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Pot Stocks of the Month: July 2019

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After the dismal month of May for pot stocks, this past month saw even more upheaval.

Industry leader Canopy Growth ousted its CEO. CannTrust Holdings had about half of its inventory seized by regulators. And the U.S. Surgeon General lost his mind on Twitter about babies getting high on breast milk.

There’s a lot to unravel there. But in short, cannabis isn’t having a good few weeks.

Canopy dropped its co-CEO (Bruce Linton) without warning like he was on fire. While the investment community began speculating on the reasons, Linton was already making the rounds on CNBC to put the blame on Constellation Beverages.

You’ll recall that last year, Constellation made the single largest investment in cannabis in history — $4 billion in Canopy for four seats on the board and about a 38% ownership stake. Well, with Canopy’s terrible first quarter earlier this year, the maker of Corona isn’t too happy.

Linton says the company just dropped him. Analysts are noting that Linton has been a bit cavalier with the financial press and investors about his company’s large losses. But he does have a point. The industry is so new, Canopy does have to spend money to make it.

Just this year, Canopy has invested heavily into the newly pseudo-legal CBD market in the U.S., locked in a huge $3.4 billion deal to buy Acreage Holdings if the U.S. legalizes marijuana and has aggressively increased its growing capacity. Those things aren’t cheap.

Constellation, too, has a point. The beverage company itself would have had a fairly decent first half of the year if not for the massive losses it incurred due to its Canopy investment.

Time will tell if the pot leader changes strategy. But if it does, just to save some money in the short term, it might not be the industry leader forever. In any case, that certainly rules the company out of contention for this edition of Pot Stocks of the Month.

CannTrust’s problems were more recent… but even more severe. The company kicked off this week confirming that Canadian regulators seized 13 metric tons of its cannabis, because they found that the company grew it illegally.

This is the kind of story investors first feared when these pot stocks started going public. With such stringent regulation and dubious legality, serious money is on the line relying on the cannabis producers themselves to make sure everything was on the up and up. CannTrust lost that trust with investors.

Already, within hours of this announcement, the company now faces several lawsuits from investors seeking compensation for this mistake. It will be a long month for the company. But I fear it will be an even longer year or two to try and regain that trust.

CEO Peter Aceto has made the right first steps, taking blame for the mistake and offering a strategy to do better – new employee training, outside counsel and oversight and new processes. But losing half of your product in the first year of legal sales isn’t going to attract new investors very much.

Finally, those most eager to see when marijuana might become legal in the U.S. woefully watched this exchange on Twitter…

In response to a Surgeon General Jerome Adams tweet about post-C-section opioid prescriptions of all things, a commenter asked about medical marijuana as a solution to the opioid problem.

Adams responded:

“NO!!! Cannabis components can be passed to baby in utero and in breast milk, and there are numerous concerns regarding exposing the developing brain to cannabis – especially with more potent strains and consumption methods that mean even more THC for baby.”

From there the conversation turned nastier with complaints about “whataboutism” and what actually is a “plant.” The gist of it is that the Surgeon General – one of, if not the most, important people to weigh in on legalization – publicly upholds the opinion that marijuana is extremely dangerous and that he’ll “never consider [legalization for medical purposes] a reasonable position.”

Of course, the conversation started about babies “getting high on cannabis” (his words). But the off-cuff arguments by the SG make it clear there’s still an ongoing battle in Washington about legalization… even for just medical marijuana. That doesn’t even touch on the idea of recreational pot.

So, as noted, there’s a lot to take in this month. Big investors are getting trigger happy and impatient. Regulators are stepping in and can have devastating effects on smaller companies. And U.S. legalization faces a still-large challenge.

To sum it all up… smart investors need to be cautious right now. Everyone is dancing on eggshells in the industry. So, for this month, we’re going tackle a different side of cannabis. Rather than recommending companies that produce the most product or brands it the best, we’re looking at logistics… the real missing piece in this industry.

Let’s look at this month’s pot stocks…

Pot Stock of the Month No. 1: TruTrace Technologies Inc. (TTT.CN/TTTSF)

The core issue of the CannTrust story was human error. The company had filed for regulatory approval at the sites that produced the now-seized product. But it hadn’t waited to receive it before the company started producing.

Now, for a $1 billion company – as CannTrust was before this collapse – that’s a serious problem. Most others wouldn’t make the same mistake… and I doubt CannTrust will either going forward. But that little problem is going to cost the company millions in revenue over the next several months and years.

However, it does point out a market opportunity. You see, logistics for this industry is new and fragile.

As pointed out with the firing of Linton, huge amounts of money is being invested and moved around in cannabis. Even more, is going into production increases.

Then, on the other side, once marijuana is grown, there’s marketing, packaging, transportation, and distribution. These companies – most of them anyway – haven’t been in these necessary businesses long.

So, they’ll need to turn to logistics companies, database management, and regulatory oversight firms. But again, cannabis has only been legal in Canada since last October… and remains illegal (technically) in the U.S. So, few have years of experience doing it… even professionals.

