Before the open on Monday, CannTrust (CTST) shocked the cannabis industry in revealing that the company failed a Health Canada audit. With the stock down over 30% to nearly $3.00, the market is over reacting to the actual ramifications of using unlicensed grow rooms.
CannTrust reported that the Canadian cannabis player got a non-compliant rating from Health Canada for cannabis grown in five unlicensed rooms from October 2018 to March 2019. The rooms were eventually licensed in April 2019, but the issue is what happens to the related inventory from that period.
Health Canada has 5,200 kg on hold and the company has voluntarily held 7,500 kg of dried cannabis for a combined 12,700 kg on hold. CannTrust only sold 3,000 kg last quarter and produced 9,400 kg during the March quarter.
CEO Pete Aceto made the following statement about the issue:
“We made errors in judgement, but the lessons we have learned here will serve us well moving forward. “
Bank of America ML analyst Christopher Carey placed a $53.5 million estimated cost on the inventory, though the amount is likely lower as the higher production levels should’ve generated some large-scale efficiency that reduced costs per gram. Losing all of the inventory would be a massive cost for the company with a listed market cap in the $500 million range now
The big issue is whether Health Canada approves the product as suggested by the language from the company or CannTrust has to destroy the product. The company claims the dried cannabis passed all tests at Health Canada certified labs and with the rooms now licensed the likely outcome is a large fine for bad judgement.
Supposedly, this move occurred due to Health Canada taking a significant amount of time to license the facilities. The ramifications go beyond the inventory and will likely lead to lawsuits from investors that bought into the recent $170 million secondary offering.
The other issue is when Health Canada will approve the outdoor cultivation site following this regulatory issue. The company had already stated that a delay in Health Canada approval was holding back planting of the site that was expected to generate an estimated 75,000 kg of dried cannabis production this year. Investors should expect the facility to not generate cannabis this year inline with the recent updated forecast to produce anywhere from 0 to 15,000 kg in 2019 based on the delays.
The key investor takeaway is that Health Canada is better served to fine CannTrust for jumping the gun on growing cannabis in unlicensed facilities. The stock will remain under pressure as the market awaits the expected 10 to 12 business day testing period for Health Canada. With the ongoing delays with the regulatory body, investors should be prepared for a prolonged testing period that could push the stock lower.
Ultimately, CannTrust appears positioned for a strong 2020 season as the company lines up 240 acres of outdoor growing space combined with the indoor space that would place the Canadian cannabis company at a 2020 exit production rate closer to 300,000 kg and this issue all but forgotten. The key here is to make sure a bigger regulatory issue doesn’t exist before buying the stock.
To read more on the nitty gritty of what’s going on in the rising cannabis industry, click here
Disclosure: No position.
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