By Caitlin McCabe
Krispy Kreme faced a looming threat: the growing popularity of buzzy weight-loss drugs.
For months, short sellers had piled on bearish wagers on the theory that Krispy Kreme customers using drugs such as Ozempic would lose their appetite for treats. The company's shares tumbled.
As it turns out, picking losers from the weight-loss drug revolution isn't so easy.
In late March, Krispy Kreme announced a nationwide partnership with McDonald's that, starting this year, would allow the burger chain to begin selling doughnuts around the U.S.
Krispy Kreme shares surged 39% -- the best one-day performance in the stock's recent history.
It was a classic short squeeze. Hedge funds that borrowed and sold Krispy Kreme stock to bet against it had to furiously buy the shares back.
The episode cost short sellers a total of about $65 million in one session, turning what had been a winning bet for the year into a losing one, according to Ihor Dusaniwsky, managing director of data and analytics group S3 Partners.
"It went from being a very profitable trade to being a very bad trade in one day," he said. "Virtually all of short sellers' profits were wiped out."
Since drugs such as Mounjaro, Wegovy and Ozempic became sensations last year, Wall Street has rushed to work out just how disruptive the drugs, called GLP-1s, might be.
No longer are hedge funds and asset managers interested in just plowing money into Novo Nordisk and Eli Lilly, the leading makers of the therapies. Instead, they are eager to pinpoint the companies that could flop or flourish as waistlines shrink and consumers' habits change.
There has been no shortage of ideas. Analysts forecast that upheaval could spread through a range of industries, affecting snack companies, fast-food restaurants and medical-device stocks. Even airlines could be affected, a team at Jefferies predicted, calculating how much carriers could save on fuel by transporting lighter passengers.
Kidney-dialysis stock DaVita crashed 17% in one day after a trial showed Ozempic could slow kidney disease. Companies including Utz Brands and Oreo-maker Mondelez International sold off sharply after a Walmart executive said buyers of weight-loss drugs at its pharmacies were starting to purchase less food.
But in the months since then, investors have realized the effects aren't straightforward -- and could take years to play out. All three stocks bounced higher in the months that followed; DaVita has gained nearly 90% from last year's low.
Another factor that has made picking losers even harder: the surging U.S. stock market. The S&P 500 has gained more than 9%, in its best start to a year since 2021, thanks to strong corporate earnings and hopes of interest-rate cuts. The rising tide has lifted both weaker and stronger companies, adding to the risks of taking short positions.
"This is going to be a twisting, winding road," said George Michelakis, founder of Gladstone Management, a London-based hedge-fund firm. "This is a five-, seven-, 10-year story that's in the early innings."
Gladstone is among the investors whose wager against Krispy Kreme was upended this year. The holding was a small position that averaged less than 0.5% of its assets and had "no material impact on performance," Gladstone said.
The question confronting investors: How do you trade a trend that could take years, if not decades, to play out?
JPMorgan Chase estimates 30 million Americans could be using GLP-1s by 2030 , either for weight loss or to treat diabetes. But before then, barriers remain. Insurance coverage can be spotty, and out-of-pocket buyers can pay nearly $1,000 or more a month.
GLP-1 supply shortages have also weighed on usage.
Bryant VanCronkhite, a senior portfolio manager at asset manager Allspring Global Investments, scooped up shares of knee-replacement and hip-replacement specialist Zimmer Biomet, after its shares plunged in the second half of last year. Analysts and investors initially predicted weight-loss drugs would weigh on companies such as Zimmer, as healthier consumers put less stress on hip and knee joints.
VanCronkhite saw it differently. As more people lose weight, he said, a greater number might instead qualify for replacement surgeries. Severely overweight patients are often barred from such procedures because of the potential for complications.
The shares have since recovered 18% from last year's low.
"It's a very classic market reaction path, where we tend to overreact in the short run and underreact in the long run," said VanCronkhite.
Gladstone, which oversees more than $2 billion in assets, remains firm that the effect of the weight-loss drugs on consumers -- and on share prices -- will be profound.
The firm has bet on GLP-1s since early last year, when the drugs started exploding in popularity. Today, weight-loss-related bets are one of its largest trading strategies.
Gladstone analysts dug into consumer surveys and calorie models to try to determine which companies might emerge as surprising winners -- and which would be the hardest hit.
The firm settled on a small basket of names. It plowed millions of dollars into Novo Nordisk and briefly held shares of Eli Lilly . It focused its short positions on three companies -- Krispy Kreme, Hershey and J.M. Smucker.
Gladstone picked companies it believed would contend with a number of major issues. The firm predicted Hershey, for example, would be hit by the sharp rise in cocoa prices, while J.M. Smucker would struggle with the price it paid to acquire Twinkies maker Hostess Brands. Krispy Kreme, meanwhile, was confronting higher costs and a substantial debt load.
On the whole, it has been an approach that's yielded gains: Gladstone's GLP-1 strategy generated approximately a fifth of the firm's 13% gain after fees and expenses last year, according to a person familiar with the situation. This year through March, the strategy returned approximately 2%; the firm's flagship fund has risen a net 11.8%, the person said.
Gladstone also wanted to target companies it believed had relatively narrow options, with little room to adapt.
"What's certainly not true is that McDonald's and Pepsi and all these categories are going to disappear," Michelakis said, noting that McDonald's can alter its menu and PepsiCo can push into zero-calorie alternatives. "It's about finding the weakest links."
Krispy Kreme's tie-up with McDonald's showed it had more room to fight back than it appeared. Even so, the effects have been relatively short-lived. The stock has fallen 25% since the nationwide partnership was unveiled. And many investors are still betting against the shares. About 16% of Krispy Kreme's free float, or stock available for trading, has been sold short, according to S3 Partners -- roughly triple the average for U.S. stocks.
At Gladstone, the firm has closed its short bet against the doughnut maker. Some of its other positions have performed well: Novo Nordisk, the largest position at the hedge fund, has jumped 27% year to date. J.M. Smucker has fallen 10%, building on last year's 20% drop. Short sellers profit from stock declines.
But pitfalls remain. The firm recently added a small short position against Dutch healthcare-equipment maker Royal Philips, wagering that weight-loss drugs will help reduce the severity of sleep apnea.
What Gladstone couldn't expect: Royal Philips surged 29% in one day in late April, after the company agreed to settle litigation linked to its breathing devices for less than originally expected.
Write to Caitlin McCabe at caitlin.mccabe@wsj.com
(END) Dow Jones Newswires
May 09, 2024 16:32 ET (20:32 GMT)
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