Few industries have been kicking "bud" and taking names quite like legal cannabis has in recent quarters. With Wall Street calling for up to $75 billion in global sales by 2030 (up from $12.2 billion in 2018), perhaps it's no surprise that marijuana stocks are among the market's top performers over the past couple of years.
Over that time, we've witnessed Wall Street warming up to the industry by initiating coverage on a handful of pot stocks. Given the large uncertainties surrounding cannabis, most Wall Street firms are waiting on the sidelines for the industry to mature a bit before offering their take, and coverage. Of course, a few Wall Street firms, including Jefferies, Cowen Group, Bank of America, GMP Securities, and Piper Jaffray, have all chimed in to some extent.
These popular marijuana stocks are worthy of a sell rating
As you might imagine, Wall Street's buy-bias (i.e., its penchant for assigning far more buy ratings than hold or sell ratings) has carried over from the general market into the cannabis industry. Projected leading producer Aurora Cannabis has three buy-equivalent ratings, including the distinction of being Cowen's top pick in the industry. Meanwhile, the largest pot stock in the world, Canopy Growth, has at least five buy ratings from Wall Street.
Yet, if I were a Wall Street firm, I'd have little issue handing down hold or sell ratings in the nascent and mostly uncharted cannabis industry. In fact, I view three of the nearly 60 cannabis stocks I track as being fully worthy of a sell rating.
Whereas Wall Street firms aren't shy about offering their top picks, if I could offer a "worst pick" of the industry, it'd be Cronos Group (NASDAQ:CRON). Cronos already has three Wall Street firms that rate the company as a sell, and I'm frankly surprised it's not a higher number.
Cronos Group pretty much has two things working in its favor. First, it completed a $1.8 billon equity investment from Altria in March that removed any near-term cash and dilution concerns. With more than enough cash on hand, Cronos can approach its expansion plans in a number of different ways, including making complementary acquisitions, expanding its derivative offerings, or boosting production.
Additionally, Cronos Group has an intriguing deal with Ginkgo Bioworks, worth up to $100 million, giving it access to Ginkgo's microorganism development platform. In simple terms, Cronos will be able to use yeast strains to produce eight targeted cannabinoids, some of which are rare, at commercial scale, and presumably for a lower cost than if traditional extraction techniques were used. This commercial-scale production yields much higher margins than dried-flower sales.
Then, there are Cronos Group's numerous deficiencies. It has a minimal overseas presence, with distribution agreements in Germany and Poland, and a modest production presence in Israel and Australia. In the meantime, most of its largest peers have a production, export, research, or distribution presence in at least one dozen overseas markets. In my view, this grounds Cronos too closely to the domestic Canadian market, which could be easily oversupplied by marijuana as early as 2022.
Cronos also isn't a major player in terms of production or retail. I show it currently slotting in as the country's No. 9 producer, but not even a top-10 retailer once other joint ventures and royalty operators are factored into the equation.
The icing on the cake is the possibility that Cronos may not even be profitable in 2020. Even with $1.8 billion in cash, a $5.4 billion market valuation makes little sense.
Despite declining more than 85% from its intraday high set in September, Tilray (NASDAQ:TLRY) is another popular pot stock that I'd bestow with a sell rating, if I were a Wall Street firm.
Arguably Tilray's greatest assets are its partnerships, and perhaps its newest acquisition of Manitoba Harvest. Tilray expanded a noncombustible cannabis product distribution partnership with Novartis' subsidiary Sandoz in December, and it secured a joint venture with Anheuser-Busch InBev to develop nonalcoholic cannabis-infused beverages in Canada, which should be legal by this coming October.
Its acquisition of Manitoba Harvest gave Tilray access to a North American hemp foods giant. The distribution network Tilray inherited from this acquisition could come in handy if the U.S. ever changes its tune on marijuana at the federal level.
But Tilray today looks like a shell of the company we imagined it could be when it filed its S-1 prospectus with the Securities and Exchange Commission a year ago. That S-1 contained peak cultivation area of 3.6 million square feet, with an initial 850,000 square feet being developed for growing. But over the past year, only around 150,000 square feet of additional capacity was developed. Tilray, depending on its yield per square foot (which is not something the company has divulged), may not even be a top-10 producer based on peak annual production at the moment.
There's also CEO Brendan Kennedy's decision to focus Tilray's future investments on entering the U.S. and moving into Europe. Although these are larger opportunities than Canada, it's an odd move to make with Canada's recreational weed industry just a few months into its launch.
Not surprisingly, Wall Street remains undecided on whether Tilray will be profitable next year, with the consensus EPS figure hovering a few pennies above or below the breakeven line for months. Given the company's abrupt strategy shift, and its slow capacity expansion, I'm inclined to believe Tilray won't deliver the green in 2020. That makes it a pot stock to avoid.
The third and final pot stock that's deserving of a sell rating isn't a perceived-to-be major player like Cronos Group or Tilray, but it's nonetheless a company I'd strongly suggest avoiding: TILT Holdings (OTC:TLLT.F).
When TILT debuted as a public company via a four-way reverse merger in December, it offered clear intrigue to the investment community. It combined a Canadian pot grower, a Massachusetts dispensary operator, a cannabis-delivery software company, and a customer-relationship software developer under one roof. In the first quarter, which the company reported results on two weeks ago, this led to more than $40 million in pro forma revenue (a year-over-year increase of 169%).
But TILT Holdings has done a poor job of instilling faith in its management team. On Dec. 5, 2018, the day prior to becoming a publicly traded stock, TILT filed a manifesto of a prospectus in Canada that showed more than $900 million in pro forma assets, of which 80% was tied up in goodwill (i.e., premium above and beyond tangible assets). An announced change in accounting practices led to a buzz-killing writedown of $496.4 million in the fourth quarter, which in turn led to a more than $552 million annual loss in 2018. That's not the sort of writedown investors simply overlook and place in the rearview mirror.
Following its first-quarter operating results, TILT lists $541.4 million in total assets, of which $145.8 million is still goodwill and another $210.8 million is recognized as intangible assets. This is a company with a lot of promises and premium built into its valuation, and not so much substance.
Making matters worse, total current liabilities, as of March 31, 2019, was outpacing total current assets by more than $54 million. In plain English, TILT doesn't have enough capital to cover its expenses over the next 12 months. Understandably, its management team does believe it has access to additional financing options, but this is clearly worrisome, and it's therefore no surprise that auditors have attached a going-concern warning in the company's SEDAR filing. All of this makes TILT Holdings very worthy of a sell rating.