Wall Street stock traders are piling into bets against cannabis stocks, even as shares have plummeted

Jeremy Berke

Nov 27, 2019, 23:52 IST

Wall Street stock traders are piling into bets against cannabis stocks, even as shares have plummeted

REUTERS/Jorge Duenes

A burning pile of marijuana and other drugs are being incinerated at a camp of the Mexican Army's 28th infantry battalion in Tijuana, Mexico.

Wall Street is piling into bets that cannabis stocks will keep falling, amid industry turmoil.
Traders have added a net $1.4 billion of short positions in cannabis stocks this year, even as the North American Marijuana Index has dropped over 44%.
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Traders are still bearish on cannabis stocks after months of turmoil in the industry.

A new report from financial analytics firm S3 Partners shows that investors are increasing their bets that the stocks will fall, a practice known as short selling. Shorts have added a net $1.4 billion of short positions in cannabis companies this year, per S3 data through November 20.

Shorting a stock means that you're betting it's going to fall by borrowing the stock, selling it on the open market, and then - if the share price drops - returning those shares to the seller and pocketing the difference.

So one measure of how much traders are betting against a stock is how much it costs to borrow it. Of the top ten stocks with the highest borrow fees, four-Aurora Cannabis, Tilray, Hexo, and Aphria-are cannabis companies, according to the report.

"Short sellers pay a fee to borrow stock to cover the settlement of their short sales," S3's head of predictive analytics, Ihor Dusaniwsky said in the report. "Stock loan is a supply\demand market; if supply gets tight or demand spikes borrow fees are bound to go up."

Aurora Cannabis has the highest borrow fees of any cannabis company, per the report, with short positions costing 66.55%. Tilray is a close second, with borrow fees at 63.05%.

The average borrow fee for cannabis stocks is 23.45%, per the report. Those fees have been steadily rising, indicating increased demand to short. In August, the average borrow fee for cannabis stocks was 16.75%.

For what it's worth, the average borrow fee in the US and Canadian market is around 0.8%, per S3.

Short-sellers are piling in even as cannabis stocks decline

Short-sellers have kept piling into these stocks even as they've declined, meaning they think they still have a ways to fall. The North American Marijuana Index, a composite of US and Canadian cannabis companies, has fallen over 44% since the beginning of the year.

Still, Dusaniwsky said traders betting against the stocks may end their bets and reap profits soon, given how much the shares have declined.

"We may see short sellers in cannabis stocks that are bouncing off their lows, like Canopy Growth, reallocate their exposure to more attractive short targets," said Dudaniwsky. "Overall short exposure in the sector has been increasing for over a year as short sellers target over-bought and over-valued stocks in a sector that has lost its positive momentum. Shorts will probably reallocate their exposure to other stocks in the sector as turnarounds occur, but not swap into another sector until a more widespread rally begins."

That widespread rally has so far been elusive. While cannabis stocks were lifted last week on news that a U.S. House of Representatives committee passed a comprehensive cannabis legalization bill, they lost most of their gains on Tuesday when the FDA announced that CBD, a nonpsychoactive compound in cannabis, isn't safe to use in food and can be harmful to health.

Dismal earnings, slashed price targets, and headwinds

Sell-side analysts, for the most part, have slashed their prices targets on some US and Canadian cannabis stocks as well, casting doubt on the federal legalization bill.

"Some may see the upside and think the sector may have bottomed out. We don't think so," said Owen Bennett, an analyst at Jefferies, who said some of the gains made last week could be due to a short squeeze.

"This fundamental outlook remains one of a perceived liquidity crisis. In such an environment, the names you want to be are those with all/or some combination of near-term profitability, relatively healthy cash levels, evidence of execution and brands that are selling through," said Bennett.

On top of that, the industry has been rocked by corporate scandals - including the growing of unlicensed cannabis - as well as lower than expected retail sales in Canada and legal states like California, disappointing earnings, and a spate of lung injuries associated with vaping.