Too high? Hedge funds unimpressed by Canadian cannabis stocks' rally

© Reuters. FILE PHOTO: A Hexo Corp logo is pictured behind cannabis plants at their facilities in Gatineau

By Maiya Keidan and Shariq Khan

(Reuters) - A rally in Canadian cannabis stocks since Joe Biden was declared U.S. president-elect has done little to change hedge funds' bearish view on the industry as money managers say the election outcome may not solve the troubles of weed producers north of the U.S. border.

Canada's cannabis producers have been losing money and investor interest, plagued by over-expansion, slow retail stores roll-out, oversupply and governance issues. But the promise of U.S. decriminalization with the Biden win had investors cheering for the sector on a possible opening of U.S. markets.

That caused shares in Cronos Group, Canopy Growth and Hexo Corp to rise more than 20% between Nov. 2 and Nov. 16. But short positions in the stocks are only marginally down in the same period.

"I wouldn't recommend investing in Canadian cannabis companies because they have a cost disadvantage versus other operators," said George Schultze, founder at Schultze Asset, who has exposure to the sector.

Cronos Group saw the number of short trades as a percentage of its total traded volume fall slightly to approximately 26.7% for the first half of November, from 28% for the second half of October, regulatory filings showed.

Shorts in Canopy Growth also dropped, to 14.3% from 18.7% over the same period, while the number in Hexo Corp fell to 14.7%, from 25.8%, according to the data.

When they believe companies are over-valued, hedge funds typically borrow stocks and sell them back at a profit when the price falls.

If they still believe companies are fundamentally too expensive but stocks are rising, they may unwind their positions slightly to reduce the hit to their portfolio.

Several U.S. states voted to legalize marijuana this month. But Rob Romero, portfolio manager at Connective Capital, said there is a realisation that even with legalisation, that is not going to help many Canadian companies that have raised a lot of capital but lack a clear path to profitability.

Matt Hawkins, founder of Entourage Effect Capital, told Reuters the recent spike in Canadian weed stocks is "likely temporary."  

"It is our opinion that the Canadian LPs (licensed producers) that aren't intrinsically tied to the U.S. operators are still constrained to their country's market size because the country's export model has not worked the way it was envisioned," Hawkins said.

Aurora Cannabis bucked the trend, with shorts rising to 17%, from 11.8%. Jefferies analysts said in a note on Monday that a near 76% surge in market capitalization in November was "too stretched" and not driven by fundamentals.

Despite the recent rally, Aurora shares are down more than 73% this year, while Hexo is down 54% and Cronos lost 7%. Canopy Growth is up 14%.