% upside, and $318.56 for Home Depot with 5.6% upside.

Lacking Evidence

While it is plausible that some misclassified goods may end up in the factory outlet channel, proving large-scale and intentional fraud requires more convincing evidence.

The share price recovery following the release of the report suggests that investors remain skeptical. While the tool enthusiast community may have speculated on the issue, conclusive proof of widespread fraud is yet to be presented.

For the meantime, the investment community is ignoring Jehoshaphat’s claims. It is yet to be seen how the short seller will make its next move.

This article originally appeared on Fintel

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