When a stock is heavily shorted, it means that many hedge funds are betting on the company’s share price to fall, which is a very bearish sign. However, sometimes the hedge funds get it wrong, and this may lead to a short squeeze. This is where the stock price rises quickly, and investors are forced to close their position, consequently pushing the company’s share price up further. Heavily shorted UK stocks include ASOS, Kingfisher and Hammerson. However, with a short interest of over 8%, Cineworld (LSE: CINE) takes the top spot. With signs of a recovery, is it now time for me to buy?
Why is Cineworld so heavily shorted?
Hedge funds who have shorted Cineworld in the past couple of years have done very well. Indeed, the Cineworld share price has sunk 90% since its pre-pandemic price and 70% over the past year. There are many reasons for this large decline.
Firstly, demand remains lower than 2019 levels and is only expected to return entirely in 2024. This has caused the group to report consistent losses. For example, in 2020, it recorded a loss after tax of $2.6bn and in 2021, the loss was $560m. For a company with a market capitalisation of just £330m, these losses are extremely damaging. This has left the balance sheet looking extremely vulnerable, and the group’s liabilities are larger than its assets.
Further, Cineworld recently lost a judgment against Cineplex, relating to Cineworld’s termination of the proposed acquisition of Cineplex in June 2020. This has resulted in the Canadian court awarding Cineplex around $1bn in damages. Although Cineworld is appealing this judgment, there are “material uncertainties” over whether this will be successful. If it fails, Cineworld will be unable to pay, a factor that could result in bankruptcy. This is one of the main reasons why Cineworld is the most shorted UK stock right now.
What’s next for this UK stock?
Although there are multiple risks with Cineworld, there are also signs that demand is recovering. Indeed, during 2021, revenues were able to reach $1.8bn, up from just $850m the year before. There are also signs that the company can build on this throughout 2022. For example, in March, the group pointed to the improving environment for the company, thanks to a wide range of new releases. This includes Top Gun, Doctor Strange and Minions. This means that the firm expects to deliver positive cash flow in 2022, which will be used to help deleverage. The lack of Covid restrictions should also help boost demand.
But I’m still leaving this UK stock on the sidelines, as it is far too risky for my liking. In fact, I feel that the company’s future is very dependent on the outcome of its lawsuit appeal: if it wins, the Cineworld share price is likely to soar; if it loses, it could be heading to zero. This is not a risk I’m willing to take.