We are seeing the second consecutive day of price weakness in the Cannabis Sector after a mini-rally in the first week of September. Shorts in the top 20 most shorted Cannabis Stocks were up over +$100 million in mark-to-market profits yesterday and are up over +$44 million in mid-morning trading.
Cannabis shorts started off the year deeply in the red, the 20 largest shorts in the sector were down -$1.78 billion in mark-to-market losses in the first quarter of 2019. Their fortunes reversed in the second and third quarters with the cannabis sector gave back some of its 2017-18 rally. The largest shorts were up +$336 million in mark-to-market profits in the second quarter and up +$1.17 billion so far in the third quarter.
We follow 150 securities in the Cannabis sector with a total market cap of $100 billion and short interest of $5.0 billion. Short interest in the Cannabis sector is up $2.20 billion, +79%, in 2019. While the Cannabis sector does not have many heavily shorted securities, with a Short Interest % of Float of 10.40% versus 11.48% for the overall domestic equity market, it is an expensive sector to short stocks. The average cost to borrow Cannabis stocks is 24.27% fee versus 0.78% fee for the overall domestic equity market. Short selling is fairly concentrated to a handful of names, with the top 20 shorts making up over 84% of the total shorting executed in the sector with a Short Interest % Float of 15.81%.
In September, weâ€™ve seen an overall increase in short covering with over $30 million of buy-to-covers in Aphria Inc (APHA US, APHA CN), Cronos Group (CRON US, CRON CN) and Green Organic Dutchman (TGODF US, TGOD CN). There was not much short selling in the sector with Hexo Corp (HEXO US, HEXO CN), Canopy Growth (CGC US, WEED CN) and Aurora Cannabis (ACB US, ACB CN) having less than $14 million of new short selling so far in September. Overall, shares shorted in the sector decreased by -$16.7 million in September.
Shorting stocks in the Cannabis sector is an expensive proposition. While the average stock borrow fee for the sector is 24.27% the cost to short the top twenty most shorted names is almost 3.5% higher, at 27.74% fee. There are several stocks with borrow rates over 30% fee with Tilray Inc (TLRY US), Green Organic Dutchman (TGODF US, TGOD CN), Canopy Growth (CGC US, WEED CN) and Aurora Cannabis (ACB US, ACB CN) being the most expensive borrows in the sector. In aggregate, total daily short financing costs for the top 20 most shorted names in the sector cost short sellers $3.83 million per day. With such a high cost of financing eating into short sellersâ€™ Alpha there is a higher urgency to be correct quickly in their short thesis.
While recent mark-to-market profits have lessened the overall threat of a short squeeze in the Cannabis Sector there are specific securities that are still valid short squeeze candidates. Tilray (TLRY US), Aurora Cannabis (ACB US, ACB CN) and Aphria (APHA US, APHA CN) are still candidates for a short squeeze if the stocks return to rally mode. Their high financing costs due to lending illiquidity and in the case of Aurora and Aphria, continued large year-to-date mark-to-market losses make them more susceptible to short squeezes during upward trending markets. Future partnerships and consolidations in any of these highly shorted cannabis stocks could quickly force short sellers to cover their positions and push stock prices even higher. The sector continues to be volatile and ripe for sudden and impactful price reversals which can be a boon or a bust for short sellers.
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Managing Director Predictive Analytics, S3 Partners, LLC
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