Defensive Plays Are Gaining Steam. 5 Heavily Shorted Names Could Pop.

Shares of Freshpet have climbed 11% this month through Friday. (Chris Goodney/Bloomberg)

Key Points

The Consumer Staples Select Sector SPDR ETF gained nearly 10% as of Friday’s close, reversing a 4.5% decline in September.
Flowers Foods, Boston Beer, and Freshpet have seen high short interest, which could push prices higher if short sellers rush to buy shares.
Both Flowers Foods and Boston Beer are struggling with declining revenue, raising doubts about whether their stock rallies can last.

Some of the market’s most beaten-down consumer stocks have been making a comeback—and investors betting against them could provide additional fuel for the rally.

Consumer-staples stocks surged in October as investors shifted money away from technology companies amid concerns about lofty valuations and slowing economic growth. The Consumer Staples Select Sector SPDR exchange-traded fund has gained nearly 10% as of Friday’s close, reversing a 4.5% decline in September.

Several rebounding companies have seen unusually high short interest. Short sellers borrow and sell shares, hoping to buy them back later at lower prices and pocket the difference. But when a heavily-shorted stock rises sharply, those investors can face mounting losses and may rush to buy shares to close their positions—which could add to demand and push prices even higher.

Flowers Foods , the maker of Nature’s Own and Dave’s Killer Bread, is one potential candidate. As of Sept. 30, nearly 23% of its publicly traded shares were sold short, according to FactSet. The stock has gained nearly 11% in October through Friday.

Boston Beer , the maker of Samuel Adams and Twisted Tea, also stands out. About 21% of its float was sold short at September’s end. Shares have rallied 23% this month through Friday.

There are reasons for caution: Both companies are struggling with declining revenue, raising doubts about whether their stock rallies can last.

In the latest quarter, Flowers Foods reported a 4% revenue decline year over year and lowered its annual earnings forecast. Likewise, Boston Beer’s revenue fell 3.2% as its sales volume shrunk nearly 5% from a year ago.

Pet food company Freshpet might be a better bet. Its revenue grew 15.5% year over year in the latest quarter, driven almost entirely by higher sales volumes as the company attracted more customers and expanded distribution.

Still, 17% of its publicly traded shares were sold short by the end of September as investors worried about slowing growth and intensifying competition. Its shares have climbed 11% this month through Friday, potentially putting pressure on short sellers to close their positions if the rally continues.

Freshpet has a days-to-cover ratio—days needed to buy back all the shares sold short at a stock’s average daily trading volume—of 7.9 days, compared with 5.3 for Flowers Foods and 5.1 for Boston Beer. That suggests short sellers could face greater difficulty exiting their positions quickly if Freshpet shares surge.

Sprouts Farmers Market and Vital Farms also have relatively high short interest, with about 14% and 24% of their respective floats sold short by the end of September. Both stocks rallied Thursday, although they have been largely flat compared with the beginning of the month.

High short interest, however, doesn’t guarantee a squeeze. Some bearish bets reflect genuine business challenges, and short sellers may be willing to withstand temporary losses.

And the defensive rally itself remains fragile. The consumer-staples ETF fell about 2% on Friday, reversing part of its sharp advance on Thursday. Flowers Foods and Freshpet each dropped more than 4%, while Sprouts Farmers Market fell 3.8% and Vital Farms lost 2.9%. Boston Beer bucked the trend, gaining 3.6% following its earnings report on Thursday.

Without sustained buying pressure, short sellers have less incentive to exit. Investors will get another clue on Monday, when updated short-interest figures from Finra become available. The report will show positions as of Oct. 15, revealing whether bearish investors reduced their bets during the staples rally—or continued adding to them.

Write to Evie Liu at evie.liu@barrons.com

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