Whither CannTrust?

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CannTrust Holdings Inc (TSE:TRST) (NYSE:TRST) (FRA:C9S) has been named by Health Canada as being in violation of several instances of the Access to Cannabis for Medical Purposes Regulations Act. Specifically, the company is alleged to have been growing cannabis in several rooms that were not yet licensed for production of cannabis. Ken Munro explores the effect on the cannabis industry generally this might have, and on investors’ mindsets.

A question? Or a prediction?

It’s rare for an industry in its infancy to garner as much media attention as has the Cannabis industry. Despite being as yet in its neonatal stage, (recreational marijuana only became legal in Canada 9 months ago) headlines abound in financial publications reporting on the vagaries of fortunes of individual companies within the space, and developments regarding its major players. There is no shortage of subject material. Witness news coverage of Canopy Growth, Cronus, Aurora, Aphria, Hexo, CannTrust, etc. etc. This fledgling sector is crowded.

The spotlight these days is focused on CannTrust, an erstwhile player not likely to come up in informal conversations about the business and its industry participants. This despite the fact that CannTrust is the fourth largest Canadian pot producer based on most recently reported quarterly revenues. I choose this criterion as a metric for comparison because it is far less volatile than market capitalization. An acknowledgement of the drastic, sometimes violent, and often seemingly random fluctuations of stock prices within the group.

The US Marijuana index has shown a respectable return of 11.25% over the last year, as of the time of writing, comparing favourably with a one year return of 6.1% for the S&P 500. And yet this seemingly benevolent number belies a volatility over the period within this group that can only be described as gut-wrenching. Between November 7th and December 24th, this sub-index plummeted 37%, only to reverse and rise 62% in the ensuing 3 ½ months. Throughout this tumult, the market has rewarded some, and mercilessly punished others.

Pity the shareholders of Canntrust, who have seen their shares slide precisely 50% during this interval. Even more distressingly, they have suffered a 73% decline in a period of just 4 months from recent highs. This, as a result of the company’s consecutive releases of disappointing news. News that should raise serious questions about the competence and integrity of management. On March 28th, the company released its first quarterly results after legalization. Net loss was $25.5 million versus consensus estimates of a loss of $6.4 million. Then, on April 22nd, the company announced a highly dilutive $200 million offering at a price well below recent highs. The most recent news was a bombshell.

There is no question that this company is severely damaged. Its reporting will be grossly impaired for the foreseeable future, and, perhaps more importantly, its credibility is out the window, for shareholders, for customers, for potential financings, for everybody. The question remains: What is the likely outcome? The answer is, simply put, nobody knows. There are no precedents to establish guidelines as to what punishment will be meted out for management’s ineptitude and admitted regulatory violations. This is small solace for those shareholders who have held on throughout this torturous slide, amongst whom I’m sure there is a contingent of insomniacs.

On the subject of management, much can be said. Although this is the company’s penultimate misstep, it is not the first. According to Bloomberg’s examination of online inspection reviews, between 2015 and 2018 the company has been cited for mold in grow rooms , security issues in storage vaults, and the absence of a traceability system. This latter issue potentially an issue related to, and very possibly enabling the production and delivery of product from hidden rooms which had not yet been licensed.

How is it possible that management was unaware of production in these hidden rooms? It is not. Even if, as unlikely as it may be, this was a covert manipulation by a group of rogue employees hidden from the purview of upper management (chuckle), it indicates a gross abrogation of management’s responsibilities to shareholders. It is clearly a misguided and myopic approach by management to circumvent due process in order to get a head start on the competition. Who in their right mind would risk the future of a company with a market cap approaching 2 billion dollars to get a few extra months of weed production from 5 rooms? It is small wonder that the company and its management are the subject of 14 lawsuits at last count.

The period of unlicensed production under investigation runs from October 2018 to early April 2019, when these rooms were indeed licensed. Peter Aceto’s appointment was announced October 1st. Here are some quotes taken from his personal Instagram account and his rejoinders to questions from the press, notably Bloomberg. While not providing the full context from which they are extracted, they are nevertheless telling: “We made an error in judgement.” “We’re growing very very rapidly, and we need to make sure Cannabis is in properly licensed rooms, so we voluntarily disclosed some minor issues with regards to that.” “But look, I’m only human.”

Hmmmm. What can you possibly say to that? Clearly management has an inclination to act on future events it foresees as inevitable, as they have demonstrated. This proclivity has in turn caused this debacle. Perhaps they should act on it again and start packing up their offices.

It is premature to write this company off as a foregone conclusion. Premature in a big way. The company has assets, and a future, potentially, under new management. The company has a relatively low cost of production at $3.03 per gram. Additionally, this cost will likely decline going forward as production from newly acquired acreage in BC kicks in. Outdoor production is obviously less costly, and the cultivation of these 81 recently acquired acres will have a measurable impact. Production in 2020 is forecast in the order of 300,000 kg. It is unlikely though that if a White Knight should materialize, any substantive premium would be involved in an acquisition. There would be no instantaneous relief for shareholders.

It is impossible to determine how this story will play out. Will it rise like a Phoenix? Or sputter. Wither. Nobody knows. Anyone who professes otherwise is delusional. When asked the likely outcome here, it would be best to confess ignorance, rather than provide it. There is hope, but there is a huge element of risk. To buy CannTrust here would be akin to diving headlong into a dark pool not knowing how deep the water is.

More on Canntrust:

CannTrust Holdings (TSE:TRST) Secures Distribution Agreement with SQDC

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