Not every marijuana stock can be a winner in the fast-growing cannabis industry.
Marijuana will likely be one of the fastest-growing industries this decade. With tens of billions of dollars sold in the North American black market each year, it’s only logical to assume that, over time, consumers will shift to legal channels in Canada (the first industrialized country in the world to legalize adult-use weed in the modern era) and the United States.
But this growth won’t be without early stage hiccups. For the past 17 months, pot stocks have struggled mightily under the weight of regulatory issues, supply concerns, high tax rates on legal product, and the inability to secure traditional forms of financing. Ultimately, not every cannabis stock is going to be a winner.
As we move headlong into September, three pot stocks stand out as particularly avoidable during this “growing pains” phase the industry is navigating through.
Easily one of the most avoidable pot stocks in September also happens to be one of the most popular among millennial investors. I’m talking about none other than Canadian licensed producer Aurora Cannabis (NYSE:ACB).
This issue with Aurora is that the company investors thought they were buying for the long run isn’t the same company they own today. Aurora was expected to be the clear-cut global cannabis output leader with some of the lowest per-gram production costs in the industry. It also had access to more than two dozen international markets, so it was expected that exports would pick up almost immediately. But none of this has come to fruition.
Since the fourth quarter of 2019, we’ve witnessed Aurora Cannabis completely overhaul its operations. It’s shut down five of its smaller cultivation farms, sold off a 1-million-square-foot greenhouse (Exeter), and halted construction on two of its largest facilities (Aurora Sun and Aurora Nordic 2). The company has also enacted layoffs to reduce its selling, general, and administrative expenses. These moves were long overdue. Unfortunately, backpedaling to profitability isn’t the same as steamrolling toward profitability in a fast-growing industry.
The issue for Aurora Cannabis remains the company’s balance sheet. On one hand, it’s had virtually no means of raising capital beyond issuing stock. Its board approved a $350 million at-the-market offering earlier this year, which will continue a theme of ballooning the company’s outstanding share count to fund acquisitions and general operating expenses. In a six-year stretch, Aurora’s outstanding share count has jumped more than 80-fold, and its shareholders are the ones who’ve paid the price.
On the other hand, Aurora’s total assets are grossly overvalued. Just over half of the company’s assets are goodwill, with intangible assets, inventory, and property, plant, and equipment all in need of a proper revaluation.
Despite reporting its fiscal fourth-quarter operating results this month, I’d suggest avoiding Aurora Cannabis.
While there’s no question that U.S. multistate operators (MSO) have run circles around their Canadian counterparts, not all MSOs are going to be worth investing in. More specifically, I’d suggest keeping your distance from Acreage Holdings (OTC:ACRG.F) in September, and perhaps well beyond.
The story here is similar to Aurora in that early investors bought into one story, which has now dramatically changed. This was supposed to be an MSO that would have a broader presence across the U.S., in terms of retail footprint, cultivation, and processing, than any other MSO. But following the termination of its Deep Roots acquisition and other cost-saving measures, the Acreage investors see today doesn’t stand out from its peers.
As of the second quarter, Acreage had 27 operational dispensaries and the ability to open as many as 71 dispensaries across 15 states. At one time, investors were expecting Acreage to have a presence in close to 20 states, with far more than 71 dispensary licenses. In the latest quarter, this translated into $27.1 million in sales and an adjusted net loss on a pro forma basis of $11.1 million. By comparison, Trulieve Cannabis generated nearly $121 million in sales in its most recent quarter with only 52 operational dispensaries. Although geography plays a role, Acreage Holdings’ sales growth and push toward profitability have been unimpressive.
Another major issue for Acreage is that it’s agreed to be acquired by Canada’s Canopy Growth (NYSE:CGC) on a contingency basis in a now-amended cash-and-stock deal. The contingency being that the U.S. federal government must legalize cannabis in order for the deal to come to fruition. Even if Democratic Party nominee Joe Biden wins in November, and the Democrats manage to take a majority of the seats in the Senate, Biden is no lock to support anything more than decriminalizing marijuana at the federal level.
What’s more, this deal has tied Acreage at the hip to Canopy Growth’s share price. Canopy Growth is in the midst of an overhaul of its own that’s seeing new CEO David Klein shutter millions of square feet of licensed indoor production and cut jobs in order to reduce expenses. As Canopy Growth flounders in Canada, so might its share price, and that of Acreage Holdings along with it.
The third and final pot stock you’d be wise to avoid in September is yet another Canadian licensed producer: HEXO (NYSE:HEXO).
To keep with the ongoing theme, shareholders of HEXO have witnessed their vision of the company completely shift over the past 11 months.
At one time, HEXO looked like a surefire winner with minimal risk. It had signed a 200,000 kilo-in-aggregate deal with its home province of Quebec over a period of five years, and had acquired Newstrike Brands to bolster its annual production capacity to around 150,000 kilos of cannabis. Investors thought they were buying into a company that had plenty of committed cannabis and a clear focus on higher-margin derivatives.
But over the past couple of quarters, HEXO has spent much of its time backpedaling to control its costs. The Niagara facility, which was acquired in the Newstrike deal, was sold for a meager $10.25 million Canadian in mid-June. Meanwhile, the company has shed jobs and reduced operating capacity at its flagship Gatineau campus.
Similar to Aurora Cannabis, HEXO has had little choice but to turn to at-the-market offerings to raise capital. Three weeks ago, it completed a CA$34.5 million at-the-market offering program, with nearly 34 million shares of stock being sold. This constant dilution continues to pressure existing shareholders.
And as the icing on the cake, HEXO has been trading below the $1 continued minimum listing price for the New York Stock Exchange for months. After receiving a delisting notice in April, a coronavirus pandemic-related extension will give HEXO till Dec. 16 to get its share price back into compliance. It’s looking very possible that a reverse split could be on the horizon to avoid delisting.
HEXO is a mess and is best avoided by long-term cannabis investors.
Author: Sean Williams
Source: Fool: 3 Pot Stocks to Avoid Like the Plague in September