The marijuana industry, and once again marijuana stocks, are blazing hot. Following the end to nine decades of recreational marijuana prohibition in Canada this past October, the red carpet has been rolled out for what's now a legitimate business model. Sales in Canada could easily top $5 billion annually by the early part of the next decade, with global sales expected to more than double from $12.8 billion in 2018 to $31.3 billion by 2022, according to a report from Arcview Market Research and BDS Analytics.
As you might imagine, this expectation of rapid sales growth, and the eventual forecast of strong profitability, is what's responsible for sending pot stock valuations into the stratosphere. Following an abysmal fourth quarter, 15 marijuana stocks ended the month of January higher by at least 50%.
While this industry appears as if it can do no wrong, there are a handful of exceptionally popular pot stocks that you simply couldn't pay me to buy.
This probably comes as no surprise given that I recently referred to Cronos Group (CRON -2.01%) as the most overvalued marijuana stock, but I wouldn't buy into the company here even if I were given free money to do so.
The primary reason Cronos Group has essentially doubled in less than two months is because tobacco behemoth Altria (MO 0.82%) agreed to take a $1.8 billion equity stake in the company in December. Upon closing of the deal, the shares issued to Altria in exchange for this capital will give the tobacco producer a 45% stake in Cronos, with the possibility of upping its equity stake to 55% with the warrants it'll also be receiving. This marks the second major equity investment in the marijuana industry, and offers hope that Altria may wind up fully acquiring Cronos Group if its traditional tobacco volumes continue to fall. But even if Altria doesn't purchase the remainder of Cronos Group that it doesn't already own, Cronos will be left with north of $1.8 billion in cash to execute its long-term strategy.
While not oblivious to its envious cash position, it's the company's valuation relative to its strategy that has me baffled. At its peak, Cronos Group is on track to produce around 120,000 kilograms a year, which includes 70,000 kilos from its joint venture and 40,000 kilos from Peace Naturals. What's a real head-scratcher is that you can buy Canadian growers with, say, 100,000 kilos to 113,000 kilos in peak annual production with market caps of as low as $670 million -- i.e., basically a fifth of Cronos' existing market cap.
There's also been a lot of emphasis on international expansion, since domestic Canadian demand may only hit roughly 1 million kilos a year. With most of Cronos' larger peers focusing abroad, Cronos has only managed to really lay its footprint in Israel and Australia. In other words, it's really lagging its peers in terms of forging international sales channels.
Take away the $1.8 billion investment from Altria (which still hasn't closed), and add on a forward P/E ratio of more than 400, and you'll realize that there's really no good reason to buy into the Cronos Group growth story.
Tilray (TLRY), the second- or third-largest marijuana stock by market cap, depending on its constant dance with Aurora Cannabis for the No. 2 spot behind Canopy Growth, is another stock I wouldn't buy if you paid me to.
Tilray has found plenty of support from investors thanks to its well-known medical cannabis brands, its ability to push into new markets, and the fact that private-equity fund Privateer Holdings owns close to an 80% stake in the company, making for less chance of a major share dump, at least for now. The company's focus on high-margin alternative cannabis products is another big reason investors have given Tilray a lot of leeway, despite the company losing money.
But even with two notable deal announcements in December with Novartis and Anheuser-Busch InBev, I'm simply not impressed with a $7 billion market cap on a company with only a presumed 912,000 square feet of developed space, of which just over 850,000 square feet is devoted to growing capacity. With little in the way of production updates since the company's S-1 prospectus filing in June, prior to its July IPO, investors are left to believe that Tilray only has the capability of maybe 80,000 kilos in peak yield. That's a drop in the bucket compared to Aurora Cannabis and Canopy Growth and, as noted, investors could buy a grower with more annual production for a tenth of Tilray's current market cap.
Although I understand that investors are paying for the company's superior branding, its international push, and the comfort of having Privateer hold more than three-quarters of the company's outstanding shares, this valuation makes even less sense when you factor in the expected costs of expanding capacity further, as well as pushing into new markets overseas. There's a very real possibility that Tilray could be running in the red for years to come. At a $7 billion market cap, it's simply not a stock any fundamentally focused investor should be buying.
Finally, I wouldn't touch what's arguably the most successful publicly traded cannabinoid drug developer on the planet, GW Pharmaceuticals (GWPH).
I certainly understand the optimism surrounding GW Pharmaceuticals with the June 25 approval of its oral, cannabidiol-based lead drug Epidiolex for the treatment of two rare forms of childhood-onset epilepsy. The Food and Drug Administration (FDA) had never previously approved a cannabis-derived drug before, and with no FDA-approved treatments on pharmacy shelves for Dravet syndrome, it's believed that this creates a pretty clear path to profitability for the company.
But things aren't always what they seem. Namely, we have witnessed other synthetic cannabis products come to market in the U.S. and flop miserably (I'm looking at you, Insys Therapeutics). What's more, GW Pharmaceuticals managed to get Sativex, a cannabinoid-based treatment for spasticity associated with multiple sclerosis, approved in more than a dozen countries worldwide (but not in the U.S.). Despite this approval, Sativex has been a virtual non-contributor to its top-line results. Simply put, cannabis-derived therapies aren't guaranteed any level of success.
There's also that not-so-little problem GW Pharmaceuticals may have with Zogenix (ZGNX) on its coattails. Zogenix's lead drug, ZX008, has dazzled in late-stage trials and is targeting the same indications as Epidiolex. Even though these drugs have not gone head-to-head in a clinical trial, it's possible there could be some statistical bias for physicians to choose Zogenix's therapy, if approved, given that it's not cannabis-based, and that it demonstrated higher seizure frequency reductions relative to baseline compared to what Epidiolex achieved in its late-stage studies.
Long story short, keep your money far away from these very popular marijuana stocks.