There's no doubt that the marijuana industry has a bright future. We know this because tens of billions of dollars in annual sales are being conducted in the black market each year. As countries/states continue to legalize cannabis, legal-channel sales have an opportunity to soar. This is why varied Wall Street estimates have called for between $50 billion and $200 billion in annual sales by 2030, up from $10.9 billion worldwide in 2018.
But the fact remains that 2019 was not a good year for marijuana stocks. Supply issues in Canada, high tax rates in select U.S. states, and a resilient black market made life incredibly difficult for cannabis companies, and it was investors who paid the price.
Although the shellacking marijuana stocks took in 2019 has opened the door to some intriguing value within the industry, there are three well-known cannabis stocks you'd be wise to avoid like the plague in 2020.
Alberta-based Aurora Cannabis (ACB 1.80%) is an absolute favorite among investors. But they quickly learned in 2019 that popularity is no guarantee of profitability.
Though Aurora does have a number of factors that are seemingly working in its favor, including the highest peak production potential of all growers, the broadest international reach, and landing billionaire activist investor Nelson Peltz as a strategic advisor in March 2019, the company's balance sheet is a complete disaster, and the supply issues impacting Canada are a long way from being resolved.
One aspect of Aurora's balance sheet that's concerning is the company's cash on hand. Even with access to $400 million in at-the-market funding (i.e., dilutive common stock offerings) and a credit line with the Bank of Montreal, there's real concern that Aurora may have bitten off more than it can chew on the expansion front. One Wall Street analyst believes Aurora could go belly up due to its lack of cash.
Perhaps a bigger problem is that Aurora grossly overpaid for its acquisitions, and the company has 3.17 billion Canadian dollars in goodwill on its balance sheet. This represents 57% of the company's total assets and is considerably higher than its current market cap. I find it highly unlikely that Aurora Cannabis will recoup a significant portion of this goodwill in the future, making a massive writedown likely.
And, of course, there are the supply issues in Canada that will take numerous quarters to resolve. These problems have led to a bottleneck of supply in Ontario, the country's most populous province. Meanwhile, most international markets are still formulating their medical marijuana regulations and are, thus, not importing a lot of pot at the moment. That means Aurora's hefty overseas investments are unlikely to pay dividends anytime soon.
Even with construction on two of its largest cultivation farms now idled (Aurora Sun and Aurora Nordic 2) to lower capital expenditures, Aurora looks doomed to lose money in fiscal 2020. That makes it a popular pot stock to avoid in my book.
Another popular cannabis stock that was an utter train wreck in 2019 and should continue to crash and burn in 2020 is vertically integrated multistate operator (MSO) MedMen Enterprises (MMNFF 17.07%).
The idea behind owning MedMen seemed simple. This was a company with a big focus on California, the largest cannabis market by sales in the world. With some of its locations in the Golden State generating more sales per square foot than Apple's stores, its branding seemed to be clearly resonating with consumers. Unfortunately, what could go wrong has gone wrong for MedMen.
The biggest worry for MedMen moving forward is financing. Although MedMen has secured up to $280 million from private equity firm Gotham Green Partners, there's little assurance that this'll be enough to see MedMen survive over the long run. Management has made strides in reducing general and administrative expenses by roughly 30%, but that didn't stop the company from losing $53.3 million in the fourth quarter and $231.7 million in 2019.
MedMen also went so far as to completely shelve its acquisition of privately held MSO PharmaCann in October, just three days before the one-year anniversary of announcing what was then a $682 million all-stock deal. MedMen justified terminating the acquisition as a means of not having to push into noncore markets, but it's blatantly apparent that the issue is MedMen doesn't have the capital to take on the operating expenses of PharmaCann's existing network of dispensaries and grow farms.
The icing on the cake for MedMen is that California's pot industry has been overrun by black-market producers. The Golden State is taxing the daylights out of consumers, which, when coupled with its Swiss-cheese-like legalization process throughout the state's nearly 500 jurisdictions, has constrained legal sales. In short, I genuinely question MedMen's ability to survive.
Finally, it'd be a good idea for investors to keep their distance from Canopy Growth (CGC 10.36%), the largest marijuana stock in the world by market cap.
Similar to Aurora Cannabis, Canopy Growth appeared to have a laundry list of competitive advantages that would seemingly make it the pot stock to own. It's the second-largest producer by peak annual output, has operations in the second-most foreign countries (behind Aurora), has the best-known brand in Tweed, and is rolling in the dough following an equity investment from Constellation Brands. And yet the company is a mess.
There isn't a cannabis company out there that's losing more money on an operating basis than Canopy Growth. Even excluding a number of one-time costs, Canopy's operating loss hit a staggering CA$265.8 million in the fiscal second quarter. Mind you, this includes a more than CA$13 million benefit from fair-value adjustments. Aside from more employees leading to higher expenses, Canopy's share-based compensation has soared. Now-former co-CEO Bruce Linton believed that offering long-term-vesting stock was a smart move to keep employees loyal and motivated. Unfortunately, it's ballooned costs and made it virtually impossible for the company to get anywhere near operating profitability.
Like Aurora, Canopy Growth is also lugging around a lot of goodwill on its balance sheet. The company clearly overpaid for its acquisitions: Canopy's CA$1.91 billion in goodwill accounts for 23% of total assets. This looks to be a writedown just waiting to happen.
But the big question mark for 2020 is, what happens when incoming CEO David Klein takes over in January? Though it's a certainty we'll see some belt tightening, Klein doesn't have any experience in the cannabis industry. This leaves the company's future as a market share leader very much in limbo.
With profits nowhere in sight, I'd suggest avoiding Canopy Growth like the plague in 2020.