For much of the past half-decade, marijuana stocks were among the hottest investments on Wall Street. Investors who were able to stomach the industry's early-stage volatility were treated to gains that occasionally topped 1,000% as of 2018 and early 2019.
But over the past 14 months, the cannabis bubble has undeniably burst. While the industry still sports incredible long-term growth prospects as it transitions tens of billions of dollars in black-market cannabis sales over to legal channels, it's dealt with major supply issues in Canada, high tax rates in the U.S., financing issues throughout North America, and more recently, the coronavirus disease 2019 (COVID-19) pandemic.
In some instances, the washout in cannabis stocks has presented an opportunity for long-term investors to load up. But for certain pot stocks, even minor rallies have been met with increased resistance by short-sellers (i.e., investors who make money when a stock's share price declines). Between the end of April and the end of May, short interest rose notably for three of the most popular marijuana stocks.
After more than doubling in value following the release of its fiscal third-quarter operating results, short interest in Aurora Cannabis (NYSE:ACB) increased by 15% from the previous month to 21.3 million shares. This means that nearly 20% of Aurora's float is held by pessimists.
Although Aurora produced higher-than-expected sales in its fiscal third-quarter report and appears to be on track with cost-cutting goals that it laid out earlier in the year, there remain a number of reasons for skeptics to hang onto their positions.
To begin with, Aurora Cannabis was expected to grow into an international juggernaut but has been nothing of the sort in the early going. Despite having access to two dozen countries outside of Canada, Aurora has struggled to generate much more than 4 million Canadian dollars on a quarterly basis from overseas markets. The recent acquisition of hemp-based cannabidiol (CBD) company Reliva in recent weeks may provide a temporary boost in international sales, but it's nowhere near what's been expected, given Aurora's aggressive capacity expansion in 2018 and 2019.
Aurora's management team has also done a poor job of creating value for their shareholders. With the exception of the CanniMed acquisition, Aurora has almost exclusively used its common stock as collateral when buying other companies and funding its operating activities. As a result (and taking into account a recent 1-for-12 reverse split to avoid New York Stock Exchange delisting), the company's share count ballooned from 1.3 million in June 2014 to at least 109.3 million. This share count will keep heading higher, especially with Aurora's board approving a $350 million (U.S.) at-the-market offering.
To top it all off, Aurora's balance sheet is a disaster. Goodwill accounts for more than half of all its total assets, and there's a growing likelihood of inventory and plant, property, and equipment writedowns. In sum, there's a very good reason short-sellers are flocking to Aurora Cannabis.
Aurora isn't alone when it comes to rising short interest. Ontario-headquartered licensed-producer Cronos Group (NASDAQ:CRON) has seen the number of short shares held rise from around 42.2 million at the end of April to 48.5 million a month later. Translation: 27% of Cronos Group's float is held by pessimists.
What makes this large short-seller presence a bit of a surprise is the fact that Cronos Group has a boatload of cash, cash equivalents, and marketable securities on its balance sheet: $1.33 billion, to be precise. This bounty of capital stems from a $1.8 billion equity investment by Altria Group (NYSE:MO) that closed in March 2019, giving Altria a 45% stake in the company. With this cash accounting for 58% of Cronos' market cap as of June 17, you'd think investors would be less pessimistic, but there are certainly reasons for skepticism.
Maybe the biggest issue for Cronos Group is that it's been treated as a major player in the cannabis space despite not being a major producer. The company's core cultivation asset is Peace Naturals, which caps out at only 40,000 kilos of output per year. Further, Cronos generated a meager $8.4 million in first-quarter sales (Cronos reports in U.S. dollars). Ultimately, the company lost more than $40.6 million on an adjusted operating basis in Q1 2020, without one-time benefits.
Another concern is that Cronos has burned through its cash at a pretty staggering rate and has little to show for it. As noted, the company had roughly $1.8 billion in cash once its Altria deal closed. Since then, it's spent $300 million acquiring Redwood Holdings ($225 million of which was in cash) to gain hold of the Lord Jones line of CBD-infused beauty products and watched more than $170 million in cash evaporate in its latest quarter. Over the past five quarters, Cronos has lost over $154 million on an adjusted operating basis.
It's also worth noting that Cronos' expected domination of the vape market with Altria by its side hasn't come to fruition. Certain Canadian provinces have temporarily banned vapes, and the U.S. health scare last summer regarding vapes has hurt demand. Even COVID-19 has presented vape-pen supply issues. In other words, pessimism appears warranted.
Even the biggest marijuana stock in the world by market cap hasn't been spared from the recent resurgence of short-sellers. During the month of May, Canopy Growth (NYSE:CGC) witnessed its shares held short rocket from 39.7 million shares to 45.8 million shares. This works out to 12% of its outstanding shares and more than 20% of its float.
You'd think the amount of skepticism surrounding Canopy Growth would be relatively tame considering that the company has nearly CA$2 billion in cash, cash equivalents, and marketable securities on hand, as of its most recent quarter. Also, it has one heck of an equity investor in Constellation Brands (NYSE:STZ), which owns 38.6% of Canopy's outstanding shares. In fact, Constellation Brands' former CFO David Klein is now CEO of Canopy Growth.
So why the pessimism? For one thing, Canopy Growth's bottom-line results have been potentially the ugliest of the entire industry for multiple quarters now. Canopy had close to CA$4.5 billion in cash following the closure of its major equity investment from Constellation Brands in November 2018 and has seen more than half of that cash value whittled away by operating losses and acquisitions that haven't quite paid off as expected. As a result, the company is in the midst of a massive cost-cutting effort that'll see 3 million square feet of greenhouse cultivation space permanently closed in British Columbia.
Similar to Aurora Cannabis, Canopy Growth's balance sheet isn't pretty. Goodwill accounts for CA$1.95 billion of its CA$6.86 billion in total assets, implying that the company grossly overpaid for its acquisitions. Furthermore, inventory levels have doubled from the prior-year period, increasing the likelihood of inventory writedowns if business doesn't pick up quickly in Canada or overseas.
A final reason we've likely seen pessimists come out of the woodwork is Canopy's quarterly sales. In the fiscal fourth quarter ended March 31, 2020, Canopy's net sales declined 13% from the sequential quarter, which is a bit confusing given that Canadian retail sales in dispensaries hit an all-time record in 2 out of 3 months in the first quarter. As with Aurora Cannabis and Cronos Group, this pessimism appears to make sense.