That’s where TruTrace Technologies comes in. The company is tiny… and relatively untested. Only last month, it got approval to move to the Canadian Stock Exchange. It trades over the counter here in the States. And it has only gone by the name of TruTrace for about the same time period.

Yet, despite its size and history amongst the giants of the publicly-traded markets, it offers a crucial product and expertise… especially in light of CannTrust’s massive error.

TruTrace doesn’t grow, harvest, market, transport or sell a single bud of marijuana or drop of CBD. But it does own a proprietary software the helps everyone from farmers to distributors and even regulators track each nugget along the supply chain.

That’s an incredibly important tool in this new and fast-developing market. Its StrainSecure verification software lets all of those points of the supply chain interact and gain clarity over what exactly they are buying or selling, transporting or marketing.

The company claims this subsector of the industry could have a market value in the billions. Yet, right now, TruTrace is a true penny stock. With a market cap of $CAD 24 million and a trading history of just weeks on a major exchange, no one knows about it yet.

Right now, the company is focused on selling its software to the medical industry – from medical marijuana growers to hospitals and healthcare networks. This alone presents a great opportunity. Already, TruTrace has signed a deal with WeedMD, a small but fast-growing player in this field.

TruTrace shares do come with risk, however. Its size opens it up to competition, market volatility and balance sheet limitation others don’t have to deal with. But it could also come with the potential as a buyout candidate.

If you get in on this new and fast-moving play, be sure to use limit orders and only invest what you can stand to lose. But if you do it right, this is one of those incredibly rare opportunities that could turn into triple-digit returns or more overnight.

Action to take: TruTrace Technologies Inc. (TTT.CN/TTTSF) is a strong buy in the lesser looked at an area of cannabis logistics support. Use a limit order to minimize cost risk.

Pot Stock of the Month No. 2: Auxly Cannabis Group Inc. (XLY.V/CBWTF)

While the rest of the industry struggles with regulations, corporate maneuvers and legal headwinds in the U.S., one player is attempting the difficult task of partnering up with everyone.

There are so many moving parts to this booming industry. You’ve got to have everything in place at just the right stage to produce profits in cannabis.

You need acreage, fertilizer, and equipment, proprietary strains, production, harvesting, packaging, branding, marketing, transportation, regulatory oversight and distribution. And, of course, you need financing to get it all done.

Auxly Cannabis is attempting to bring all of that together. Now, I’ll say right up front, this company comes with risk. It has diluted its shares so much, investors are getting nervous. But there’s a reason behind that dilution… and a reason why you should still check it out.

You can think of Auxly as the middle management of the cannabis world. While it does plenty of work on its own, the real expertise is organizing this tough-to-navigate supply chain.

It brings financiers and distributors together. It connects farmers and CBD extraction. It has its hands in every tiny piece of this industry. And that makes it an essential component to other players going forward.

As noted above, the industry is new and fragmented. It is just now developing the logistical pathways to bring a product from seed to storefront. So, a company with a history – and more importantly, partnerships – in connecting all these dots has real value.

But that is also costly. To secure all of these partnerships, it has cost a lot of money. Auxly is a serious money pit. It recorded net losses of $CAD 67 million in 2018 and $CAD 13.8 million in the first quarter of this year. That’s on virtually no sales.

It has connected all the pieces. But until the product comes online in its upstream channels, it loses money at every other stage in the supply chain.

Not all is lost, however. The company has diluted shares to raise capital. But it hasn’t squandered that money. It still holds a strong cash position and low debt, choosing to finance its partnerships and acquisitions through shares rather than cash.

As it transitions to the next stage, actually using these partnerships to send cannabis from seed to storefront, that cash positions should help stabilize its wild stock price.

As you can see, it’s been a wild year for the company:

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While most others in the industry were growing in the first several months of 2019, Auxly traded flat. The company’s financial performance kept it off many investors’ trading screens. But those in the industry are likely to take a different approach.

You see, Auxly has what those others – from the mega-sized Canopy to the smaller-end HEXO – need… the partnerships and connections. Prior to its rapid partner-making, the company started as a dealer of finance. It has the connections needed to deal with investors, bankers and equity firms those other fast-growing, yet earnings-negative companies are going to be looking for.

That makes Auxly a prime takeover target. Its cash position offers an attractive quality for the mergers and acquisitions market. Investors might not like the company’s income statement. But the balance sheet looks far better to companies like Canopy that is – as noted – rapidly expanding its own offerings.

And as we’ve seen with Linton’s ousting, those big-time investors will be looking to leverage partnerships sooner rather than later. Auxly has them ready to go. If it can combine its supply chain agreements with the force of a larger player like Canopy or Aurora, this too could be an overnight double or triple for early shareholders.

Again, this isn’t a conservative play in the least. It could take several quarters before sales actually come online for Auxly. And relying on a takeover offer isn’t always the best way to make money in the market. But, like TruTrace, Auxly offers unique quick-profit potential.

Action to take: Auxly Cannabis Group Inc. (XLY.V/CBWTF) is a strong buy in the developing supply-chain and financing arena of the cannabis industry. Use a limit order to minimize cost risk.

 

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