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Hedge funds expect Sainsbury’s share price to fall. Here’s what I’d do now

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In the current economic environment, you would think that Sainsbury’s (LSE: SBRY) shares would be a fairly safe bet. After all, people aren’t going to stop buying food any time soon.

A closer look at Sainsbury’s, however, reveals that the FTSE 100 stock may not be so safe after all. Currently, it is the third most shorted stock in the UK, according to shorttracker, with 8.4% short interest. This means that a number of hedge funds expect Sainsbury’s share price to fall.

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Here, I’ll look at some of the possible reasons hedge funds are shorting Sainsbury’s shares at present. I’ll also explain how I’d play the stock now.

Hedge funds bet against Sainsbury’s shares

I can see a few reasons to be bearish on SBRY shares right now.

The first is the company’s recent performance. A report from research firm Kantar, issued on 18 August, showed that Sainsbury’s performance over the last few months has been sub-par.

Indeed, for the 12 weeks to 9 August, Sainsbury’s registered sales growth of 10.9%. Meanwhile, Tesco, Morrisons and Ocado delivered growth of 12.8%, 16%, and 45.5% respectively. The German discounters Aldi and Lidl generated sales growth of 12.7% and 15.7% respectively. Sainsbury’s market share was 14.9% for the period, down from 15.4% for the same period last year. These figures indicate that Sainsbury’s has some challenges to work through right now.

Another issue is the balance sheet. In its full-year results, the company reported net debt of £6,947m. That’s high, as total equity on the books was £7,773m. What looks slightly concerning, in my view, is the Sainsbury’s interest coverage ratio. This ratio – which tells us how easily a company can meet its interest expense – was just 1.79 last year. By contrast, Tesco had a ratio of 2.28 and Morrisons had a ratio of 5.11. I’ll also point out that Stockopedia gives Sainsbury’s an Altman Z score (this is used to predict bankruptcy) of -0.05, which indicates a serious risk of financial distress in the next two years.

Finally, recent updates from Sainsbury’s have not exactly been encouraging. For example, on 1 July, CEO Simon Roberts said: “The coming weeks and months will continue to be challenging for our customers and our colleagues and we do not expect the current strong sales growth to continue. A number of the decisions we have made have materially increased costs.” The company also suspended dividend payments earlier this year (while Tesco didn’t). This suggests that management is concerned about the near-term outlook.

Putting this all together, it’s not hard to see why hedge funds expect Sainsbury’s share price to decline.

My view on SBRY shares

Given the high level of short interest here, I’d avoid Sainsbury’s shares for now. Hedge funds don’t always get it right, of course. But quite often, they do. Carillion, Debenhams, Thomas Cook, Metro Bank, Kier… these are all stocks that have been heavily shorted by hedge funds in recent years. When a stock’s short interest is high, it can pay to steer clear.

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Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.