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3 Pot Stocks That Aren't as Cheap as They Appear

By Sean Williams - Apr 29, 2020 at 7:21AM

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Even down more than 90%, some cannabis stocks remain pricey.

Throughout much of 2017, most of 2018, and the first quarter of 2019, marijuana stocks were virtually unstoppable. Promises of top-tier production, partnerships, and high-margin derivative products sent pot stocks into the stratosphere.

But over the past 13 months, cannabis stocks have cratered, with some losing as much as 95% of their value. This shakeout was inevitable as history has shown us that not every company can be a winner when the next big investment trend arises.

However, such significant declines in marijuana stock market caps have some investors wondering if now is the time to take advantage of perceived-to-be "cheap" valuations. After all, Wall Street is still counting on cannabis to be at least a $50 billion industry by 2030. But as you're about to see, a low share price doesn't mean a stock is cheap. Here are three pot stocks that appear cheap, but aren't remotely good values.

An up-close view of a flowering cannabis plant growing in an indoor cultivation farm.

Image source: Getty Images.

Aurora Cannabis

In terms of popularity, Aurora Cannabis (ACB -1.21%) is king among pot stocks. On millennial-focused investment app Robinhood, Aurora is the most-held stock by a mile. We're talking about a company that, as of the midpoint of 2019, was on track to lead all of Canada in peak annual production, had somewhat recently hired activist investor Nelson Peltz as a strategic advisor, and appeared set to land numerous wholesale supply agreements given its exposure to 24 countries outside Canada.

At Aurora Cannabis' closing price on Monday, April 27, of $0.76 per share, it probably sounds like a steal of a deal -- but it's not.

You see, even with its share price at just $0.76, Aurora still sports a market cap of nearly $1 billion. That's because, over a span of almost six years, the company has grown its outstanding share count from 16 million to 1.31 billion! Aurora has been selling its common stock to raise cash for years, and has used its common stock as collateral for its more than one dozen acquisitions since August 2016. With the company facing a potential cash crunch in calendar year 2020, another $350 million at-the-market share offering was recently approved by its board.

Aurora Cannabis is also likely facing a trio of writedowns. Even following a goodwill impairment of $762 million Canadian in the fiscal second quarter, Aurora's goodwill still totals CA$2.41 billion and accounts for 52% of total assets. Beyond just expecting a goodwill writedown, this is a company with ballooning inventory levels and idled or underutilized assets. As a reminder, Aurora Cannabis halted construction on two projects last year, while announcing its intent to sell a 1-million-square-foot greenhouse earlier this year.

To put it bluntly, Aurora Cannabis is a dumpster fire, and a $1 billion valuation is hardly justifiable.

A cannabis bud and small vial of cannabinoid-rich liquid next to a Canadian flag.

Image source: Getty Images.

HEXO

Another perceived-to-be cheap cannabis stock is Quebec-based HEXO (HEXO 2.46%). As of this time last year, HEXO looked set to capitalize on a five-year, 200,000-kilo wholesale supply agreement with its home province, as well as utilize space at its flagship Gatineau facility for the processing and manufacturing of high-margin derivatives. These high-margin products, such as edibles and infused beverages, wound up hitting dispensary shelves in Canada in mid-December.

Yet, as of earlier this week, HEXO's share price of $0.535 makes it look like an absolute deal compared to the $8-plus is traded at in late April 2019. But looks can be deceiving.

For example, even though HEXO's stock has fallen by more than 90% over the past year, it still sports a market cap of around $185 million. The reason its market cap remains so high is because HEXO, like Aurora, is selling its common stock (or convertible debentures) to raise cash. After ending January 2019 with close to 208 million outstanding shares, the company now has closer to 344 million shares. Considering that HEXO has sold stock at significant discounts to its previous day's closing price on more than one occasion, it's become evident to Wall Street that the company is pretty desperate for cash. 

We're also talking about a company that's gone on the defensive to reduce its expenditures. HEXO has no plans to reopen the idled Niagara grow farm that was acquired via the Newstrike Brands acquisition, and it's also idling about 200,000 square feet of cultivation space at Gatineau. My guess is this reduces its peak annual output from 150,000 kilos to potentially under 100,000 kilos. In addition, HEXO laid off 200 employees last year.

Lastly, HEXO's share price makes it a target for delisting from the New York Stock Exchange. It may have to follow Aurora's footsteps and enact a reverse split. Most companies that are pressured into a reverse split to avoid delisting from a major exchange will see their valuations fall even more.

A bearded man wearing sunglasses who's exhaling vape smoke while outside.

Image source: Getty Images.

Cronos Group

Chances are that pot stock investors are probably eyeing Cronos Group (CRON 1.16%) as well following its tumble from almost $17 a year ago to just $6.44 as of Monday. As a reminder, Cronos Group ended 2019 with around $1.5 billion in cash, cash equivalents, and marketable securities on its balance sheet, which is almost entirely from tobacco giant Altria Group (MO 1.46%) taking an equity investment in the company in mid-March 2019.

While the idea of a large cash buffer and Altria as a partner sounds great on paper, there's more to this valuation than meets the eye.

Stripping out the cash value, investors are paying around $730 million for Cronos Group at the moment. This is a company that, in 2019, only managed $23.8 million in net sales and produced a gross loss of $17.9 million. Cronos Group has consistently trailed its Canadian peers in the production department, and the company currently only has Peace Naturals to lean on as a steady production source. However, the 40,000-kilo annual peak capacity of Peace Naturals is hardly worth writing home about for shareholders. 

Cronos Group's game-changing partnership with Altria also hasn't been anything to get too excited about. Aside from Altria shoring up Cronos' balance sheet, the duo have failed to find their stride. A vape-health scare in the U.S. last year, followed by coronavirus disease 2019 (COVID-19) supply disruptions in 2020, have significantly dampened the near-term outlook for the cannabis vape market.

Cronos Group is no closer to profitability now than it was a year ago. Its cash hoard should help provide more of a downside buffer than with most pot stocks, but $730 million is a ridiculous valuation (excluding cash) to bestow on a business that's been outperformed in the production department by licensed growers a fifth of its size. Cronos Group is not the value it appears.

Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends HEXO. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Aurora Cannabis Stock Quote
Aurora Cannabis
ACB
$1.64 (-1.21%) $0.02
Cronos Group Stock Quote
Cronos Group
CRON
$3.06 (1.16%) $0.04
HEXO Stock Quote
HEXO
HEXO
$0.22 (2.46%) $0.01
Altria Group, Inc. Stock Quote
Altria Group, Inc.
MO
$45.40 (1.46%) $0.66

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