If you've invested in the marijuana industry over the past couple of years, there's a good chance that you're seeing green. Many of the top pot stocks have delivered triple- and quadruple-digit percentage moves higher over the trailing three-year period.
The primary impetus for this rally is the legalization of recreational cannabis in Canada. Prime Minister Trudeau had been angling to legalize the drug for years, but was finally able, with the assistance of Parliament, to push through the Cannabis Act this year.
However, what many investors have overlooked is just how long it's going to take before growers have their capacity up to spec. Although nearly 1.9 million kilograms could be produced by the country's five top growers once they're at full capacity, these five growers are only producing at a meager annual run rate of about 150,000 kilograms at the moment. This means investor expectations for marijuana stocks are more than baked in (pun fully intended). It also suggests that a handful of pot stocks could be worth avoiding like the plague this December.
I take a lot of flak for my consistently negative opinion of Aurora Cannabis (NYSE:ACB), but a quick glance at the company's most recent operating results shows why that negativity is well deserved. Even though Aurora Cannabis is on track to be the largest producer by yield, with an author-estimated 700,000 kilograms of annual output (if not higher) following its ICC Labs acquisition, the problem lies in the company's acquisition-heavy approach, which creates a number of concerns.
To begin with, I worry about Aurora Cannabis' ability to optimally integrate all of its recent acquisitions, which includes ICC Labs, MedReleaf, and CanniMed. Even though these operations presumably have synergies, there are no guarantees that Aurora will stay on track with so many acquisitions in such a short time frame.
I also am concerned with just how much money Aurora is losing on an operating basis. Sure, the company produced a 105.5 million Canadian dollar profit in the first quarter, but that came with a pretty huge asterisk. That being the benefit of a one-time asset disposition tied to its influential stake in The Green Organic Dutchman, and an CA$85.8 million unrealized gain on derivatives. However, strip these benefits out and focus solely on revenue, costs of goods sold, and operating expenses, and the company produced a loss of almost CA$112 million. Yuck!
Lastly, Aurora's acquisition-hungry strategy has ballooned its outstanding share count, with 961.8 million shares now outstanding. Mind you, this doesn't account for the shares it just issued to complete its CA$290 million deal to buy ICC Labs. At the end of the prior-year quarter, Aurora had 371.9 million shares outstanding, and less than five years ago had just 16 million shares. The higher this share count goes, the more difficult it'll be for the company to generate a meaningful per-share profit. Aurora is worth avoiding at all costs in December.
Turning to the cannabinoid drug-development market, I don't think investors want anything to do with GW Pharmaceuticals (NASDAQ:GWPH) in the near term.
Now, I know what you're probably thinking, and I do understand those opinions. Yes, GW Pharmaceuticals just launched its leading drug, Epidiolex, less than a month ago. And yes, this means sales could shoot higher right out of the gate as prescription data becomes available. But I'd rather play the role of skeptic here for a variety of reasons.
One turnoff is the cannabidiol-based drugs' annual cost of $32,500 to treat two rare forms of epilepsy – Dravet syndrome and Lennox-Gastaut syndrome. Although GW Pharmaceuticals asserts that this is in-line with competing epilepsy medications, and Epidiolex is unique in being the only approved treatment for Dravet syndrome, this isn't an easily overlooked cost for physicians, patients, or insurers. It's not uncommon for insurers to push back on newly listed, pricey drugs, and that could be the case with Epidiolex.
Second, even though there's little precedent to cannabis-like drugs making it to pharmacy shelves, what examples we do have aren't very encouraging. Recently, I blasted Insys Therapeutics (NASDAQ:INSY) as a stock to avoid after it reported miserable quarterly operating results. In particular, Insys announced its intention to sell its troubled line of opioid-like products and instead rely on its pipeline and oral dronabinol solution known as Syndros (dronabinol is a synthetic form of tetrahydrocannabinol, the cannabinoid that gets a user "high"). The thing is, despite being unique, Syndros has been a complete dud, with just $2.61 million in registered net sales year-to-date. And please note, this was a drug that had forecasts of $200 million to $300 million in peak annual sales when Insys first launched it last year. The performance of Syndros suggests Epidiolex may run into similar issues out of the gate.
Lastly, there's potential competition looming from Zogenix. In pivotal-stage trials, ZX008 handily met its primary endpoint in treating Dravet syndrome patients. In short, GW Pharmaceuticals' competitive advantage could prove short-lived. It's a stock to avoid for now.
A third stock I'd strongly suggest investors keep their distance from in December is MedMen Enterprises (NASDAQOTH:MMNFF), an upscale retailer and grower of cannabis. The company currently operates 14 stores in three U.S. states, which goes along with five cultivation facilities.
The bull thesis here is pretty simple to understand: MedMen is attempting to normalize the cannabis-buying experience in what could become the largest pot market in the world. With sales per square foot that actually top those of Apple stores, and the recently announced $682 million deal to buy PharmaCann, thus doubling its presence to 12 states, adding 18 retail licenses, and eight cultivation facilities, there's a lot for investors to seemingly be excited about.
However, I'm not very excited about a high-end retail operation that'll need to spend an exorbitant amount of money to open new stores and construct production facilities in order to vertically control its supply. Over the long run, if recreational weed were legalized throughout the U.S., it would be a cost that fundamentally focused investors might be able to stomach. But right now it's not.
According to the company's full-year report, it generated $13.1 million in gross profit after cost of goods sold, but logged $110.4 million in total expenses, leading to a $96.6 million net loss. General and administrative expenses catapulted to $96.2 million, up from $14.1 million in fiscal 2017. With MedMen aiming for around 50 stores by 2020 (even before announcing the PharmaCann deal), and now having to absorb the costs of its pricey PharmaCann buyout, it's unlikely that it'll produce a profit anytime soon. I simply see no sense in holding a $1.6 billion company that'll probably lose more than $100 million on an operating basis in each of the next two years.
Sean Williams has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.