Oversupply, pricing headwinds, inventory writedowns, and retail store closures due to COVID-19 containment measures -- these things and more have meant a tough year for the legal marijuana market worldwide. Since the beginning of January, the Horizons Marijuana Life Sciences ETF (HMMJ +3.30%) is down 27%. That is an abysmal performance compared with the S&P 500, which is up more than 6% during the same period.
But business results -- good or bad -- are not the only metric investors should consider when picking cannabis stocks. It's also important to look at valuation. Many high-flying marijuana companies are ludicrously valued right now, indicating that all (or more!) of their future growth is potentially priced in. These three extremely overvalued cannabis stocks are among those investors would be wise to avoid.
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1. Cronos Group
Cronos Group (CRON +6.03%) is undoubtedly experiencing significant headwinds. The company -- which has a $1.9 billion market cap -- recognized a meager $9.9 million in sales, or 29% yearly sales growth, in its most recent quarter. Its gross profit was a negative $3 million.
Even if we remove Cronos's $3.1 million inventory writedown from our calculations, its gross margin is just 1%, indicating the company is not effective at turning investors' capital into profit. And with other expenses included, the company's operating loss grows to a staggering $34.8 million.
Given these lackluster results, Cronos may not be able to issue new stock to raise money, and I expect the company's $1.3 billion cash balance to become smaller and smaller as time passes. Many other reputable companies in the sector are thriving even amidst the problems for marijuana in Canada, but Cronos is definitely not one of them.
2. GW Pharmaceuticals
At first glance, GW Pharmaceuticals (GWPH +0.00%) looks nothing but exciting for investors. During Q2 2020, the company launched its CBD-based anti-seizure drug, Epidiolex, in Europe after two years of strong growth in the U.S. Epidiolex is the first CBD drug approved by the U.S. Food and Drug Administration (FDA), and it's used to treat certain types of epilepsy.
Recently, the FDA allowed the expansion of Epidiolex's label to treat seizures in patients with tuberous sclerosis complex, a condition that affects 50,000 people in the U.S. alone. GW Pharmaceuticals is also investigating nabiximols, the active pharmaceutical ingredient (API) in Epidiolex, to treat various conditions.
For example, the company expects to enroll participants in early- to advanced-stage clinical studies to treat schizophrenia, autism, and a rare genetic neurological disorder called Rett syndrome with nabiximols by the end of the month. By Q4 2020, GW Pharmaceuticals will be testing nabiximols' efficacy in combating multiple-sclerosis-induced spasms in phase 3 studies. In the first half of 2021, the company expects to be testing the API in alleviating post-traumatic stress disorder in phase 2/3 clinical trials.
GW Pharmaceuticals's year-over-year revenue growth was 68% in Q2 2020. While all of its recent advancements sound very impressive, there is a big problem with GW Pharmaceuticals as an investment: its valuation. Most recently, the company brought in $121 million in quarterly revenue and operated at a net loss of $8.8 million. However, GW Pharmaceuticals' market cap is $3.2 billion.
Even assuming Epidiolex becomes a blockbuster drug and generates $1 billion in peak annual sales, the company's forward price-to-sales valuation of 3.22 is a bit expensive considering it has yet to post an operating profit since the drug's launch two years ago. Investors who wait for a better time to purchase shares are more likely to be rewarded.
3. Organigram
Although the two companies discussed above have crucial issues, they have at least shown they're able to grow revenue. Organigram (OGI +6.29%), on the other hand, is not so fortunate. During its third quarter ending May 31, the company's revenue decreased from $24.3 million Canadian dollars in Q3 2019 to just CA$18 million.
Perhaps astonishingly, the company lost CA$50 million in gross profits. Among many things causing this was a CA$19.3 million write-off of inventory that could not be sold in time. If that wasn't bad enough, the company also laid off 25% of its workforce because of lack of consumer demand for its cannabis, and management does not expect its sales in Q4 to rebound to levels seen in early 2020.
Organigram's net loss increased almost ninefold year over year, from CA$10.2 million in Q2 2019 to CA$89.9 million. As of July 17, the company has CA$78 million in cash and investments. Given its current cash burn rate, I don't see how Organigram can become profitable in the near future. The company will very likely have to return to the capital markets for yet another round of financing. Prudent investors would do well to stay away.
