How Cannabis Investors Can Avoid Getting Burned by CannTrust Again

CannTrust

How far has cannabis really come? We’re approaching the one year anniversary of Canadian legalization, yet a cloud of mistrust still hangs over the industry. Due to the actions of a few bad apples—like CannTrust Holdings Inc. (TSX:TRST) (NYSE:CTST)—in the eyes of many, the cannabis industry hasn’t advanced far from the days of back-alley deals made through shady connections.

The fact that the public has a clear trust problem with the industry is likely why cannabis stocks have been under-performing for nearly six straight months. Since March 22, the Canadian Marijuana Index has been trending downward, falling in just half a year from a high of $110.67 to its opening today at $56.67.

Every night investors hope that cannabis stocks have found a bottom, and every morning they wake up disappointed.

The price problem has been exacerbated by a plague of cannabis scandals that have rocked the industry. As mentioned, the most public and dramatic of these scandals—by far—belongs to CannTrust Holdings, a name that is now ironically synonymous with the abuse of trust.

More and more, the CannTrust situation appears to be a scandal without end. While buckets of digital ink have already been spilled detailing the company’s various wrongdoings, there’s still a lot of work to be done to understand what exactly went wrong with the once-proud cannabis producer.

By breaking down the scandal into its elements, we can better understand why this scandal had such an impact on the industry, and how investors can avoid getting burned like that again.

From CannTrust to Cann’t Trust

It might be surprising to some that, not long ago, a survey of about 400,00 people found that CannTrust was the third most reputable cannabis producer in Canada. Of the 11 percent of the public that knew of the Ontario-based company, only 3 percent held a bad opinion of it.

The survey was released just five weeks before news of the first CannTrust scandal broke.

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On July 8, the cannabis industry was shocked to learn that, from October 2018 to March 2019, CannTrust Holdings was growing cannabis in rooms that were not licensed for it. Because of this, an estimated $70 million worth of cannabis was put on hold as Health Canada investigated the company further.

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What followed was an almost comical parade of bad news for CannTrust. Class action lawsuits, Health Canada tribunals, and news that senior executives at the company not only knew about the illicit cultivation but insisted on it, brought the already beleaguered company to its knees.

To its credit, CannTrust did attempt a course correction. Both the chief executive, Peter Aceto, and the chairman, Eric Paul, were ousted from the company for their role in the fiasco.

A New Low for Cannabis

Sadly, things just kept getting worse for CannTrust Holdings. In August, a full list of the company’s Health Canada violations was published.

The dirty laundry included: the construction of two new areas without prior approval of Health Canada, insufficient security controls, insufficient quality assurance, operating procedures that did not meet regulatory requirements, and a lack of adequate documentation that could allow Health Canada to finish its audit.

That’s a hell of a lot of malfeasances. That list must encompass the entirety of CannTrust’s misdeeds, right?

Sadly, it does not. In early September, documents obtained by BNN Bloomberg revealed that cannabis seeds from the black market were brought into CannTrust production rooms. These seeds were planted, grown to flower, packaged, and ultimately sold into the recreational market.

Within two weeks, Health Canada suspended the company’s license to produce and sell cannabis. Though the regulator did not issue a recall of CannTrust product, the Alberta government opted to return $1.3 million worth of cannabis to the company.

While this was not quite a deathblow to the troubled cannabis producer, it’s certainly the new low for a company with shares that once sold at $15.50.

When the scandal first hit headlines, TRST stock fell 50% in one week. Over the next few months, it continued to be battered by bad press until it slumped its way to $1.55. That’s an 88% reduction in share price since March.

How to Avoid Getting Burned Again

On Thursday morning, CannTrust stock showed signs of life by rising to $1.98. This is still a long, long way from its highs earlier in the year, but it shows that some investors think the company still has value.

Some analysts have suggested that TRST’s ability to intermittently shoot back up—as it did in mid-August, just before the list of violations was published—can be attributed to takeover rumors.

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As a once very attractive company that’s fallen on hard times, CannTrust Holdings makes sense as an acquisition target. The name is unsalvageable, but its remaining staff and facilities can be bought for pennies on the dollar. If investors get in now, they could ride a surge of excitement in TRST stock to make a quick and dirty profit. So, why not?

As Trina Fraser, a cannabis lawyer who works in acquisitions, recently told the Financial Post, major share purchase acquisition would have to first be approved by Health Canada. On top of that, a buyer would have to accept CannTrust’s future liabilities, even those that are the fault of previous management and haven’t been made public yet.

While it’s tempting to frame CannTrust as a potential comeback story, the company simply isn’t out of the woods yet. It’s a risk to acquire, it’s a long way from profitable, and even more scandals could come to light in the upcoming weeks.

At least until the suspension on its license is lifted, both investors and cannabis companies should probably stay far, far away from CannTrust Holdings.

A Cannabis Stock to Trust

Investors looking to put their money into a cannabis company worth backing, one that’s moving up following a big scandal, should consider Namaste Technologies (TSXV:N) (OTCQB:NXTTF).

After its CEO Sean Dollinger was caught committing insurance fraud in February, Namaste stock plunged 21 percent. It continued to fall into the summer, losing about 70% of its worth.

Since July, however, Namaste stock has been steadily rising on news that it brought in two new licensed producers to its CannMart marketplace. Last week, CannMart also secured a purchase order from the BC government, giving Namaste shares another boost.

On top of that, the old CEO is long gone, and the new CEO is working hard to rebuild trust in the Namaste brand. So while CannTrust should still be considered too hot to touch, look to Namaste as a sign of the cannabis industry’s redemption, as well as its potentially brighter future.

>> Read More CannTrust News

Featured image: DepositPhotos © Valentyn_Volkov

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