Cannabis Stocks Take a Hit Amid Industry Setbacks

Photo Credit: Ryland Zweifel/Shutterstock
July 22, 2019

By Chloe Aiello

Cannabis stocks sunk lower on Monday, continuing the sector's downward trend as investors reeled from a series of high profile setbacks in the industry. William O'Neil and Co. cannabis analyst Andrew Kessner said that although a loss of momentum in the cannabis sector could dissuade more tentative investors from diving into the space, tempered valuations ー particularly in the U.S. and in second tier Canadian cannabis stocks ー could prove attractive.

"When you do see the weakness like this in the space, for many investors who have more of a momentum-driven methodology, it's tough for them to get in now. But if you really look at the valuations, there are, we think, a lot of attractive opportunities, particularly on the U.S. side," Kessner said.

Cannabis stocks were down across the board on Monday, with several major cannabis stocks, including Canopy Growth ($CGC), Aurora Cannabis ($ACB), and CannTrust ($CTST), down more than 1 percent. Cronos Group ($CRON) and Aurora Cannabis were both down just over 40 percent from 52-week highs ー and CannTrust down about 75 percent ー despite broader optimism in the market.

Kessner said recent high profile upsets in the cannabis industry have weighed on cannabis stocks and spooked institutional investors. In Canada, the ouster of Bruce Linton, and CannTrust's recent regulatory breach; and in the U.S., antitrust concerns and legalization setbacks in New York and New Jersey have all weighed on sentiment.

Linton, the former Canopy CEO, was ousted rather unceremoniously several weeks ago, following weak earnings results and comments by William Newlands, CEO of Canopy's largest shareholder Constellation Brands ($STZ), saying that he was "not pleased."

"You had Bruce Linton who had more of a long term, build up the company, build up the infrastructure, spend a lot of money now and we'll see profits later, sort of an Amazon-type view. Whereas you have a lot of investors now, especially as institutional investors start to enter the space, who want to see perhaps more near-term financial results," Kessner said.

CannTrust, on the other hand, completed a $170 million public offering, with participation from some major U.S. banks, including Bank of America Merrill Lynch, Citigroup, Jefferies, and Canaccord Genuity. Several months later, the company announced it was caught by Health Canada growing cannabis in unlicensed rooms in one of its facilities. About 28,000 pounds of the company's cannabis has been frozen pending a Health Canada investigation, which could result in suspension or cancellation of CannTrust's federal license.

"Look what happens. This company is apparently breaking the law, and not enough due diligence has been done by those banks, so I think that spooked larger investors that were getting into [cannabis]," Kessner said.

Regulatory breaches and fraud may seem like completely different issues, but Robert Galarza, CEO of TruTrace Technologies said they reflect a desire by investors to see more immediate results ー and a desire by companies to do whatever it takes to perform.

"It's almost like it's too early to have [public companies]," said Galarza, whose company makes blockchain-based cannabis and intellectual property tracking software that, among other things, aims to ensure companies don't cut corners in medical cannabis. "We saw this massive explosion and this arms race, and I think that arms race creates economic pressures that causes people to cut corners."

"Those market pressures are real, and they are only going to get worse," he added.

Especially in U.S. cannabis, where the valuations are lower, Kessner said there are still a lot of "attractive opportunities," despite antitrust concerns over proposed mergers involving MedMen, Cresco Labs, and Cannex Capital. And stagnant progress in broader federal legalization may actually benefit established players in the U.S. market.

"We actually see the status quo as the best case scenario for some of these U.S. multistate operators that have emerged, because at the federal level, as long as cannabis is still illegal, you're not going to see big companies ... so it gives these smaller multistate operators that have popped up a window of time to grow before the big guys come in," Kessner said.

Of course there is incremental progress on the federal level, as well. Earlier this month, a House Judiciary subcommittee held a hearing to debate how best to legalize cannabis. The Senate, meanwhile, is expected to hold a hearing on the SAFE Banking Bill, a bill that seeks to provide a safe harbor for banks that assist the cannabis industry and is thought to have the broadest bipartisan support of any cannabis legislation moving forward in Congress.