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3 Pot Stocks With Skyrocketing Short Interest

Sean Williams, The Motley Fool

Since the year began, the marijuana industry has seemingly done no wrong. Following the legalization of recreational marijuana in Canada in mid-October, Wall Street is projecting that global weed sales could top $50 billion in roughly a decade's time . And with a compound double-digit annual growth rate comes some very lofty expectations from investors.

The Horizons Marijuana Life Sciences ETF , the very first cannabis exchange-traded fund to list in Canada, and a fund that currently holds about four dozen pot stocks of various weightings, is up 63% year to date through this past weekend. With few exceptions, investors have been able to blindly throw a dart at marijuana stocks since Jan. 1 and come out a winner.

A man in a suit pressing the sell button on a digital screen.

Image source: Getty Images.

Pessimism is peaking with these three marijuana stocks

However, a precipitously rising market is also a recipe to draw short sellers out of the woodwork. Over the past month (through the end of February), quite a few pot stocks have seen a modest uptick in short interest. Aurora Cannabis , the projected largest producer at peak annual output, has seen the number of short shares held by pessimists rise to 72.08 million (as of Feb. 27), up from 71.03 million four weeks earlier. The same is true for the largest pot stock in the world, Canopy Growth , which had its shares short increase to 22.56 million from 22 million on the dot over the same four-week period. On a percentage basis, though, these increases in pessimism are relatively mild.

That, however, is not the case for three other pot stocks, which have seen their short interest skyrocket over the noted four-week time frame.

Village Farms International

Village Farms International (NASDAQ: VFF) , which uplisted to the Nasdaq exchange earlier this year, has seen its short interest more than double since the end of January. Using data from the Toronto exchange (since the move to the Nasdaq was recent), Village Farms' short shares have risen from around 600,000 at the end of January to 1.44 million by the end of February.

The increase does make some degree of sense with Village Farms' stock rising by 342% just since the year began. Uplisting does help the company improve visibility and liquidity, so that may have helped its share price a bit. The bigger lift, though, comes from the completion of Pure Sunfarms' first sales.

An indoor cannabis grow farm under special lighting and ventilation.

Image source: Getty Images.

Pure Sunfarms is a joint venture between Village Farms International and Emerald Health Therapeutics (NASDAQOTH: EMHTF) that involves retrofitting just over 1 million square feet of vegetable-growing facilities in British Columbia to cannabis production. The vegetable-growing facilities are owned by Village Farms, with Emerald Health handling the retrofit and bringing its cannabis industry knowledge to the table. When fully licensed and operational, the 1.03 million square feet devoted to growing space should yield at least 75,000 kilograms a year at its peak , beginning in 2020.

This past week, Village Farms reported a very small, but nonetheless surprising, fourth-quarter profit, as well as a microscopic profit from its Pure Sunfarms operations. However, a deeper dive into the company's results reveals a low margin and unexciting vegetable growing business that was partially buoyed in 2018 by one-time changes to the fair value of Pure Sunfarms' biological assets. Remove one-time benefits and costs, and Village Farms still has a lot to prove to Wall Street doubters.

Although this company has a nice fallback with its vegetable-growing business , Pure Sunfarms isn't truly delivering for Village Farms or its partner Emerald Health as of yet.

Insys Therapeutics

Near the end of January, drugmaker Insys Therapeutics (NASDAQ: INSY) had roughly 8.5 million short shares outstanding. But four weeks later, when the data was run again, its short interest had spiked to just shy of 11 million shares. That works out to more than 40% of Insys' outstanding float, and it suggests that pessimism is really growing.

A physician with a stethoscope around his neck holding a cannabis leaf between his hands.

Image source: Getty Images.

For those unfamiliar with the company, Insys has two Food and Drug Administration-approved therapies. One is a fentanyl-based sublingual spray known as Subsys for breakthrough cancer pain that has nothing to do with cannabis, while the other is Syndros, an oral dronabinol solution for the treatment of chemotherapy-induced nausea and vomiting. Dronabinol in the scientific term for synthetically produced tetrahydrocannabinol (THC), the cannabinoid that gets a user high. The problem? Both drugs are absolute cement blocks right now .

Around a half-dozen former Insys executives, including its billionaire founder, John Kapoor, were arrested in 2017 and charged with bribing physicians to prescribe Subsys for off-label use. It appears that 80% of the peak $330 million in annual sales tied to Subsys wasn't for breakthrough cancer pain. As a result, physician, patient, and insurer trust has been lost in Insys, with sales of its lead drug plunging to $78.8 million in 2018.

As for Syndros, its once highly touted new therapy with perhaps $200 million in peak annual sales managed just $3.3 million in full-year sales in 2018, and has totaled less than $4.8 million since its launch in the summer of 2017. In other words, it's a complete flop.

The icing on the cake is that Insys' annual report also included a going-concern warning , suggesting that it may not have the capital necessary to keep the lights on. All told, rising short interest seems warranted, given the challenges that lie ahead.

Innovative Industrial Properties

Another hot pot stock that suddenly finds itself in the grasp of pessimists is cannabis real estate investment trust (REIT) Innovative Industrial Properties (NYSE: IIPR) . Since the end of January, the company's outstanding short interest has risen from 1.31 million shares to 2.11 million shares, which now represents almost 23% of its float.

A cannabis processor holding a freshly trimmed bud in their left gloved hand.

Image source: Getty Images.

The marijuana REIT model involves purchasing land and facilities (i.e., cultivation farms and processing facilities) that are then leased out for an extended period. The rental income these long-term leases provide, coupled with a 3.25% annual rent increase and a 1.5% management fee based on the rental rate, are what provide steady cash flow and modest organic growth for Innovative Industrial Properties. According to the company, which now owns 13 properties in 11 states, it has an average lease length of 14.3 years, and a return on invested capital of 15.1%. Essentially, it should recoup its invested capital within five years.

As one of the only profitable pure-play pot stocks, you might be wondering why short sellers are picking on Innovative Industrial Properties. Part of the reason might be its forward price-to-earnings ratio of more than 40. REITs are a traditionally slow-growing business, with the aforementioned organic growth likely amounting to near 4%. The bulk of the company's income growth is derived from acquisitions , which makes a forward P/E of more than 40 sort of pricy.

The other probable reason for pessimists to be piling on is the expectation that Innovative Industrial Properties will continue to sell its stock to raise capital in order to buy more properties. Selling stock to raise cash is really common for REITs, but it can be dilutive to existing shareholders. Having undertaken two big capital raises last year , short sellers might be counting on another coming relatively soon.

While a pullback could certainly be justified, it's by far the strongest performer (from an income perspective) of the three pot stocks mentioned here, so take your pessimism with a heavy dose of caution.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends Innovative Industrial Properties and Nasdaq. The Motley Fool has a disclosure policy .