Marijuana stocks have had a particularly strong start to 2019, with the first-ever cannabis exchange-traded fund, the Horizons Marijuana Life Sciences ETF, nearly tripling up the return of the S&P 500 since Jan. 1. The legalization of recreational marijuana in Canada last year, coupled with ongoing legalizations throughout the U.S. and the world, have both Wall Street and investors seeing green.
But as is often the case with rapidly growing industries, they tend to bring out skeptics and pessimists. Over the past quarter-century, every next-big-thing investment has encountered some pretty big hiccups, and short-sellers are looking to pounce on those moments of weakness. As pot stock valuations have risen, so has short interest in many instances.
However, in recent weeks we've witnessed a significant (i.e., greater than 10%) decline in short interest in two high-flying marijuana stocks. Is this short covering a simple matter of profit-taking, or are we seeing a turnaround in the works for these two pot stocks? Let's have a closer look.
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Village Farms International: Short interest down 20% between Feb. 27 and March 28
No marijuana stock has seen a greater decline in short interest over the last reported month than Village Farms International (NASDAQ: VFF), which only uplisted to the Nasdaq Stock Exchange about two months ago.
Among the more than four dozen marijuana stocks with a market cap of $200 million or higher, Village Farms is this year's top performer. In fact, at one point in March it had almost quintupled since the year began. That made it a not-so-surprising target for short-sellers.
Yours truly called Village Farms one of the three marijuana stocks to avoid in April, namely based on valuation. Although it and partner Emerald Health Therapeutics (NASDAQOTH: EMHTF) should see substantial revenue growth from Pure Sunfarms (their joint-venture cannabis growing operation), nearly all of Village Farms' revenue at the moment is derived from vegetable growing. Generally speaking, growing vegetables is a weather-based, low-margin business model, so it made little sense for Village Farms to be soaring as much as it did in such a relatively short time frame.
However, between March 21 and April 22, Village Farms has retraced 34%. Some of this could be due to profit-taking. More recently, though, this pullback has been the result of a report from noted short-seller Citron Research, released a week ago, suggesting that Village Farms is a fraud. Keep in mind that Citron almost always has a vested short interest in the companies it releases negative reports on.
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Where does this leave Village Farms International? Having pulled back significantly, and with additional production being developed at Pure Sunfarms, I'd no longer consider it a stock to avoid.
Recently, Emerald Health announced that it had optioned a second 1.1-million-square-foot greenhouse from Village Farms that it'll retrofit for cannabis production. All told, Emerald Health and Village Farms will have 2.2 million square feet of growing space that will eventually yield at least 150,000 kilos a year, with revenue split down the middle. Also, considering that Canada is having supply issues galore, it's not as if this duo is missing out on too much market share in the early going by taking on this additional retrofit so late in the expansion cycle.
To be clear, Village Farms' short interest reduction doesn't make it buy-worthy; but it's no longer on the avoid list.
Cronos Group: Short interest down 11% between Feb. 27 and March 28
The other pot stock that's been given a bit of a short-seller reprieve is Cronos Group (NASDAQ: CRON), the third-largest cannabis grower by market cap.
Like Village Farms, Cronos was among the year's top performers out of the gate. At one point, just over five weeks into 2019, shares of the company had risen almost 125%. Then, its stock got a flat tire. Since March 5, shares have dipped by 29%.
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The big reason for the early-year ascent was the closing of a $1.8 billion equity investment from tobacco giant Altria (NYSE: MO). Altria has been contending with declining cigarette shipping volumes, and lower adult smoking rates, in the U.S. for years. Rather than continue to raise prices, Altria believed it needed new channels of revenue. Buying a nondiluted 45% stake in Cronos Group was viewed as a bet on a rapidly growing vice industry. Not to mention, Altria and Cronos could potentially partner on future derivatives, such as vapes, in the very near future. Multiple cannabis derivatives will soon be given the green light in Canada.
Now flush with cash, Cronos should be able to capitalize on its long-term growth strategy. This may include complementary acquisitions, capacity expansion, and new product development.
But does an 11% decline in short interest signal that a turnaround for Cronos is imminent? Unlike Village Farms, which has a fallback vegetable-growing business, things aren't looking nearly as peachy for Cronos Group. The company reported an almost laughable $4.2 million in sales during the fourth quarter, and Wall Street believes that revenue will be flat, or perhaps even down, in the sequential first quarter.
The biggest issues for Cronos are that it completely lags its peers in production capacity (120,000 kilos at its peak) and it's moved into just four international markets. Additionally, most of Cronos' production won't even be on line until later this year. If you had told me this was a $2.5 billion stock with a boatload of cash, it would make sense. But a valuation of $5.6 billion for a company with marginal revenue and clear deficiencies makes no sense. My expectation is that short-sellers will reload their positions at any sign of strength in Cronos Group's share price.
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