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3 Pot Stocks to Avoid Like the Plague in August

By Sean Williams - Aug 3, 2020 at 7:21AM

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Not every cannabis stock can be a winner.

For the past 16 months, marijuana stocks have been a nightmarish holding for investors. Many have fallen 50% or more as growing pains have picked up throughout North America. Regulatory-based supply issues in Canada and exorbitant tax rates on legal weed in select U.S. states have allowed illicit marijuana to thrive.

The good news is that there's definitely a path forward for the North American legal cannabis industry. As the industry matures, standouts will emerge.

On the other hand, it means that not every pot stock can be a winner. While it's still a bit too early to concretely call certain marijuana stocks long-term winners or losers, there are a handful of companies that should be surrounded with yellow caution tape, at least in the near term. The following three pot stocks are the perfect examples of cannabis companies that should be avoided like the plague in August.

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

Image source: Getty Images.

HEXO

Topping the list of marijuana stocks that investors would be wise to avoid this month is Quebec-based HEXO (HEXO 1.79%).

At one time, HEXO looked as if it had a winning formula. The company had a signed five-year agreement with its home province of Quebec to supply 200,000 kilos (in aggregate) of cannabis for the adult-use market, and was ramping up capacity and derivative production (i.e., non-flower products, such as edibles) to meet an expected surge in Canadian demand. But, as noted, supply bottlenecks wrecked this vision.

Today, HEXO is scrambling to reduce its operating costs and bring its output potential in-line with demand. This has involved shuttering and selling off the Niagara grow farm that was acquired via the Newstrike Brands acquisition in 2019, as well as idling some of its grow space at the flagship Gatineau facility. HEXO's also had little choice but to lay off some of its workers to reduce costs.

Beyond just backpedaling to right the ship, HEXO's cash balance is a bit of a concern. In June, HEXO announced a $34.5 million Canadian at-the-market stock offering, which comes after multiple rounds of stock issuances and convertible debt offerings. This is a roundabout way of saying that shoring up the company's balance sheet has involved drowning existing shareholders with new stock. This is unlikely to end anytime soon.

And let's not forget that HEXO is playing with fire by having a share price that's consistently been below $1 for almost the entirety of the past four months. Without a reverse split, HEXO appears destined to be delisted from the New York Stock Exchange. These are all good reasons to steer clear for now.

A bearded man in sunglasses exhaling vape smoke while outside.

Image source: Getty Images.

Cronos Group

Another cannabis stock that investors ae going to want to steer clear of in August is Canadian licensed producer Cronos Group (CRON 3.93%), which happens to be reporting its second-quarter operating results later this week.

Like HEXO, Cronos appeared to have a solid growth strategy, especially following a $1.8 billion equity investment from tobacco giant Altria Group (MO 0.04%) that resolved all of its near-term cash concerns. With plenty of cash and Altria in its corner, the expectation was that Cronos Group would become a cannabis vape superstar and quickly reap the rewards of Canadian derivative sales. Though you can probably guess what I'm about to say, this didn't happen.

First off, Cronos Group has run into all sorts of issues with its derivatives/vape-focused approach. Health Canada delayed the launch of derivative products by two months, and in key provinces like Ontario, an inability to license retail locations led to supply bottlenecks. There were also safety concerns, with a handful of Canadian provinces banning cannabis vape products.

That brings me to the next point: Cronos isn't a major player on the production front. Though it has cash at its disposal, Cronos is leaning on Peace Naturals as its primary source of cannabis production. At its max, Peace Naturals is only capable of 40,000 kilos a year, and some of its cultivation space was repurposed by Cronos Group. Suffice it to say that Cronos isn't the big player it's perceived to be.

The company is also losing quite a bit of money on an operating basis. If investors parse out the derivative liability revaluations tied to the Altria equity investment, they'd see a company that hasn't come close to generating an operating profit. Perhaps more concerning is that Cronos' $1.8 billion in cash has been whittled down to $1.33 billion in cash, cash equivalents, and marketable securities in a year.

There's no real plan or catalyst here, which makes Cronos Group easily avoidable.

A smoldering cannabis bud that's beginning to turn black.

Image source: Getty Images.

Aurora Cannabis

Finally, investors would be best-served if they kept their distance from popular millennial-owned pot stock, Aurora Cannabis (ACB 8.70%).

To be clear, Aurora Cannabis' outlook today isn't nearly as bad as it was, say, three months ago. But "less bad" doesn't mean good, which is why it once again finds itself on the naughty list.

Similar to HEXO, Aurora Cannabis is backpedaling on its costs as quickly as it can to achieve positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). Positive adjusted EBITDA is a requirement of the company's debt covenants by the end of the first quarter of fiscal 2021 (ended Sept. 30, 2020). By closing five smaller production facilities, selling off the 1-million-square-foot Exeter greenhouse, halting construction on two of its larger projects (Aurora Sun in Alberta and Aurora Nordic 2 in Denmark), and engaging in multiple rounds of layoffs, Aurora should be able to get its selling, general and administrative costs to between CA$40 million and CA$45 million per quarter.

Again, this is good news. But this isn't the news that Aurora investors signed up for. They believed they were buying into a production leader that would have little issue landing long-term export agreements and/or an equity investment. None of this has come to fruition, despite hiring billionaire activist investor Nelson Peltz as a strategic advisor. And Aurora is no longer the projected leader in cannabis output, either.

While we've seen operational improvements for Aurora, there's still a long way to go to fix its broken balance sheet. Aurora's board approved a $350 million (that's U.S.) at-the-market offering in mid-April, signaling to investors that the company's dilutive actions would not cease anytime soon. Meanwhile, goodwill, intangible assets, and property, plant and equipment all look to be line-items that could face significant writedowns in the future.

It's good to see Aurora tackling its operational issues. Next up is that hideous balance sheet. Until that's dealt with, Aurora Cannabis remains a pot stock to avoid.

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
$1.75 (8.70%) $0.14
Cronos Group Stock Quote
Cronos Group
CRON
$3.17 (3.93%) $0.12
HEXO Stock Quote
HEXO
HEXO
$0.23 (1.79%) $0.00
Altria Group, Inc. Stock Quote
Altria Group, Inc.
MO
$45.15 (0.04%) $0.02

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