Key takeaways from ‘CannTrust market fallout’

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On Thursday, July 25, Cannabis Professional hosted a conference call to discuss what the continued CannTrust fallout means for the cannabis industry. Cannabis Professional’s Mark Rendell was joined in conversation with Greg Taylor, CIO of Purpose Investments.

Thank you to the more than two dozen subscribers who listened in to this lively discussion. You can read a recap of the key takeaways below.

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Background information

Three weeks ago CannTrust acknowledged that it is under investigation by Health Canada, after federal regulators found the company had grown thousands of kilograms of cannabis in unlicensed rooms over a five-month period.

The news sent shock waves through the industry, putting deals at risk, making financing more difficult and raising questions about whether Health Canada will respond by upping regulatory oversight.

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• Greg Taylor is the Chief Investment Officer of Purpose Investments. A data-driven manager with a focus on managing risk through active-trading strategies, Greg specializes in finding and exploiting pockets of volatility in the market to drive returns. He spent more than 15 years managing pension and mutual fund assets at Aurion Capital Management. He also held the role of senior portfolio manager at Front Street Capital and LOGiQ Asset Management before joining Purpose Investments.

When you launched the (Purpose Marijuana Opportunities Fund) in January 2018, CannTrust was a significant position. How have you changed that in the last year or so?

Greg Taylor: CannTrust going through this story is really unfortunate on a number of levels. You could argue this is almost the worst company this could happen to, for investor sentiment.

If you go back a year-plus, when we launched the fund in January 2018, the biggest holdings we had in the fund were CannTrust and Aphria. It seems comical to say now, but when we looked at the fund last January, the perception was that those companies, and Canopy, were the best run companies out there. Everyone loves the management, they thought they were the guys that were the most credible, they could actually deliver. The expectation was that these were the guys that were actually able to do the best job, and some of the other companies we shrugged off as more volatile.

At one point, [CannTrust] was 80-90 per cent of the portfolio, going back well over a year. When we did that, it was because [CannTrust] was one of the more credible companies.

If you look back at the history, this was a company that was set up by serious guys. Their marketing, when they IPOed, was 'we are the guys who have the best pharma-grade product, we know how to work with drug stores, we know how to work with Health Canada, we know how to do all this regulatory compliance stuff and we are going to be the perceived partner for big pharma coming into the sector’ and that’s how they spun it.

They weren’t really focused on the [recreational side], they were all medical. It seemed like they were the less volatile way to get into the space.

Last year, they had a bit of a rocky start to the summer, there were some questions about ramping up capacity. There were a lot of arguments at the board and management level which resulted in the original CEO, leaving the company in the fall. That combined with some of the delays in some of their launches, and the inability to make up some shipments, we took our position [in CannTrust] down to about two per cent in our portfolio, so way off the highs we had, and that was in October/November of last year.

Then going into the events of this story that you broke, we were down to about one per cent in CannTrust. We were basically out of the company and as soon as the news broke that there were Health Canada violations, we didn’t sit around to ask questions. We were basically gone within the next hour, as soon as the market opened.

CannTrust allegedly used fake walls to hide pot from Health Canada

Beyond institutional investors potentially being scared away, what does this [CannTrust news] do for the retail investors?

Greg Taylor: Events like this are not going to help with the trust factor in the area. Retail investors generally have a higher risk tolerance than institutions so they will probably be the first to come back and they will probably catch the turn but the institutions I think are going to be a little skittish to make a big leap back into the [cannabis] area once we get some bigger questions answered about what Health Canada is going to do but also with the operations. There has been such a massive disappointment with these companies not being able to deliver on expectations.

At the end of the day, the sector has not been able to deliver on expectations and people have been looking elsewhere.

Do you find some of the retail investors are unsophisticated because of the big money promises of early cannabis stock chatter?

Greg Taylor: I would say there has been too much money thrown at too many companies and they are not all going to win. The numbers change every day so I’m not sure – how many licenced producers there are in Canada? Is it 170 or 180? That is just too many. We are not a big enough country to have that many licenced growers.

There is going to be consolidation. For a while people were buying almost every deal out there because you wanted your allocation and to bet on all the horses. That has changed dramatically. There are a lot of people who have been pulling back. The people who can’t deliver are going to fade away. As retail investors and institutional investors you have to make sure you’re not just blindly buying into hype.

On the CannTrust regulatory breaches: What do you think they end result will be?

Greg Taylor: That is the big question here right now. We are sitting on the sidelines watching to see what the ramifications are.

I think as an observer there are two people who are going to decide this, maybe three. Health Canada is the first and one of the bigger question marks because you really have to figure out what they are going to do, by all accounts this looks like a blatant violation of all of their rules and what they are going to do to respond to that? Will they suspend their licence for a certain length of time?

If they decide to make an example of CannTrust then all bets are off. Then you could argue CannTrust is not worth much at all. Add into that the fact that this last equity raise was done in the U.S. with a large syndicate of U.S. banks with U.S. investors, as much as people say that Canadian investors can be hostile, you haven’t seen the SEC or a bunch of really pissed off U.S. hedge fund managers. They will come after these guys. There is going to be massive litigation around this.

So when you factor in Health Canada risk, U.S. potential litigation or SEC action and this stock is something that we are not comfortable picking up or holding right now.

It is hard to predict how this is going to end but I would say it is not going to end well.

Related Cannabis Professional reporting:

CannTrust chairman, CEO were informed in November of unlicensed cannabis growing, e-mails show

CannTrust appoints lead of special committee investigating hidden cannabis

CannTrust plunges as company faces shortages after Health Canada says pot producer broke rules

CannTrust allegedly used fake walls to hide pot from Health Canada

Pot stocks plunge as CannTrust woes cast shadow over cannabis sector

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