Why CannTrust (TSX:TRST) Crashed More Than 20% Yesterday

CannTrust Holdings Inc (TSX:TRST)(NYSE:CTST) found itself in some hot water with Health Canada after being non-compliant with some of its regulations.

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CannTrust Holdings Inc (TSX:TRST)(NYSE:CTST) investors got more bad news on Monday when they learned that the company’s operations were found non-compliant with Health Canada’s regulations.

In its Pelham, Ontario facility, CannTrust had been growing cannabis in rooms that were not yet licensed and still pending approval. Although they did ultimately receiving licenses in April 2019, it didn’t change the fact that the company was growing in the rooms prior to then.

What’s also troubling is that regulators noted that “inaccurate information” was provided by CannTrust employees. As a result of the infractions, Health Canada is holding 5,200 kilograms of dried cannabis that CannTrust previously harvested from those rooms. The company is also voluntarily holding 7,500 kilograms at its Vaughn location, which also has cannabis produced from those rooms.

What Health Canada is doing now is performing quality checks on the samples that have been held at Pelham, which is expected to take at least two weeks. The problem in the interim is that now those products can’t be shipped to customers and patients and will cause shortages until Health Canada releases them — assuming it does so.

CannTrust’s CEO Peter Aceto affirms that the company has made the necessary changes and that it will learn from its mistakes: “We have made many changes to make this right with Health Canada. We made errors in judgement, but the lessons we have learned here will serve us well moving forward.” Some of the changes noted by the company that it plans to make include more employee training, and reviews of the processes done by external advisors.

The company couldn’t provide an estimate as to the potential impact on its financials given the uncertainty around the current hold and when the products will be released.

Key takeaways for investors

There are two big concerns I see from this, neither of which relate to sales, at least not directly.

The first is that these added quality control measures, while important, will add a lot more cost to the company’s income statement. With losses being a big problem in the industry and CannTrust reporting a significant net loss last quarter, it may make it even less likely that the company is able to get to breakeven anytime soon.

The company will likely overcompensate for the audit failure, and while it’s understandable to help win back the trust of investors, it’s going to come at a price.

The other concern is the trust issue. In the cannabis industry, investors are starting to worry that the growth prospects in Canada may not be as good as advertised, and so having and establishing trust is critical for companies.

With CannTrust misleading regulators on its facilities, it damages that trust, and the stock had already been struggling, losing 37% of its value over the past three months entering Monday’s trading session, which is going to make raising capital even more challenging.

It may take some time for the company to win back the trust of investors.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor David Jagielski has no position in any of the stocks mentioned.

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