For years, the marijuana industry has been thriving, and the expectation is that even greener pastures await. After all, according to a recently released report from Arcview Market Research and BDS Analytics, "The State of Legal Cannabis Markets," global weed sales should grow at a better than 24% annual clip through 2024 to north of $40 billion. Mind you, this figure focuses on licensed-store pot sales, but excludes cannabinoid-based pharmaceuticals and general-store cannabinoid revenue. Nevertheless, it signals robust growth in the years that lie ahead.
Yet, if things are so perfect for the budding pot industry, you might be wondering why the bulk of cannabis stocks have been sinking for nearly four months?
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Cannabis stocks face a wide range of challenges
Part of the blame rightly goes to Health Canada in our neighbor to the north, and state-level legislatures in U.S. states that legalized recreational marijuana.
In Canada, regulatory agency Health Canada has been contending with an overabundance of licensing applications since day one of recreational legalization. Although nearly 200 companies have received a cultivation, processing, or sales license through this past week, a monstrous stack of more than 800 applications awaited review when the calendar switched over to 2019. Even with Health Canada making changes to its cultivation application policy, the Canadian dried flower shortage isn't going to be corrected overnight, or anytime soon for that matter. In fact, it could very well carry over into the launch of derivative cannabis products in mid-December.
In the United States, the legal industry has struggled under the weight of exorbitant taxation. In California, for example, some locales are being burdened with aggregate tax rates of as high as 45% for legal weed. This involves the aggregate sum of the state tax, local tax, marijuana excise tax, and a wholesale tax on either dried flower or cannabis leaves. The Golden State's projected tax revenue in its first full year of recreational pot sales wound up badly missing estimates.
Federal regulators could be to blame, too, given that cannabis stocks have struggled to gain access to nondilutive forms of financing. Although Canadian pot companies do now have access to loans and lines of credit, U.S. marijuana stocks are still predominantly shut out of the traditional banking system, with any attempts to alter this at the congressional level met with opposition in the Senate.
But maybe the biggest problem marijuana stocks are contending with is a lack of investor trust.
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Pot stocks appear to have a trust problem
From nearly off-the-radar cannabis stocks to the most popular names in the entire industry, pot stocks have been pushing the boundaries of trust with investors for quite some time -- and investors look to now be pushing back. Below, you'll see three ways that marijuana stocks are violating their trust with shareholders.
1. Conflicts of interest
One way marijuana stocks may have violated the trust of investors is by engaging in deals that had clear conflicts of interest. Both Namaste Technologies (NXTTF 2.44%) and Aphria (APHA +0.00%) were guilty of such occurrences.
In October, Namaste Technologies was accused of fraud by noted sell-side firm Citron Research, which often holds shares short in the companies it issues scathing reports on. Although an independent review found no merit to Citron's fraud allegations, it did uncover that now-former CEO Sean Dollinger had sold company assets to a related party without making the appropriate disclosure to investors. Dollinger was terminated with cause, and Namaste's stock has been floundering ever since.
Aphria faced a similar fate in early December when Quintessential Capital Management and forensic analysis firm Hindenburg Research alleged that it had grossly overpaid for its Latin American assets. Here, again, those claims proved false. However, the independent committee review did uncover conflicts of interest in these purchases that led to a few executives stepping down, including longtime CEO Vic Neufeld. Today, Aphria remains one of the least expensive companies from a fundamental perspective, primarily because investors are struggling to trust management.
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2. Blatant fraud
Another way cannabis stocks have lost the trust of shareholders is through acts of blatant fraud. Whereas Namaste's and Aphria's conflicts of interest may not have had malintent, the bombshell that Ontario-based CannTrust Holdings (CTST +0.00%) laid on investors recently was about as bad as it gets.
For the more casual observers of the cannabis space, here's a brief rehash. A little over two weeks ago, CannTrust announced that it had been growing marijuana in five unlicensed rooms at its flagship Niagara facility in Pelham, Ontario, between October 2018 and March 2019. These rooms became fully licensed in April. As a result of this admission, Health Canada is holding 5,200 kilos of inventory from Niagara, with CannTrust also voluntarily holding 7,500 kilos at its Vaughan facility, for a combined 12,700 kilos of cannabis that's now in limbo. Recently, CannTrust also suspended all cannabis sales until Health Canada provides added clarity on the company's ability to operate.
As of this past weekend, one of three scenarios appeared likely. CannTrust could get a slap on the wrist in the form of a 1 million Canadian dollar fine, and it may or may not lose its 12,700 kilos in inventory. That would be a best-case scenario. A middle ground for the company would be a temporary suspension in its sales and/or cultivation license at Niagara, which would leave it reliant on its tiny Vaughan campus. A third scenario could see its growing license revoked completely.
The problem is that if perhaps the third-largest grower by peak annual output is subverting the law, other growers might be, too.
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3. Incessant share-based dilution
A third and final way that marijuana stocks are losing the trust of investors is due to share-based dilution.
As noted, most U.S. pot stocks have extremely limited or nonexistent access to basic banking services, which almost always means turning to common stock issuances or convertible debt to raise capital. But that's not the case in Canada, where banks are more willing than ever to work with pot stocks on financing solutions. Even so, most Canadian weed companies have continued to issue their stock like Monopoly money to fund aggressive expansion efforts, all to the detriment of their shareholders.
The most popular pot stock on the planet, Aurora Cannabis (ACB +0.14%), is the poster child of share-based dilution, having increased its outstanding share count by roughly 1 billion over the past five years. Having made 15 acquisitions since August 2016, Aurora Cannabis has expanded its global reach and added significant value to its market cap. Unfortunately, nearly all shareholders have seen losses since the beginning of 2018, despite a huge surge in market cap, all of which is the result of Aurora Cannabis funding its expansion by issuing stock.
And it's not alone.
Auxly Cannabis Group (CBWTF +1.98%) has been drowning its shareholders in common stock issuances. Until the midpoint of last year, Auxly Cannabis Group was solely focused on becoming a royalty operator. It would offer up-front capital to licensed growers to help them complete greenhouse projects, and in return would receive a fixed percentage of output at a below-market cost. It could then sell this cannabis at market rates and pocket the difference as profit. But without any operations, the up-front capital Auxly was supplying came entirely from issuing stock.
More recently, Auxly has moved into owning grow farms of its own and into joint ventures of cultivation farms. This all means added expenses for Auxly, and the likelihood of ongoing share-based dilution.
The fact is, investors' faith in cannabis stocks should rightly be questioned, which places a cloud of uncertainty over marijuana stocks that may not lift for some time.
