Last year was supposed to be a pivotal one for cannabis stocks. With valuations having soared, pot stocks were expected to push toward profitability on the back of rapidly rising sales. Unfortunately, investor expectations weren't realized.
To our north, Canada has contended with supply problems since day one of recreational sales, which began on Oct. 17, 2018. Meanwhile, in the U.S., high tax rates in select states, along with the ability of jurisdictions to deny retailers a presence in legalized states, have fueled an already resilient black market. In short, pot stocks plunged across the board in 2019.
However, this decline in marijuana stocks has some investors wondering if deep discounts abound. For example, embattled pot stock CannTrust Holdings (CNTTQ) shed more than 90% from its highs and wound up losing 81% last year. But is an 81% decline in this troubled marijuana stock reason to enough to pull the trigger and take a position in 2020?
As you're about to see, I think it is, but investors would be wise to take that position later this year.
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Here's why CannTrust was clobbered last year
Before I dive into the various reasons the risk-versus-reward profile for CannTrust is intriguing, let's first examine the reasons behind CannTrust's implosion last year.
The collapse of CannTrust was clearly fueled by the company's admission in early July that it had illegally grown cannabis in five unlicensed rooms for a period of six months (October 2018-March 2019) at its flagship Niagara facility. However, this blatant violation of Cannabis Act regulations wasn't all. It was uncovered that now-former CEO Peter Aceto was aware of this legal grow and did nothing to halt it, and that the company made efforts to purposely deceive regulators and hide this illicit grow. Ultimately, Health Canada wound up suspending the company's cultivation and sales licenses in September, and CannTrust has since destroyed $58 million worth of inventory derived from these grow rooms.
Being unable to plant new crops and, more importantly, sell cannabis and derivatives until it regains its licenses, CannTrust is also losing money. The company did announce 140 job cuts in the fourth quarter and is benefiting from reduced expenses from not growing any weed, but having no viable operations at the moment isn't sitting well with investors who are eager to see the cannabis industry generate some green.
Canadian regulatory agencies have also done marijuana companies no favors. Health Canada has been slow to approve licensing applications, and CannTrust's home province of Ontario has slow-stepped the rollout of physical dispensaries. At the one-year anniversary of adult-use sales in Oct. 2019, a mere 24 retail stores were open. That works out to one store per 604,000 people in the province.
Lastly, CannTrust's share price continues to hover around the minimum requirement for continued listing on the New York Stock Exchange (NYSE), and the company has failed to report its operating results since May. In short, delisting appears to be a very real possibility.
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CannTrust may very well be a bad-news buy in 2020
There's no doubt that CannTrust's uphill climb is steeper than most pot stocks at this point, but I do believe the company has a shot at becoming a bad-news buy this year.
For one, take note that the company's licenses were suspended by Health Canada and not completely revoked. The agency made sure to make an example out of CannTrust, but supplied the company with a laundry list of requirements that it could meet to regain compliance, and eventually its licenses. According to CannTrust's overhauled management team, the company anticipates making good on its deficiencies by the end of the first quarter. Again, while the agency isn't exactly the quickest at reviewing and approving licensing applications, it puts CannTrust on track to potentially regain the ability to grow and sell weed this year.
Also, understand that not being able to sell or grow cannabis hasn't put CannTrust at a major disadvantage to its peers. Supply issues have bottlenecked product in Ontario, meaning CannTrust hasn't lost significant market share to its competition. If anything, CannTrust has avoided the perils of overspending like some of its peers. And, as a reminder, CannTrust is one of five pot stocks that has supply deals with every Canadian province.
Investors also shouldn't overlook that CannTrust has the capacity to be a major, low-cost grower, assuming it regains its licenses. Prior to the cannabis hitting the fan in July, the company was expected to generate 100,000 kilos a year from its low-cost hydroponic farms, with another 100,000 kilos to 200,000 kilos annually from its outdoor grow, once it was up and running. CannTrust was poised to utilize its outdoor grow to create a host of high-margin derivatives, while its hydroponic operations led to below-average-cost production.
Image source: Getty Images.
Here's the caveat that investors should wait for
However, you'll note that my suggestion is for investors to hold off on buying CannTrust until the second half of 2020. That's because of an event that I expect to occur in the first half of the year that will, in all likelihood, push this stock down even further.
Last month, CannTrust received a warning letter from the NYSE that its stock failed to meet the minimum required share price ($1) for continued listing. In recent days, CannTrust has briefly rallied back above $1, but this doesn't put the company too far out of non-compliance. More importantly, CannTrust hasn't filed its operating results with the Securities and Exchange Commission, and probably won't until sometime later in the first quarter. This looks to be more than enough grounds for the NYSE to boot CannTrust off the exchange and back to the over-the-counter (OTC) exchange.
Generally speaking, when an NYSE- or Nasdaq-listed company gets the heave-ho from a major U.S. exchange to the OTC exchange, its share price gets clobbered. While we're not fans of trying to time the market at The Motley Fool, the tea leaves seem to indicate pretty clearly that a delisting is highly likely in 2020. I would strongly suggest that investors looking to buy into the CannTrust turnaround story not only having a high tolerance for volatility, but also wait until after this potential delisting event before making their move.
There's clearly a lot of risk with CannTrust moving forward, but also plenty of long-term value if the company can right the ship and rebuild trust with investors over time.
