Even before the coronavirus pandemic, most cannabis companies were struggling to get a grip on their financial situations. Whether the issue was continued losses, increasing inventory buildups, or substantial goodwill write-downs, few companies were thriving going into this pandemic.
As COVID-19 continues to spread and shut down various aspects of the economy, the vast majority of pot stocks are now trading at steep discounts. While there are some stocks worth buying at these low prices, investors should be cautious about investing in most cannabis companies.
In particular, these three pot stocks have some major red flags and should be avoided.
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1. Aurora Cannabis
Aurora Cannabis (ACB 1.04%) has been one of the biggest disappointments in the entire industry. Its fall from grace is made all the worse when you consider that Aurora used to be one of the most prestigious names in the market. Now the company has officially become a penny stock. Its shares, trading for less than $1, could easily fall even further.
Now that Aurora's trading at bottom-of-the-barrel prices, does that mean this stock could be a bargain buy? Not exactly. Aurora still has a lot of problems with its business that make it far from a sound investment right now.
For one, Aurora still has a lot of goodwill on its balance sheet. The cannabis giant reported back in February it would be writing down almost a billion dollars of its goodwill. Many other companies made similar adjustments in the weeks following Aurora's announcement. However, Aurora's remaining goodwill is alarmingly disproportionate in comparison to the rest of its assets.
The company's goodwill and intangible assets, as reported in its fiscal second-quarter financial results, are at $2.9 billion Canadian dollars. That's more than twice Aurora's CA$1.4 billion market cap. If further writedowns are on the horizon, which is very possible, Aurora could see hundreds of millions -- if not billions -- of dollars' worth of assets go up in smoke. In such a situation, its already battered shares could plunge even further.
Even worse for Aurora, however, is how the Canadian pot market has reacted to the coronavirus. One of its largest markets, the province of Ontario, officially designated dispensaries as "nonessential" stores, requiring them to shut down until further notice beginning April 11. While this shutdown is scheduled to last just 14 days, it could easily be extended.
This will end up further hurting Aurora's bottom line. Net losses for the recent quarter (excluding goodwill adjustments) came in at about $384 million. These losses could easily worsen now that Ontario's pot stores are closed. With just $156 million in cash, Aurora's situation looks bleaker than ever.
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2. Tilray
Shares of Tilray (TLRY) have been on a wild ride for the past couple of weeks, with the stock having more than doubled since mid-March. However, shares have still lost the majority of their value over the past quarter.
While Tilray's Q4 2019 revenue of $167 million has doubled from Q4 2019, net losses have worsened substantially. The cannabis company reported a $219.1 million net loss, although about $112.1 million of that was due to a one-time impairment charge related to its partnership with Authentic Brands Group. Tilray also reported a $68.6 million impairment to its inventory reserves, which further pushed down the quarter's net losses.
Right now, Tilray has only $96.8 million in cash on its balance sheet, having burned through most of the $487.3 million in cash it had back in Q4 2018. With less than three quarters' worth of financing in the best-case scenario (it's likely to be less than that), Tilray will have to try to secure further funding soon. However, now's probably the worst time for cannabis companies to raise funds, thanks to the COVID-19 pandemic. Should Tilray choose to issue more shares instead, the company's stock could easily tumble even further because of the dilution of equity.
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3. Cronos Group
Cronos Group (CRON 5.00%) is a little different from most other cannabis stocks on the market. For one, the stock has continued to trade at remarkably high financial ratios in comparison to its peers. Aurora and Tilray trade at price-to-sales ratios of 4.3 and 4.1 respectively, whereas Cronos boasts a P/S of 84.
However, this is primarily thanks to Cronos's substantial cash position, which is what's bolstering the company's market cap. Unlike most other pot stocks, which are struggling with dwindling cash reserves, Cronos has $1.2 billion in cash and cash equivalents as of Q4 2019. That's a remarkable sum for a company with net revenue of only $7.3 million for the quarter.
Because of this cash position, Cronos has a good chance of surviving through this coronavirus bear market. However, investors shouldn't get too caught up in the company's cash position at the expense of everything else. If Cronos didn't have $1.2 billion in cash sitting on its balance sheet, would the business still be considered healthy?
That seems very questionable. For one thing, a recent inquiry from the U.S. Securities and Exchange Commission (SEC) ended in Cronos having to revise its financial figures over the past three quarters. The company ended up writing off $7.6 million, or as much as 32% of the $23.8 million in revenue it reported over the 2019 year. This major accounting slip-up hasn't helped reassure investors about the health of the company.
Additionally, Cronos's annual operating losses have deteriorated from $21.3 million to $121.5 million over the past year. With revenue growth likely to see further declines thanks to cannabis store closures in Canada as well as reduced demand in America, Cronos doesn't have much to impress investors with besides its cash position.
