CannTrust Holdings (TSX:TRST)(NYSE:CTST) is the latest marijuana stock to be hit by a major scandal.
Investors who are following the story are wondering if they should take a contrarian position in the shares or avoid the stock altogether.
Background CannTrust is the target of a Health Canada investigation that came about as the apparent result of a tip from a former employee.
The company was accused of growing marijuana plants in unlicensed rooms. The initial report that came out from Health Canada on July 8 confirmed the claim, resulting in a plunge in the share price of CannTrust. The stock fell from a previous close of $6.46 to $3.34 over the next five trading sessions.
CannTrust halted all sales of its product while the investigation continued, and the latest revelation by Health Canada indicates it has identified a second facility that was not in compliance with regulations. The newest report says CannTurst converted five rooms into storage areas and constructed two new sections without Health Canada approval at its Vaughan, Ont. site.
Investors have put additional pressure on the stock after the second non-compliance announcement, with analysts wondering how the new findings might impact the company’s ability to begin sales again in a timely enough manner to allow it to recover.
Penalties CannTrust is awaiting a decision from Health Canada as to the extent of the penalties it will face as a result of the non-compliance findings.
The agency could go easy on CannTrust and simply issue a fine for up to $1 million. In that case, the stock would likely rebound in a meaningful way, as investors would expect the company to quickly move back to normal operations.
The larger risk, however, is that Health Canada decides to take a more serious stance.
CannTrust says it has put 12,700 kilograms of dried cannabis on hold as a result of the initial non-compliance finding, which represents 53% of its total inventory. An order from Health Canada to destroy the product grown in the unlicensed rooms is possible. CannTrust says its financial results could be “materially adversely impacted” as a result.
In addition, Health Canada could suspend or even revokes CannTrust’s permits to grow and market marijuana and cannabis products.
Pundits are concerned this would be a death sentence for the company.
What should investors do? As of June 30, CannTrust had about $250 million in cash and cash equivalents, but it is uncertain how much of the cash has been used in the past six weeks.
The broader marijuana sector remains under pressure amid profitability concerns and weaker-than-expected sales for some products in the recreational market.
At the time of writing, CannTrust trades at $2.75 per share. CannTrust’s stock had already fallen 50% from its 2019 high around $13 before the Health Canada issues became public.
Investors who buy now are betting on the hopes that Health Canada will give CannTrust a break. If that scenario pans out, the stock is probably very cheap today.
That said, there are concerns that Health Canada will choose to send the message that non-compliance is absolutely not tolerated. As a result, investors should be prepared for a more serious decision.
In that case, the stock could eventually become worthless.
Given the downside risk, I would avoid CannTrust and search for other cheap stocks today.
Fool contributor Andrew Walker has no position in any stock mentioned.
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