In just over two more months, marijuana investors should begin to "see the green." After years of promises and months of debate, the Cannabis Act, which legalizes recreational marijuana, was passed by Canada's Parliament on June 19. By Oct. 17, 2018, adult-use weed will officially go on sale.
While estimates vary wildly, as is to be expected with no industrialized country in the world having given the green light to recreational pot before, the industry could generate an additional $5 billion in sales once it's fully ramped up. With domestic demand expected to be strong, and export opportunities abounding, investors believe pot stocks could be the next-greatest thing since sliced bread.
But as with all investable industries, there will be winners and losers. It's my opinion that the following three marijuana stocks can be safely left out of your investment portfolio for the time being until they prove their value to Wall Street and investors.
Make no mistake about it, Aurora Cannabis (NYSE:ACB) is one of the most popular marijuana stocks of the group. It's been extremely active this year, expanding its production capacity via organic build announcements, partnerships, and acquisitions. In fact, it recently completed the biggest deal in cannabis history when it gobbled up Ontario-based MedReleaf for about $2.5 billion.
On one hand, there's certainly value in being a cannabis kingpin. With all of this added production capacity, Aurora Cannabis has forecast more than 570,000 kilograms of peak annual production. Though output remains fluid, depending on the grower, this could put Aurora Cannabis in pole position in terms of domestic production. Plus, with the company focusing on medical cannabis patients, margins should be notably higher than pot stocks focusing on recreational consumers.
The issue is that Aurora Cannabis has flooded the market with its common stock through multiple bought-deal offerings. Since access to basic banking services wasn't a thing prior to the passage of the Cannabis Act, the only way to build its weed empire was to issue stock in order to raise capital. Now, with perhaps 1 billion shares outstanding, it's investors who've paid the price.
While investors might see Aurora Cannabis's $5 share price and perceive a bargain, they have to remember that this still equates to a massive market cap because of its bloated outstanding share count.
Furthermore, the company would need to generate perhaps $200 million in net income just to not scare fundamentally focused investors away at its current share price. It could be a long time before the company reaches those levels. This is a pot stock that can safely be left out of your portfolio for now.
Here's the thing about investing in the cannabis industry: It's very easy to like a company's business model, but absolutely loathe its valuation. That's the case with posh cannabis dispensary MedMen Enterprises (NASDAQOTH:MMNFF), which became the largest U.S.-based company to list its shares in Canada.
MedMen's mission is to normalize the sale and consumption of marijuana, as well as control the vertical supply chain of pot in its dispensaries. Thus far, it appears to be doing an excellent job of that in its three major markets: California, Nevada, and New York. With three new stores in development in Nevada, the company will soon have 16, with aspirations of expanding this count to 50 by 2020. It owns a handful of cannabis grow farms, too, since U.S. law prohibits the interstate transport of marijuana. Going public should allow MedMen the ability to raise capital with greater efficiency going forward.
It's also partnered up with Cronos Group to bring its brand north of the border once the official green flag waves on recreational weed sales. Though the U.S. market is clearly its focus, there's no denying the opportunity that Canada could offer, at least in provinces that allow private retailers to operate.
The biggest concern I have with MedMen is just how much of its capital will be thrown at expanding its retail presence over the next two-and-a-half years. Understand that I fully agree with management's decision to bolster its presence in key markets. The problem is that spending on new locations is probably going to ensure steep losses for some time to come. While factoring in the importance of branding, I just don't see how a $1.25 billion valuation can be squeezed out of this company at the moment. Until we see genuine bottom-line improvement, there's no need to own MedMen Enterprises.
Then there are marijuana stocks that have no feel-good story whatsoever and should be just plain avoided, like drug developer Insys Therapeutics (NASDAQ:INSY).
Insys has been a mess since the end of 2015, with a number of former executives being arrested. The company's legal and financial woes stem from fentanyl-based Food and Drug Administration (FDA)-approved drug Subsys, which generated around $330 million in sales in 2015. Allegations suggest that Insys knowingly and willingly coerced physicians to prescribe Subsys for off-label use (it was approved to treat breakthrough cancer pain). This resulted in as much as 80% of all Subsys prescriptions being written for off-label use. Insys could now face steep fines and possible sales restrictions, and it has seen its extrapolated annual sales of the drug fall below $100 million as of the second quarter.
Making matters worse, the FDA sent a Complete Response Letter (CRL) to Insys last month regarding its buprenorphine sublingual spray, which is targeted at moderate to severe acute pain. A CRL is essentially a rejection letter that outlines the deficiencies a drug developer would need to tackle in order to have their drug reconsidered for approval. In Insys' case, efficacy wasn't the issue. Instead, the FDA has safety concerns with the drug, which could be very difficult for the company to overcome without running additional costly studies.
And then there's Syndros, a dronabinol-based oral solution aimed at treating chemotherapy-induced nausea and vomiting and anorexia associated with AIDS. Dronabinol is a synthetic form of tetrahydrocannabinol (THC), the psychoactive component of cannabis that makes you "high." Expected to launch out of the gate, Syndros has fallen flat, with $637,000 in total sales in first-quarter sales. It's taken about two-and-a-half quarters for Syndros to tally just over $2 million in sales, which doesn't bode well for its future.
With legal issues looming large, Insys Therapeutics is a pot stock to keep out of your portfolio.