There's a lot of doom and gloom in the cannabis industry. It's hard to avoid when even the Horizons Marijuana Life Sciences ETF (OTC:HMLSF) has crashed 65% in the past year. Many cannabis companies have continued to struggle to stay out of the red even amid rapid growth. In the past that was fine, because their share prices were much stronger and they just had to issue more stock. But now it's getting harder to raise money. And with cash more scarce than ever before, many companies aren't far away from going completely under. Canadian cannabis company Tilray's (NASDAQ:TLRY) CEO believes that at least 12 marijuana companies will go under this year. Let's take a look at why he's so pessimistic and whether that's a reasonable estimate.
Tilray raised cash while it still thought it could
In March, Tilray announced that it would be raising $90.4 million through an offering, largely because the company still could. CEO Brendan Kennedy told BNN Bloomberg that he "wasn't sure anyone was going to be able to raise any money in this industry again" and that "when we had the opportunity to strengthen the balance sheet, we did."
Based on his connections and the information he's receiving from people in the industry, Kennedy's expecting to see at least another dozen companies go bankrupt, in addition to those that already have. Thus far, it's been small companies that have gone under. The biggest name to run into trouble has been CannTrust Holdings, which started crashing in July 2019 when investors learned the company was growing cannabis illegally. That was a result of CannTrust's ongoing scandal, but the bankruptcies that will happen this year will likely be due to liquidity issues.
No shortage of possible cannabis bankruptcies this year
Earlier this month, Green Growth Brands (OTC:GGBXF) became the latest company to face a shortage of cash. On May 20, investors learned that the company had filed for insolvency protection. Green Growth is most well known for making a $2.1 billion bid for Aphria (NASDAQ:ACB) in late 2018. Aphria ultimately rejected the offer, but the bid helped put the spotlight on Green Growth at the time.
It's not hard to come up with others that may be on Green Growth's path. Pot producer iAnthus Capital Holdings (OTC:ITHUF) was supposed to release its full-year results on April 6, but instead, it announced that it had defaulted on its interest obligations. MedMen Enterprises (OTC:MMNFF) was running behind on its bills back in January, and there's little reason to expect things have gotten much better since then.
These are just a couple of examples of companies already in distress even before COVID-19. And there could be even bigger chips to fall.
In February, investment bank Ello Capital estimated that pot giant Aurora Cannabis (NASDAQ:ACB) had just a couple of months' worth of liquidity at its disposal. As of March 31, Aurora reported that it had 230 million Canadian dollars on its books. And while it may be OK for now, a prolonged period of lackluster sales due to the pandemic could combine with excess overhead to spell disaster for the company in the months to come. In addition, there are also many other smaller companies that will be at even more risk this year.
That's why Kennedy's estimate of a dozen companies looks conservative to me. If we're counting both public and private businesses, the number will likely reach well over 12. With all that risk, investors may be wondering if it's worth it to invest in the industry today.
Should investors be getting out of the cannabis industry?
There do exist cannabis companies that are safe bets to get through 2020 and the COVID-19 pandemic, but they're definitely in the minority. Companies such as Canopy Growth (NASDAQ:CGC) and Cronos Group (NASDAQ:CRON) that have partners from other industries and more than CA$1 billion on their books are relatively safe bets to survive. Aphria also has more than CA$500 million on hand, which should seem safe enough given its strong results. Unless a company has hundreds of millions of dollars at its disposal, I wouldn't consider it a safe investment this year.
Even Kennedy's own company, Tilray, is by no means guaranteed to get through 2020 in one piece. The company's coming off a year in which it lost $321.2 million and burned through $258.1 million in cash from its day-to-day operating activities. As of the end of the year, it had $96.8 million in cash. And there's no guarantee that even the additional cash raised with the stock offering this year will be enough to get the company through the pandemic given its cash burn.
Risk-averse investors may want to avoid the cannabis industry entirely. Even if a cannabis company gets through the pandemic, that doesn't mean its returns will be strong. More daring investors, who are willing to take on the risk of investing in the marijuana industry, should keep a close eye on a company's cash flow before deciding to buy shares of any pot stock this year.