The marijuana industry is coming off of an incredible year in which it gained validity like never before. This legitimacy primarily comes from the legalization of recreational marijuana in Canada. Putting an end to nine decades of prohibition, the legal Canadian weed industry should be capable of $5 billion (or more) in annual added sales by the early part of the next decade.

There was also positive news in the U.S. and in various countries around the world. A handful of U.S. states legalized cannabis in some capacity, the U.S. passed the Farm Bill, legalizing hemp and hemp-based cannabidiol in the process, and previously staunch opponents of cannabis, like Thailand, passed medical pot legislation.

Unfortunately, this game-changing year didn't translate into success for marijuana investors. A majority of big-name pot stocks ended 2018 substantially lower than they began it. How could pot stocks decline when all of the news surrounding the weed industry has seemingly been positive? The simple answer is that things aren't as good as they appear to be, and one company proved that earlier this week.

A bottle of dried cannabis buds tipped over atop a messy pile of cash bills.

Image source: Getty Images.

Earnings season is off to a less-than-green start for pot stocks

On Tuesday morning, Jan. 8, Aurora Cannabis (ACB -3.37%) became the first marijuana stock to issue sales guidance in a postlegalization environment. This is particularly noteworthy given that Aurora Cannabis is on track to become the largest grower by peak annual production. Following its now-complete buyout of ICC Labs in South America, yours truly has opined that 700,000 kilograms in annual yield isn't out of the question by perhaps 2021. Thus, not only are we getting our first look at how a marijuana grower performed in Canada during the first legalized quarter, but it just so happens to be the projected top producer in Canada.

The early-morning press release called for the company sales to range between 50 million Canadian dollars and CA$55 million in its fiscal second quarter. That compares to CA$11.7 million in the year-ago period and CA$29.7 million in the sequential first quarter.

Of note, Aurora now has 71,000 registered medical patients in Canada and is operating at a run rate of 100,000 kilograms per year as of the end of calendar year 2018. It now anticipates increasing its annual run rate to 150,000 kilograms by the end of its fiscal third quarter (March 31, 2019), which is a full quarter ahead of its prior estimates, which had called for 150,000 kilograms in run rate by the end of its fiscal year (June 30, 2019). 

But the big problem with this outlook is that Wall Street had been looking for CA$67.4 million in sales, with analyst estimates ranging from CA$60 million to almost CA$75 million. In other words, Aurora completely missed the mark.

With demand as strong as it is, how on Earth does the projected largest grower in Canada whiff so badly? Let's take a closer look at five standout reasons.

Scissors cutting a hundred-dollar bill in half.

Image source: Getty Images.

Five reasons pot stocks are going to disappoint this quarter

To begin with, and to give Aurora a little leeway, Wall Street really has no clue what to expect from pot stocks in the recently ended quarter. No industrialized country has legalized recreational marijuana before, so sales expectations and profitability are just as much guesswork as they are connecting the dots at this point. Given how wide Wall Street's revenue expectations are for most pot stocks, we can likely expect instances like this to be common this quarter.

Second, don't forget that many of these cannabis growers are still months or years away from completing their capacity-expansion projects. Sure, Aurora Cannabis has 700,000 kilograms in peak capacity at its disposal, but it'll probably take another 12 to 18 months before these projects are complete. At the moment, the company is only producing at one-seventh of what I perceive to be its annual potential output. This is true of every grower out there, and it is one reason why domestic demand simply isn't being fully met.

Third, and to make matters worse, regulatory red tape is exacerbating pot shortages in select provinces. As of May, regulatory agency Health Canada had a backlog of more than 500 cultivation licenses to approve or deny. Likewise, sales permits were taking an average of 341 days (more than 11 months) to approve. As growers race to complete their greenhouse projects, they could just as easily be stymied by cultivation license and sales permit backlogs.

Fourth, go ahead and blame the black market. Illicit producers don't have to wait for cultivation licenses and sales permits, and they certainly don't pay excise or income taxes on pot sales. This allows the black market to consistently undercut legal producers like Aurora on price and to pick up the production slack when the legal industry is unable to fulfill demand. If even a small percentage of consumers chooses to remain in the illicit channels, it'll reduce sales estimates for growers like Aurora Cannabis.

A lit cannabis joint being held in front of a red maple leaf.

Image source: Getty Images.

And finally, alternative consumption options are still limited. When the Cannabis Act was approved, dried cannabis flower, cannabis oils, and sublingual sprays were the only forms of consumption given the green light. Other high-margin options that could appeal to a broad base of consumers, such as vapes, edibles, and cannabis-infused beverages, are waiting on approval this coming summer from Canada's Parliament.

All five of these points paint the picture of why Aurora Cannabis missed the mark in Q2 2019 and why other growers might follow in its footsteps. These are the growing pains pot stock investors must be prepared to deal with if they're going to invest in the cannabis industry.

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