When the year began, there wasn't a hotter investment on the planet than marijuana. It's not hard to understand why, either, with worldwide weed sales more than tripling between 2014 and 2018 to $10.9 billion, according to the State of the Legal Cannabis Markets report from Arcview Market Research and BDS Analytics.
However, following a red-hot first quarter that saw over a dozen well-known cannabis stocks soar by at least 70%, we've seen the bubble burst in the marijuana space. Over the past eight months, most pot stocks have lost at least half of their value, if not more.
While this decline may appear enticing to some investors, it's important to realize that investing in the cannabis space remains dicey, at best, as we head into 2020. Here are 10 reasons the cannabis industry could struggle next year more than folks realize.
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1. Health Canada's license approval process is a mess
First off, Health Canada has been buried by cultivation, processing, and sales license applications. When 2019 began, the agency had over 800 licensing applications on its desk awaiting review. Even with a rules change in regard to how growers apply for a cultivation license, Health Canada hasn't been able to quickly review applications. In fact, Aphria (APHA) recently received a growing license for Aphria Diamond after at least an 18-month wait. These long wait times to grow and sell cannabis in Canada are liable to continue in 2020.
2. Retail rollouts have been slow in select provinces
Even in instances where marijuana stocks have been granted to right to grow or sell cannabis, there's no guarantee that legal channels exist to get this product into stores. Ontario, Canada's most populated province, with 14.5 million people, had just 24 open dispensaries a year after the country legalized recreational pot sales. With so few purchasing options available for consumers, it's opened the door for black market marijuana to thrive. Don't expect retail stores to pop up in these challenged provinces overnight.
3. High tax rates are a killer in the U.S.
In the United States, high tax rates have been the bigger issue. California, the largest marijuana market in the world by sales, is taxing the daylights out of its pot users. Consumers are having to absorb already high state and local tax rates, a 15% excise tax rate, and a tax on cultivation. Making matters worse, the Golden State's cannabis tax is going up come Jan. 1, 2020. This high tax rate has made it virtually impossible for California-focused operator MedMen Enterprises to succeed. In each of the past two quarters, MedMen has delivered just 5% and 10% sequential sales growth from its existing California locations.
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4. There remains a large pricing gap between legal and illicit weed
Add up the previous points and you get a situation where black market marijuana is thriving and legal-channel weed is struggling. Remember, illicit producers don't have to wait for cultivation and sales license, and they won't pay state or local income tax, an excise tax, or a cultivation tax. This makes it virtually impossible for legal growers to compete with the black market on price. Not surprisingly, Statistics Canada reported that black market weed was 45% cheaper on a per-gram basis than legal-channel cannabis during the third quarter.
5. Vape concerns could hurt derivative sales
Although derivative sales are expected to be a significant growth driver throughout North America, there's no telling what lasting damage vaping health concerns could do to the industry. According to the Centers for Disease Control and Prevention, 2,290 cases of vaping-related lung illnesses had been identified, as of Nov. 20, leading to 47 deaths in the United States. Even though the additive vitamin E acetate in the illicit market looks to be the potential culprit, the CDC is recommending that no one vape liquids containing tetrahydrocannabinol (THC), the cannabinoid that gets users high. This could create problems for the launch of derivatives in Canada.
6. Overseas sales are virtually nonexistent
A sixth issue is that international sales for Canadian pot stocks are practically nonexistent. While these foreign markets should prove crucial years down the line when Canadian demand is being met, the reality is that Canada's supply chain is a mess that'll take some time to correct. Until that happens, overseas exports are liable to be minimal. That's bad news for Aurora Cannabis (ACB -2.96%) and Canopy Growth (CGC -0.66%), which have a presence in 24 and 16 countries, respectively, outside of Canada.
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7. Pot stocks are losing a lot of money
Instead of making the green, cannabis stocks have been burning through the green throughout 2019. With few exceptions, pot stocks are losing a lot of money, and it's not expected to get better anytime soon. Canopy Growth's most recent quarter featured share-based compensation that was higher than its net sales. Meanwhile, Aphria was profitable, but only as a result of fair-value adjustments on its biological assets. If you remove one-time benefits and fair-value adjustments from the equation, marijuana stocks have left a lot to be desired.
8. Goodwill is a ticking time bomb
Cannabis stock balance sheets are also a bit of a mess. More specifically, goodwill -- i.e., the premium paid by an acquiring company that's above and beyond tangible assets -- has gone through the roof. I'd conservatively estimate that the North American pot industry has $10 billion in goodwill on their balance sheets, including $3.17 billion Canadian from Aurora Cannabis, CA$1.91 billion from Canopy Growth, and nearly CA$670 million from Aphria. With goodwill comprising a whopping 57% of total assets for Aurora Cannabis, it appears to be the likeliest to take a future writedown.
9. Financing remains challenging
It's also important to note that financing issues persist for marijuana stocks, especially in the United States, where cannabis remains a Schedule I substance at the federal level. With minimal access to basic banking services, including something as simple as a checking account, most pot stocks have chosen to issue shares of their own stock, or offer convertible debentures, to raise capital and fund their operations. Unfortunately, this can lead to problems, as you'll see in the next reason why cannabis stocks will be a potentially dangerous investment in 2020.
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10. Dilution continues to be a serious concern
Lastly, pot stocks continue to utilize their common stock as their own form of Monopoly money, even in instances where non-dilutive forms of financing are available. Aurora Cannabis has seen its share count balloon by more than 1 billion shares in a little over five years as it funds its aggressive acquisition strategy. Unfortunately, it's Aurora's investors who've paid the price.
To be clear, this isn't to say that marijuana stocks can't be solid long-term investments. However, there's a pretty sizable learning curve and maturation process to come, and that doesn't necessarily bode well for pot stock investors in 2020.
