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The Only 2 Pot Stocks Wall Street Expects to Decline in Value

By Sean Williams - Jan 27, 2020 at 7:21AM

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Surprisingly, these are two of the most popular marijuana stocks with investors.

To say that things did not go as planned for marijuana stock industry in 2019 would be an accurate statement. High tax rates in select U.S. markets, and persistent supply problems throughout Canada, allowed an already resilient black market to prosper in North America. This, in turn, wound up clobbering cannabis stocks.

But according to Wall Street, things should get better. Aside from the fact that various analysts have projected annual worldwide weed sales of $50 billion to $200 billion by 2030, almost every pure-play pot stock with a market cap of at least $200 million has a higher consensus price target from Wall Street than their current share prices. That's really not a surprise given how Wall Street tends to be highly optimistic on high-growth businesses and always forward-looking.

However, what you might find surprising is that two of the most popular pot stocks in the world happen to be the only companies in the marijuana industry with lower consensus price targets than their current share price. Translation: Wall Street actually expects these pot stocks to decline in value over time.

Let's take a closer look at these two marijuana stocks and find out why Wall Street might be pumping the brakes on their current valuation.

Scissors cutting a one hundred dollar bill in half.

Image source: Getty Images.

Canopy Growth: Implied downside of 9.5%

First up is only the largest marijuana stock in the world by market cap, Canopy Growth (CGC -5.98%). According to Wall Street's consensus price target, Canopy has nearly 10% downside from where it closed this past Wednesday, Jan. 22.

On paper, Canopy Growth looks to have a number of factors and intangibles that would work in its favor. It should be the leading or No. 2 pot producer in Canada, is the leading cannabis company in cash on hand, is No. 2 in international presence, and has supply deals in place with all of Canada's provinces. This looks like a winning recipe. But if you've in any way been following Canopy Growth over the past two years, you've watched the company's income statements and balance sheet deteriorate, which is likely why Wall Street has become so cautious.

In Canopy Growth's fiscal second-quarter operating results, the company recorded only $76.6 million Canadian in net sales, representing a 15% decline from the sequential quarter. A big portion of this decline was tied to a CA$32.7 million revenue adjustment related to oversupply and weak demand for its higher margin softgel and oil products. Comparatively, the company's share-based compensation alone outpaced its net sales. All told, Canopy lost CA$265.8 million on an operating basis in Q2 2020, and nearly CA$389 million (also on an operating basis) through the first six months of its current fiscal year. Canopy Growth is nowhere near profitability, and its price target reflects this.

Two rows of dried cannabis buds lying atop neatly arranged one hundred dollar bills.

Image source: Getty Images.

Wall Street's skepticism is also factoring in the company's worsening balance sheet. On one hand, the nearly CA$5 billion in cash on hand that Canopy had on its balance sheet following the closure of Constellation Brands' $4 billion (that's U.S. dollars) equity investment has fallen to CA$2.74 billion in cash and short-term investments in nine months. While this cash does act as a buffer, Canopy's aggressive expansion activity, coupled with its huge operating losses, is quickly whittling away its hoard.

On the other hand, Canopy's overzealous expansion led it to grossly overpay for a number of acquisitions. The company's goodwill has ballooned to CA$1.91 billion, or 23% of its total assets. This percentage is likely to continue climbing given the company's dwindling cash pile, and the unlikelihood of Canopy recouping a significant portion of its goodwill. In other words, Wall Street may already be factoring in a sizable writedown. 

Canopy Growth may have name-brand appeal, but it and its new CEO have a lot to prove, as reflected by Wall Street's price target.

A man in a suit giving the thumbs-down sign.

Image source: Getty Images.

Cronos Group: Implied downside of 16.8%

The same goes for Cronos Group (CRON -6.20%), which is even more "overvalued" in the eyes of Wall Street. According to analysts, Cronos should have about 17% downside, based on its closing price on Jan. 22.

What's really interesting about Cronos Group being the other company deemed as pricey by Wall Street is that it happens to be No. 2, behind Canopy Growth, in cash on hand. It goes to show that cash can only act as so much of a buffer when a company's business isn't performing as expected.

Despite ending the most recent quarter with nearly CA$2 billion in cash and cash equivalents, as well as recording three consecutive quarterly profits (all thanks to the revaluation of derivative liabilities), Wall Street is likely skeptical of Cronos Group for three key reasons.

First of all, Cronos Group isn't exactly holding its own in the production department. Whereas most of its similarly sized peers are all major marijuana growers with at least 100,000 kilos of peak annual output, Cronos is leaning entirely on Peace Naturals, which is capable of no more than 40,000 kilos per year of production (and probably even less now, with some of Peace Naturals' campus being repurposed for derivative development and research). Although Cronos should see a joint venture project come online in the second half of 2020, it should be noted that this company is not the major grower its market cap would suggest it is.

A person using a calculator to check an income statement.

Image source: Getty Images.

Second, a quick look at Cronos Group's operating performance without all the one-time bells and whistles reveals It's not in better shape than its peers. Without the aid of fair-value adjustments or derivative liability revaluation, Cronos' CA$12.7 million in net sales in the third quarter would be dwarfed by its CA$7.4 million in costs of goods sold and CA$34.8 million in operating expenses. In essence, Wall Street is able to look past Cronos' asterisk-laden profits.

Third, and finally, there are clear concerns surrounding Cronos and the launch of high-margin vape products in Canada. In the U.S., more than 2,600 people have been impacted by vape-related lung illnesses since mid-2019, leading to nearly five dozen deaths. Though the Centers for Disease Control and Prevention (CDC) identified vitamin E acetate as a likely cause of these lung issues, the CDC also noted that 1 in 6 purchases leading to these illnesses came from legal channels. This overhanging health concern could put a major damper on Cronos' efforts to become a top-tier vape player in Canada.

It's evident that Cronos Group still has a lot of growing up to do, and Wall Street's price target certainly appears to imply it.

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Stocks Mentioned

Canopy Growth Stock Quote
Canopy Growth
$5.19 (-5.98%) $0.33
Cronos Group Stock Quote
Cronos Group
$3.18 (-6.20%) $0.21

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