For much of the past half-decade, cannabis stocks have been among the hottest investments on Wall Street. With Canada becoming the first industrialized country in the modern era to green light adult-use cannabis, and two-thirds of U.S. states legalizing weed in some capacity, the door appeared to be wide open for pot stocks to thrive and snag the tens of billions of dollars in cannabis sales conducted in the black market each year.
However, sentiment shifted in a big way beginning in April 2019. Over the trailing 15-month period, most marijuana stocks have lost in excess of 50% of their value. Persistent regulatory-based supply issues throughout Canada, high U.S. tax rates on legal products, and financing concerns, have weighed on pot stock investors.
While there's no question that this is an industry that's here to stay (which means there will be winners), there are a trio of cannabis stocks that investors would be wise to avoid like the plague for the second half of 2020.
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Aurora Cannabis
The first marijuana stock you'd be wise to keep your distance from the remainder of the year is Alberta's Aurora Cannabis (ACB -1.15%). Aurora happens to be the most popular pot stock among millennial investors, despite the fact that it's lost nearly 90% since mid-March 2019.
Like most Canadian pot stocks, Aurora is backpedaling after overshooting in the capacity expansion department. Following a halt in construction on two of its largest projects, and the more recently announced closure of five smaller production facilities, the company looks to be on track to generate positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) by the fiscal first quarter of 2021 (ended Sept. 30, 2020), as required by its debt covenant. While this does represent a step in the right direction for Aurora, a number of issues are still left to be dealt with.
For example, Aurora Cannabis' balance sheet remains a mess. Having not landed an equity investor, Aurora has relied on issuing its common stock to fund day-to-day activities and make acquisitions. Even accounting for the 1-for-12 reverse split enacted on May 11 to avoid delisting from the New York Stock Exchange, the company's share count has exploded from approximately 1.3 million shares six years ago to what I suspect is around 113 million shares after the recently completed Reliva deal. With a $350 million at-the-market offering at its disposal, Aurora continues to show little regard in the value-creation department for its shareholders.
Additionally, Aurora's total assets are a problem. A recently announced inventory charge of up to $140 million Canadian is a start given the company's rapidly rising inventory levels, but there's much more to do. The company's remaining facilities are likely overvalued on the company's balance sheet, and its CA$2.42 billion in goodwill is highly unlikely to be recouped. Sweeping asset writedowns are needed.
The fact is that cost-cutting isn't a long-term growth strategy. Though Aurora has taken some of the steps necessary to rebuild shareholders' trust, it has a long way to go before it becomes worthy of investment.
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Cronos Group
Another exceptionally popular cannabis stock you're going to want to bypass owning in the second half of 2020 is Cronos Group (CRON -1.66%).
Interestingly, Cronos is one of only a select few Canadian pot stocks that's not having cash concerns. It landed an equity investment from tobacco giant Altria Group that closed last year. The deal gave Altria a 45% stake in Cronos Group, with Cronos landing $1.8 billion (that's U.S.) in cash. It was good timing, too, as Cronos has only around $25 million in the quarter prior to the closing of the deal.
Unfortunately, cash alone doesn't make a cannabis stock worth buying. In fact, Cronos' cash has been dwindling at an alarming rate. Last year, Cronos acquired Redwood Holdings for $300 million, of which roughly $225 million was in cash. This brought the Lord Jones brand of cannabidiol (CBD) beauty products into Cronos' product portfolio. However, CBD sales in the U.S. have underwhelmed due to the U.S. Food and Drug Administration putting its foot down on CBD as an additive to food and beverages. As a result, Cronos' cash position has now dwindled to $1.33 billion from $1.8 billion in a year.
Perhaps more concerning is the fact that the company's sales have been inexcusably small for a company with a market cap and cash pile its size. Aside from the Lord Jones brand failing to pay dividends, Cronos' core production facility, Peace Naturals, is only capable of 40,000 kilos of output a year. Canada's slow adult-use ramp-up, compounded with Cronos Group's pedestrian output, has the company generating less than CA$9 million in sales per quarter.
Investors also can't overlook the numerous issues tied to the vape industry. Altria was expected to help Cronos Group become a dominant vape player. However, a vape-health scare in the U.S. last summer, supply issues tied to the coronavirus disease (COVID-19) pandemic this year, and select Canadian provinces banning vape sales pending further safety review, have stymied Cronos' plans to dominate this high-margin market.
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HEXO
Finally, cannabis stock investors are strongly urged to avoid Quebec-based HEXO (HEXO) for the second half of 2020, if not beyond.
Similar to Aurora Cannabis, HEXO is in the midst of a massive cost-cutting campaign that's designed to drastically reduce its operating expenses and move the company toward profitability. HEXO is attempting to accomplish this by halting production at select facilities and reducing staff. While this is a smart move given the state of marijuana demand in Canada, it's by no means a business-saving maneuver for the company.
The first thing you need to know about HEXO is that it's operating as a going concern, at least according to its quarterly filings with SEDAR in Canada. Companies that are labeled as going concerns typically don't have the capital on hand to cover their expenses over the coming 12 months. This is why we've seen HEXO pare back its spending and sell the Niagara facility for a meager CA$10.25 million.
To build on this point, HEXO's primary means of raising capital at the moment is to sell its common stock. The company's at-the-market offerings are continuing to balloon its share count and dilute what remaining value its shares have left. It's also not helping HEXO's case to remain listed on the New York Stock Exchange. With the exception of three trading sessions over the trailing three-month period, HEXO has closed below the $1 minimum threshold for continued listing on the NYSE.
But the most damning evidence of all might come from CEO Sebastien St-Louis, who in October 2019 commented that the company would need to secure 20% market share in Canada to become profitable. That's a seemingly impossible task given that the company is simply trying to reduce its costs enough to survive at this point.
Keep HEXO out of your portfolio for the foreseeable future.
