Momentum in the marijuana industry has been practically unstoppable in 2018. This year, we've witnessed Canada lift a nine-decade prohibition on recreational cannabis, watched the U.S. Food and Drug Administration approve its very first cannabis-derived drug, and saw two additional U.S. states -- Missouri and Utah -- legalize pot in some capacity. Oh yeah, and Michigan became the 10th state to OK recreational weed use for adults. Just your run-of-the-mill breakthrough year for cannabis.
But as we transition from an environment where marijuana stocks offered promises galore and into a legalized setting (at least in Canada), investors' attention now turns to tangible results. Translation: Marijuana stock earnings reports actually matter now.
Over the past week, some of the biggest names in the industry -- Canopy Growth Corp. (NYSE:CGC), Aurora Cannabis (NYSE:ACB), Tilray (NASDAQ:TLRY), and Cronos Group (NASDAQ:CRON) -- reported their quarterly operating results. Though no two marijuana stocks are the same, the operating results from these four polarizing pot stocks revealed a number of trends that could prove prominent throughout the industry.
1. Sales are surging
This probably goes without saying, but year-over-year sales growth for marijuana stocks has been exceptionally strong, albeit year-ago sales were relatively low considering that only medical cannabis was legal in Canada and foreign exports were minimal.
Canopy Growth delivered the "weakest" sales growth in percentage terms at 33% to 23.3 million Canadian dollars. It, however, had the highest year-ago quarterly sales of CA$17.6 million. Meanwhile, Aurora Cannabis, Tilray, and Cronos Group recorded year-on-year revenue improvement of 260%, 86%, and 186%, respectively. Then again, year-ago sales for these growers totaled only CA$8.2 million, $5.4 million (Tilray reports in U.S. dollars), and CA$1.3 million, respectively.
The Canadian cannabis industry hasn't even scratched the tip of the iceberg in terms of annual sales potential domestically and abroad, so investors can expect triple-digit sales growth for pretty much every quarter for probably the next two years.
2. But so are expenses, at even a faster rate
If you think revenue is growing quickly, then you haven't taken a closer look at expenses for marijuana stocks, because they're growing at an even faster rate than sales. This shouldn't surprise investors, as pot stocks are busy completing their capacity expansion projects, ramping up their marketing and branding, laying the groundwork to expand overseas, broadening their product portfolios, and, in some cases, using share-based compensation to acquire new businesses. The result has been steep operating losses.
In terms of expenses, Canopy Growth takes the cake -- and not in a good way. Sales and marketing costs more than quintupled to CA$39 million, general and administrative expenses surged more than fourfold to CA$37.1 million, and share-based compensation (all forms) nearly hit CA$96 million, up from just CA$7 million in the year-ago period. All told, Canopy lost CA$214.6 million on an operating basis and CA$330.6 million for the quarter. Yuck!
Similar figures were seen with the other major players. Aurora Cannabis produced an operating loss of CA$111.9 million, Tilray lost $20 million on an operating basis (again, U.S. dollars for Tilray), and Cronos Group's operating loss was CA$4.9 million.
3. There's no recreational impact yet
Although it was the expectation from the outset, marijuana stock investors are probably a bit disappointed to find out that there's been virtually no impact from the recreational legalization of cannabis in the latest round of earnings reports. The recently ended quarters for these companies cut off at Sept. 30, 2018, and legalization didn't officially occur until Oct. 17, 2018, meaning investors will need to wait one more quarter before any sales impact is recognized.
Market-cap kingpin Canopy Growth and expected production leader Aurora Cannabis wound up recognizing just CA$0.7 million and CA$0.6 million, respectively, in recreational market revenue in their latest reports.
4. Fair-value adjustments can swing both ways
One of the most interesting revelations with the newest round of marijuana earnings reports is that fair-value adjustment of biological assets (i.e., cannabis plants) is a two-way door.
Canadian companies (not including Tilray) report their financial results using International Financial Reporting Standards, or IFRS. IFRS accounting differs from GAAP accounting in the U.S. in a variety of ways. Perhaps the most interesting difference, considering that marijuana growers are considered agricultural companies, is that the value of biological assets constantly must be adjusted throughout their growing cycle. In other words, the value of flowering cannabis plants differs from that of nonflowering plants. These fair-value adjustments also include the cost of goods sold prior to the actual sale of said goods, which, as you can imagine, can lead to wild above-the-line fluctuations.
Until recently, most pot stocks have benefited from IFRS accounting. As capacity has expanded, marijuana companies have recognized a higher value for their biological assets. But this isn't always going to be the case. In the recent quarter, Canopy Growth's fair value adjustment turned its gross profit of CA$6.6 million into a loss of CA$34 million. This door swings both ways, and investors need to realize it.
The time for wishful thinking about cannabis companies is over. Investors have concrete results to rely on now.