Following a stunning first quarter of 2019, which saw more than a dozen popular cannabis stocks rally by at least 70%, the past 11 months have been nothing short of a train wreck for the green rush. Supply issues (both shortages and bottlenecks) have plagued the adult-use legal Canadian market, while wide price gaps between legal and illicit weed have led to struggles for vertically integrated multistate operators in the United States.
Then again, there's little doubt that the legal pot industry could be a long-term moneymaker for investors. There are tens of billions of dollars being conducted annually in the black market, meaning there's plenty of potential to gradually transition these users to legal channels over time.
But let's be clear -- there will be losers within this industry. As we move headlong into March and also contend with the first stock market correction in two years, here are three marijuana stocks you'd be wise to avoid like the plague.
First up is the most popular marijuana stock in the world (at least among millennial investors), Aurora Cannabis (ACB -4.71%). Aurora Cannabis was expected to be Canada's leading producer and has a broader international presence than any other pot stock. However, all of these perceived-to-be attractive traits have been overshadowed by a cadre of operational issues and a truly ugly balance sheet.
As noted, supply issues throughout Canada have been a big issue. In response, Aurora Cannabis wound up announcing the halting of construction at two of its largest cultivation farms in November (Aurora Sun in Alberta and Aurora Nordic 2 in Denmark). More recently, the company also announced that it'd be putting its 1 million-square-foot Exeter greenhouse up for sale for a mere $17 million Canadian. This vegetable-growing greenhouse, which hasn't been retrofit, could produce as much as 105,000 kilos of weed per year at its peak. Altogether, Aurora has reduced its peak annual output by well over 400,000 kilos.
The bigger issue here might just be the company's balance sheet. On one hand, Aurora's aggressive acquisition strategy led the company to grossly overpay for its more than one dozen purchases since Aug. 2016. Even with a CA$762.2 million goodwill writedown in the fiscal second quarter, the company still boasts more than CA$2.4 billion in goodwill, which accounts for 52% of Aurora's total assets. There's a very good possibility of additional writedowns down the line.
On the other hand, Aurora's lack of cash is a very big concern. The company's management discussion & analysis filing with SEDAR showed CA$156.3 million in cash and cash equivalents, CA$26.1 million in marketable securities, and the expectation of CA$373.6 million in liabilities over the next 12 months. There's the real chance that, even after adjusting the covenants tied to its secured debt, Aurora may not be able to meet all of its obligations. As such, it remains a pot stock to avoid like the plague in March (and for the foreseeable future).
You're probably going to notice a decisive theme with this list: keep your distance from most Canadian licensed producers. Next up is British Columbia-based Tilray (TLRY).
Similar to Aurora Cannabis, Tilray has been seriously backpedaling as Canada's legal marketplace has struggled to move product from growers to retailers. Early last month, Tilray announced that it was laying off 140 of its employees, or about 10% of its workforce, as part of a restructuring to reduce its expenses. I would expect this serious belt-tightening to continue throughout 2020.
Tilray is also facing a potential cash crunch. Between the beginning of 2019 and the end of September, Tilray's cash, cash equivalents, and short-term investments fell from $517.6 million (Tilray reports in U.S. dollars) to a mere $122.4 million. Although a good chunk of this reduction was tied to the purchase of hemp foods company Manitoba Harvest, Tilray has also logged an $83.7 million operating loss through nine months of 2019. Things are certainly not expected to improve anytime soon, meaning Tilray may need to rely on share issuances or convertible debentures to obtain funding.
It's also noteworthy that Tilray's push into the U.S. hasn't gone anywhere near as planned. The purchase of Manitoba Harvest, which gave Tilray access to approximately 16,000 retail doors throughout North America, was expected to be an avenue for Tilray to distribute cannabidiol (CBD) products. However, CBD sales have disappointed in the U.S., especially with the U.S. Food and Drug Administration casting doubt on CBD's safety last year. It's for all these reasons that Tilray should be avoided in March.
Last, but not least, investors would be smart to avoid Quebec-based grower HEXO (HEXO) like the plague this month.
Like its peers, HEXO has been a busy bee in the cost-cutting department. To account for supply bottlenecks in Ontario and a resilient black market, HEXO announced 200 job cuts and has chosen to idle the Niagara facility (acquired with the Newstrike Brands purchase) as well as 200,000 square feet of its flagship Gatineau campus. In total, I believe HEXO's peak output has been reduced by around a third, which is concerning considering that HEXO's management believes it needs 20% market share throughout the country to become profitable.
HEXO is also facing some serious cash concerns. The company has raised approximately CA$100 million from a combination of stock offerings and a convertible debenture in recent months, but this doesn't look as if it'll be enough to cover ongoing operating expenses or cover debt payments when they become due.
As the icing on the cake, HEXO's share price fell to within $0.11 of the $1 minimum share price required for continued listing on the New York Stock Exchange (NYSE) this past Thursday, Feb. 27. Although a reverse stock split is an option for continued listing, it's looking increasingly likely that HEXO's stay on the iconic NYSE may be short-lived.