CannTrust announced that it was found non-compliant by Health Canada over illegal cultivation in unlicensed rooms at its Pelham facility.
CannTrust has suffered a string of setbacks beginning with a disappointing 2018 Q4 results that drove shares down 20%.
We think CannTrust could face more uncertainties as regulators conduct investigation and investors re-assess investment thesis.
CannTrust (CTST) shareholders woke up to an unpleasant surprise delivered by the leadership team at the company. Shares ended the day down 22% after CannTrust told the public that it was found to be illegally growing weed in its facility and could face severe legal and financial consequences after Health Canada seized its inventory. The new leadership team at CannTrust has destroyed a massive amount of shareholder value since last October and the company could face more headwinds after Monday’s events.
(All amounts in C$)
On Monday morning before the market opened, CannTrust issued a press release informing investors that it has been found non-compliant with certain regulations. The Health Canada inspectors conducted a surprise visit to the facility and found that CannTrust had been growing cannabis in unlicensed rooms between October 2018 and March 2019, until the company received the license in April 2019 for these rooms. The unlicensed rooms are located in the Phase II expansion part of the Pelham facility, which is CannTrust’s main production facility where it is currently constructing a Phase III expansion. After they issued a non-compliance notice, Health Canada placed a hold of 5,200 kg of cannabis illegally produced and the company voluntarily decided to hold another 7,500 kg of products stored at its Vaughan facility.
CannTrust CEO Peter Aceto said the following regarding this incident:
We have made many changes to make this right with Health Canada. We made errors in judgement, but the lessons we have learned here will serve us well moving forward.
Investors did not hold back their frustration as they send CannTrust shares tumbling 22% on the day, the largest one-day decline in the stock’s history. After Monday, CannTrust closed at $3.83 which is down 62% from its most recent high of $10.04 reached on March 27. There was another recent event where CannTrust shares dropped close to 20% – when the company reported its disappointing 2018 Q3 results. It is inconceivable for the former market darling to fall so hard and so many times (we were also positive about the stock until our downgrade following 2018 Q3 results).
Since CannTrust reached its recent high in March, the stock has dropped 62% while its closest peers outperformed. HEXO (HEXO) dropped 23% and OrganiGram (OGI) gained 3%, both under the backdrop of a tough market for pot stocks as the popular Horizons Marijuana ETF (OTC:HMLSF) lost 19% during the same period. Clearly, CannTrust underperformed the market significantly and the 22% drop on Monday made everything even worse for its investors.
The biggest question for investor following Monday’s trading disaster is what could happen to CannTrust shares going forward. We believe the stock will remain subject to heavy selling pressure and there will be significant uncertainties surrounding its near future – all making CannTrust not investable at this point for the average investors.
First of all, the immediate impact would be disrupted operations and lost inventory which will inevitably lead to product shortages and customer attrition. CannTrust already warned to its medical patients that they should expect some product shortages and we fully believe that some patients will switch to other LPs permanently, especially given the nature of the matter which could lead to concerns on product quality. CannTrust will also likely be required to destroy all the products it produced from the unlicensed rooms, including a minimum of 12,700 kg of cannabis which is worth C$64 million based on an average selling price of C$5.0 per gram. CannTrust will suffer additional costs because it needs to source third-party supplies to fill orders which mean higher costs and lower margins.
Secondly, CannTrust has already sold products made from harvests in the unlicensed rooms to customers, provincial distributors, and exports to international markets. Given that it is a criminal offense to grow and sell illegal cannabis, there is a potential risk of severe legal consequences for the company or some of its senior executives. As the industry is extremely young we haven’t seen a case of criminal charges being laid on management upon compliance breaches (we covered Ascent Industries when its license was revoked by Health Canada due to compliance issues – a first in the industry). However, we think significant uncertainty remains over whether Health Canada will take further action against CannTrust and if so, whether existing licenses will be revoked and its future license applications are impacted.
We believe the recent events at CannTrust has destroyed its hard-earned reputation as a reliable medical cannabis company. Patients will suffer due to supply disruptions and investors have also suffered a great deal since the current CEO took office last October. We believe the damages from Monday’s events will be long-lasting and it is too early to be able to quantify the impact. As a result, as much as investors are easily lured by the big one-day share price drop on Monday, we think the stock is still highly speculative and risky at this point.