Canadian cannabis producer CannTrust is warning customers to expect product shortages after Health Canada said the company broke rules by growing cannabis in greenhouse rooms that didn't have a licence to operate at the time.

Vaughan, Ont.-based CannTrust grows much of its product at a large greenhouse operation in Pelham, Ont., near Niagara Falls. The facility has 12 rooms, all currently licensed to produce cannabis. Between October 2018 and March 2019, however, Health Canada says the company was growing marijuana in five rooms that had yet to obtain an official licence to do so.

"These rooms were constructed in accordance with regulations and good production practices, and licences were issued for each of the five rooms in April 2019," the company said.

Some CannTrust employees also provided inaccurate information to the regulator, the federal department said.

As a result, Health Canada has put a hold on roughly 5,200 kg of dried cannabis that was cultivated in those five rooms during the period in question until it deems the company has complied with regulations.

Conducting quality checks

In addition, CannTrust says it is voluntarily putting a hold on about 7,500 kg of dried pot that it says was previously manufactured in those rooms.

For reference, CannTrust only sold 3,014 kilos of cannabis last quarter, so that means the company now has roughly an entire year's worth of supply sitting on shelves, unable to be sold, for the moment.

"We believe there is meaningful risk to revenue growth over the coming months," RBC Capital Markets analyst Douglas Miehm said. "CannTrust shares may also trade at a wider discount to the peer group, given the outstanding questions about the company's internal quality controls and/or governance," he said in a note to clients.

The lessons we have learned here will serve us well moving forward. - Peter Aceto, chief executive

Health Canada is currently doing quality checks on the company's products, a process that is expected to take up to two weeks. While that's happening, the company is warning its customers to expect delays and shortages.

"All product sold from the impacted rooms has passed quality control testing at Health Canada certified labs as well as CannTrust's own quality control processes and safety reviews," CannTrust said.

"We have made many changes to make this right with Health Canada," CannTrust chief executive Peter Aceto said in a release. "We made errors in judgment, but the lessons we have learned here will serve us well moving forward."

Ryan Tomkins, an analyst with Jefferies, said that in the near term there will "undoubtedly be a financial impact."

Impact on credibility

"They will have to go to the open market to fill the shortage gap with little bargaining power, which means they could pay inflated prices or take inferior product which could lead to lost market share," he said in a note to clients.

In the long term, there will be an impact on CannTrust's credibility, Tomkins added.

"The fact the company never spotted this, or indeed still doesn't know how it happened, is a concern," he said. "For us, this will make institutional investors think twice, and could also likely make it harder for CannTrust to attract high quality" partnerships with consumer-packaged goods companies.

The initial reaction from investors was to sell off the shares, as the company's stock plunged almost 23 per cent on the TSX on Monday, to $5 a share — their lowest level since 2017.

Investor John Mastromattei, who keeps a close eye on the cannabis sector but doesn't currently own any CannTrust shares, says the move is a major hit to the company's reputation.

"Management's reputation is completely tarnished," he said in an interview, and that has spread to the rest of the sector, for fear there may be more similar cases out there.

"It's taken a huge negative on all of the Canadian-licensed producers."