Whether you realize it or not, the marijuana industry is a big-money business. Although "only" $10.9 billion in legal sales were recognized in global licensed cannabis stores last year, we know that tens of billions of dollars in sales are occurring in the black market. As more and more countries legalize, it provides an opportunity for consumers to be moved from illicit to legal channels.
According to various Wall Street estimates, marijuana sales in just a decade's time are expected to soar to somewhere between $50 billion and $200 billion per year. I know that's a pretty wide range, but it's not unexpected given how unprecedented it is for industrialized countries like Canada to give recreational weed the green light. The point is, legal cannabis is going to generate a lot of money, which investors expect to pump up pot stock valuations.
Surprise! Cannabis stock profit projections are plunging
However, things haven't been going to plan since Canada legalized adult-use cannabis in October. Rather than rolling in the dough, some cannabis stocks have actually seen their sales decline recently on a sequential quarterly basis. Wall Street, in response, has significantly lowered its consensus profit projections for a variety of pot stocks.
Following, and in no particular order, you'll see 12 pot stocks with plunging forward-year earnings estimates, based on Wall Street's consensus from three months ago, and as of today. Companies that report in Canadian dollars are denoted with a "CA$" in front of their estimate.
|Company||Forward-Year EPS (90 Days Ago)||Forward-Year EPS Today|
|Canopy Growth (CGC -5.96%)||CA$0.45||(CA$0.37)|
|HEXO (HEXO -5.11%)||CA$0.20||CA$0.12|
|CannTrust Holdings (CNTTQ -16.67%)||CA$0.29||CA$0.09|
|KushCo Holdings (KSHB)||($0.04)||($0.15)|
|MedMen Enterprises (MMNFF -4.55%)||($0.02)||($0.13)|
|Green Organic Dutchman||CA$0.15||CA$0.01|
The issues that the pot industry are contending with aren't focused on any single group of companies. There are Canadian growers, vertically integrated U.S.-focused multistate operators, and even an ancillary cannabis company, in the above list.
Let's take a brief look at what's causing these earnings estimates to tumble.
Multifaceted supply issues in Canada
For starters, Canadian cannabis growers have been clobbered by a number of supply-side issues throughout the country.
For example, Health Canada, the regulatory agency that's overseeing the rollout of legal marijuana, began the year with more than 800 licensing applications to review. For context, it had approved licensing applications for only around 200 companies over five-plus years. Most growers have been waiting many months, if not more than a year, for the OK to grow, process, and/or sell cannabis.
Our neighbor to the north has also experienced a shortage of compliant packaging solutions. The result is that marijuana has been left unprocessed, further adding to supply shortages in many of Canada's provinces.
Both Canopy Growth and HEXO are forecast to be major growers in Canada, with this duo producing more than 500,000 kilos, and around 150,000 kilos, per year, when at full capacity. But in their most recently reported quarters, Canopy Growth and HEXO both delivered a sequential cannabis sales decline, which is almost unfathomable given the opportunity that lies ahead. Canopy and HEXO are also heavily reliant on the recreational market for sales in the early going, which is where most of the supply-side issues have popped up.
Tax concerns in the United States
Canada's southern neighbor, the United States, hasn't had nearly as many supply issues to contend with. Rather, taxation on marijuana has become a far bigger problem.
Whereas Canada set its excise tax rate on marijuana at 10%, a number of recreationally legal U.S. states have chosen to get more aggressive with taxation to pad their budgets. California, the largest legal weed market in the world, has hit consumers with aggregate tax rates of as much as 45% in some locales. This includes state and local tax rates, the cannabis excise tax, and the wholesale tax imposed on leaves or flower. Having high tax rates in place makes it impossible for legal-channel cannabis to compete with the black market on price. Illicit producers don't have to wait for licensing, they don't pay any excise or sales tax, and they won't owe income tax to the federal government or state. In other words, the black market is thriving in a number of key U.S. states, which has slowed the push of consumers into legal channels.
Further highlighting California as an example is multistate dispensary operator MedMen Enterprises. Despite opening the doors to adult-use cannabis in 2018, MedMen's third quarter featured anemic sequential sales growth of just 5% from its established California locations. This means that on top of opening new locations and building its brand, multistate operators like MedMen may also have to get aggressive with black-market pricing – and that could weigh on margins.
Tariffs are being felt
Another reason we could see earnings estimates tumbling is trade-war tensions between the U.S. and China. Although cannabis grown within a legal U.S. state can't leave that state, the equipment that growers use in their cultivation farms, as well as the components used in cannabis paraphernalia, may very well be subjected to tariffs and higher costs.
Ancillary pot stock KushCo Holdings is one such name that's seen its earnings outlook dim substantially over the past three months. Issues with packaging in Canada, as well as U.S. tax rates, are certainly playing their role. But don't overlook the trade war, especially with KushCo generating most of its sales from vaporizers, not packaging solutions.
Until recently, KushCo had been eating the higher costs on tariffs from China for its vaporizer accessories. This wound up pushing its gross margin to under 13% in the second quarter on a generally accepted accounting principles (GAAP) basis. However, KushCo recently announced its intention to pass along higher costs to consumers, boosting its gross margin nearly 5 percentage points in the third quarter, albeit it still has a long way to go to get its gross margin to a respectable level.
Trust is a budding problem
Lastly, trust has become a big problem in the cannabis industry. We've witnessed everything from accounting woes and conflicts of interest at the executive level, to blatant fraud from the likes of CannTrust.
It's no secret why CannTrust's profit projections for next year have been sliced by two-thirds over the past three months. Last month, CannTrust announced that it had been growing unlicensed cannabis in five rooms for a six-month period. The resulting admission has led to 12,700 kilos of inventory being put on hold (7,500 kilos being a voluntary hold), and CannTrust's sales being suspended until it knows its punishment from regulatory agency Health Canada.
It's possible that Health Canada comes back with a relatively modest punishment for CannTrust, such as a fine, loss of inventory, or even a suspension of sales over a short period. But if CannTrust's cultivation license were to be revoked, its sales and earnings estimates could really slide.
Investor trust in cannabis stocks is a serious problem right now, and it does have the potential to tangibly impact operating results.