A year ago, marijuana stocks could do no wrong. Valuations for nearly all pot stocks were soaring on the expectation that the global cannabis industry would grow by a strong double-digit percentage for years to come, as well as the fact that Canada was becoming the first industrialized country in the world to legalize recreational cannabis.
But what a difference a year makes.
Over the trailing year, pretty much every brand-name pot stock has lost 50%, 60%, or even more of their value -- and there's a veritable laundry list of factors being blamed for this precipitous decline.
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The cannabis industry contends with problems galore
To begin with, Canadian growers have been struggling with persistent supply shortages since the green flag waved on adult-use sales on Oct. 17, 2018. Part of the blame can be placed on the cultivators themselves, with many waiting too long to begin expanding capacity.
However, a significant portion of the blame on the Canadian supply front rests with regulators. Health Canada has been overwhelmed by cultivation, processing, and sales license application backlogs, leaving many growers to wait months, or perhaps even longer than a year, to get the go-ahead to plant, process, or sell marijuana. Likewise, select provinces have been slow to approve licenses for physical dispensaries, which has encouraged black market producers to step up and fill the supply void.
To add the icing on the cake for Canadian pot stocks, the launch of derivatives, such as edibles, vapes, and infused beverages, was delayed until mid-December. At the beginning of the year, the industrywide expectation was that derivatives would reach dispensary shelves by no later than October.
Meanwhile, in the United States, high tax rates have plagued the legal cannabis industry. In California, the largest marijuana market in the world by annual sales, state sales tax, local taxes, cannabis excise taxes, and wholesale tax, can add up to as much as 45% in some cities. When added to the fact that roughly four out of five California jurisdictions won't allow legal marijuana dispensaries to open, it's given rise to a robust illicit market.
Lastly, we've seen issues at the individual level, with goodwill acting as a potential powder keg for marijuana stocks, and ongoing share-based dilution dragging down the share price of well-known companies.
But none of these issues represents what's truly the biggest problem the marijuana industry is contending with: a lack of investor trust.
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Trust, or the lack thereof, is the pot stocks' biggest problem
Each and every one of these issues is something that regulators or the cannabis industry can work out a plan to fix within the next couple of quarters to perhaps two years. In fact, Health Canada has already implemented changes to its cultivation license application process that are meant to expedite the review process and get product onto the market faster.
However, there is no concrete blueprint to fixing investor trust issues, as marijuana companies are beginning to understand. Over the past year, a number of events have caused investors to question how much they can trust this once-illicit industry.
The most egregious violation of investor trust was CannTrust Holdings' (CNTTQ) admission in early July that it grew unlicensed cannabis in five rooms for a period of six months (October 2018-March 2019). Not long after this announcement, it came to light that then-CannTrust CEO Peter Aceto knew of this illegal production and did nothing to stop it, leading to his eventual termination. CannTrust subsequently had all pot sales suspended by Health Canada while the regulatory agency conducted its investigation. Last month, punishment was handed down: an official suspension of the company's cultivation and sales licenses until the company regains compliance, in the eyes of Health Canada.
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Conflicts of interest rear their head
While, thankfully, there haven't been any other investor trust issues as bad as CannTrust, there have been no shortage of head-scratching moves throughout the space.
For example, Aphria (APHA) was the target of a short-seller report in December that alleged the company has grossly overpaid for its Latin American assets. Although an independent committee cleared Aphria of this allegation, it also uncovered conflicts of interest from this transaction. This led Aphria's longtime CEO, Vic Neufeld, to step down.
A similar issue was uncovered in February with Namaste Technologies (NXTTF 4.00%), whereby a short-seller report alleged fraud, but the only validity to the claim was a conflict of interest with now-former CEO Sean Dollinger. An independent committee found that Namaste's Dollinger had sold company assets to a related party without disclosing this sale in any of the company's security filings. This led Namaste's board to fire Dollinger with cause, to which the company's stock has been in a steady decline ever since.
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And yes... accounting errors, too
Marijuana stocks have also made some serious accounting flubs that have weakened investor trust. In February, Canopy Growth (CGC 10.92%), the largest weed stock in the world by market cap, had to refile its management discussion and analysis with SEDAR (Canada's equivalent of the Securities and Exchange Commission) because of errors with a spreadsheet. Canopy Growth had initially reported a nine-month adjusted EBITDA loss for fiscal 2019 of $69 million Canadian. But after fixing the issue, Canopy's adjusted EBITDA loss ballooned to CA$155 million.
Then, in April, ancillary cannabis stock KushCo Holdings (KSHB) uncovered accounting errors tied to three acquisitions between May 2017 and July 2018. According to KushCo, certain shared-settled contingent considerations were being treated as equity when they, instead, should have been accounted for as a liability. Ultimately, restating KushCo's 2017 and 2018 results led to a slight uptick in 2017 net income and a more than doubling of its 2018 net loss.
The real issue for marijuana stocks is that it's going to take an undetermined amount of time before Wall Street and investors have faith in these companies again. We're likely going to need to see the industry overcome its supply and/or tax issues, as well as report a couple of quarters of recurring profitability before investors are truly willing to give cannabis stocks a legitimate shot of being long-term investments. Until such time, volatility, and even extended declines, could become the norm.
