In October 2018, Canada became the first industrialized western nation to legalize recreational use of marijuana. This event -- likely still the most important for the marijuana industry to date -- was well received by investors, who saw a golden opportunity to cash in on the projected growth of sales of marijuana products by investing in cannabis stocks.
Unfortunately, once the initial honeymoon phase was over, a slate of issues got in the way of Canadian pot companies, which haven't performed nearly as well as expected. Let's review two of those issues and whether, in light of these developments, it might be worth removing all Canadian pot stocks from your buy list.
Some Canadian cannabis companies have been involved in major scandals. For instance, Aphria ( APHA ) got itself in a world of trouble after allegations emerged that the company overpaid for its LATAM Holdings acquisition in a ploy by some of its executives to enrich themselves. Aphria denied these accusations and even appointed a special committee to investigate them.
The outcome of this ordeal was certainly not pleasant: Not only did then Aphria CEO Vic Neufeld step down, but the company also incurred a 50 million Canadian dollars non-cash impairment charge as a result during the third quarter of its fiscal year 2019.
Elsewhere, e-commerce-focused cannabis company Namaste Technologies ( NXTTF 0.00% ) encountered its own troubles after a report by short-seller Citron Research alleged that the company was a "complete fraud." This report led to Namaste forming a special committee to investigate some of the claims made by Citron Research, and lo and behold, one of them seemed to be right on the money: CEO Sean Dollinger failed to disclose the details of a deal for the sale of Dollinger Enterprises between himself and another Namaste executive. This lack of transparency on Dollinger's part was not tolerated and the executive was fired, but not before the drama dragged down Namaste's share price.
Finally, in what has been the most publicized scandal of them all, CannTrust Holdings ( CNTTQ 0.00% ) landed itself in hot water when Health Canada discovered the company had grown and sold weed in five secret rooms for several months before these rooms received the proper regulatory approvals. Obviously, this is a big no-no, and CannTrust's license was taken away by Health Canada.
Although all of these scandals were company-specific, they likely played a role in dragging down the entire industry.
Issues in the Canadian market
Despite pot becoming legal in Canada, the market has encountered -- and is still dealing with -- a series of problems. Perhaps the most severe issue is the fact that the process to obtain cannabis retail licenses is incredibly slow. This is particularly true in the province of Ontario that, due to its population, is the largest marijuana market in Canada. Here's what Canopy Growth ( CGC -3.53% ) CEO Mark Zekulin said about issues in the Ontario pot market:
It [the Canadian recreational market] is the first national, federally legal, large-scale market opportunity for the sector to execute upon. And the market opportunity today is simply not living up to expectations and that this risk of oversimplifying the inability of the Ontario government to license retail stores right off the bat has resulted in half of the expected market in Canada simply not existing. Ontario represents 40% of the country's population yet has one retail cannabis store for 600,000 people. When one year into the market, the addressable market is nearly half what is expected, there is going to be meaningful short-term problems.
This is a telling admission, and this problem is at least partly responsible for the poor financial results most high-profile Canadian cannabis companies recently delivered.
What's next for Canadian pot companies?
Fortunately, the problem of retail licenses should be fixed soon -- at least in the province of Ontario where the government vowed to issue more retail licenses. Further, there's no doubt that Canopy and its peers are looking forward to the cannabis derivatives market opening in December.
Derivative products, such as vapes, edibles, and cannabis-infused drinks, are set to hit the shelves sometime next month. These products offer higher margins and present a much better opportunity for these companies to perform as well as we originally expected. But given the issues that Canadian pot companies have faced, it might be best to observe from afar until much improved financial results are actually on record. Until this happens, Canadian cannabis companies are best avoided.