Last month, I wrote an article about the cannabis sector, pointing out that supply growth is massively overshooting limited legal demand growth in Canada. Since then, Q2 earnings proved out this point. You know it’s bad when industry leader Canopy Growth (CGC – USA) grows net revenue by 249% but sees gross margin shrink from 43% to 15% (yea, I know, there’s some moving pieces to the gross margin number but the magnitude is the key). These numbers are horrid. The industry is screwed. The more they produce, the worse they do. The only question now is; when does Constellation Brands (STZ – USA) take their impairment?
With that backdrop, why have I booked my short position? To start with, in a month, I’m up quite a lot (these stocks have dropped by 20 to 50%). Secondly, despite their best efforts to light their capital on fire, most of these companies raised substantial capital at the top. It will take some time for them to go bust. Finally, put premiums are expensive, my short calls keep getting assigned to me and borrow costs are running a few percent a month depending on the name. I think all of these share prices are much lower in a year or 2, but that’s a long way forward with an expensive carry. The easy money seems to have been made.
Knowing my own personal history, once these companies have burned through their capital bases and trade for a fraction of their invested capital, I’ll probably be long a basket of these names. Then I’ll probably lose half before they finally bottom and give some nice gains. We can discuss that in a few years. For now, I’m flat.
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