Over the past 18 months, the North American marijuana industry has struggled, and a number of popular pot stocks have been pulverized. Every next-big-thing investment contends with growing pains, and that's exactly what marijuana stocks are navigating their way through at the moment.
To our north, Canada has been punished by a plethora of regulatory-based supply issues. Meanwhile, in the U.S., high tax rates in select legalized states have made it difficult for licensed producers to compete with black-market growers.
While there's little question that cannabis can be one of the fastest-growing and most-exciting industries in North America this decade, not every pot stock can be a winner. As we prepare to move headlong into October, I'd strongly encourage investors to avoid the following three pot stocks like the plague.
At one time, there was a lot of promise here. Aurora Cannabis was supposed to lead the world in marijuana output. It was also expected to have little issues snagging long-term supply deals given that it had a presence in two dozen overseas markets. In March 2019, the company also brought billionaire activist investor Nelson Peltz onboard, which looked like an obvious clue that Aurora was looking for a food or beverage partner.
Yet, here we are 18 months later, with more than half of Aurora's cultivation facilities closed, sold, or having had construction halted. It's also generating very little income from overseas markets, and has no brand-name partnerships or equity investments to speak of.
The most worrisome recent development is the company's reliance on value-priced pot brands in the recreational Canadian market. The June-ended quarter saw Aurora report an average net selling price per gram of just $3.60 Canadian ($2.69/gram U.S.), which was down 22% from the sequential quarter, ended in March. What this means is Aurora is having to go toe-to-toe with black market producers on price in order to lure in new users. That's a failure of Canada's regulators to stamp out illicit producers, and it's going to absolutely decimate the company's operating margins.
Although Aurora finally bit the bullet on its ugly balance sheet in the fiscal fourth quarter, it still has issues to contend with. Most notably, the company's cash situation remains precarious. Even with reduced selling, general, and administrative (SG&A) expenses, Aurora's board OK'd the sale of up to $350 million (that's U.S.) worth of shares via at-the-market offerings. This company has been continually diluting its shareholders, with its outstanding share count ballooning from 1.3 million to more than 115 million in six years.
There simply aren't any redeeming qualities for investors to latch onto.
Though I recall how fascinating penny stocks were in my younger days, I also remember how often they just kept heading lower. Just because Quebec-based licensed producer HEXO (NYSE:HEXO) sports a sub-$0.70 share price does not mean it can't head lower.
Similar to Aurora Cannabis, HEXO looked like it had a solid foundation in Canada's pot industry. It signed the largest multiyear wholesale supply agreement with its home provinces of Quebec in 2018, and appeared ready to tackle a supposed uptick in demand via its acquisition of Newstrike Brands. But this house of cards has come tumbling down in a big way over the past year.
First of all, we saw HEXO shutter the Niagara facility that was acquired from Newstrike, then sell this grow site for a measly CA$10.25 million. HEXO wrote down the vast majority of the value of its Newstrike acquisition.
Second, we've watched as HEXO has attempted to backpedal its way toward profitability -- or perhaps its survival, at this point. Multiple rounds of layoffs coupled with reduced output are designed to lower the company's SG&A expenses. Unfortunately, this has done little to offset a lack of significant sales growth. As a result, HEXO's quarterly losses have yet to narrow.
A third issue can be found in the company's April-ended quarterly report. In that quarter, HEXO reported an average selling price per gram of CA$3.64 per gram. Like Aurora, HEXO's value brand is completely sapping its operating margins.
But the fourth problem might be its biggest. With HEXO's share price stuck under $1, it risks delisting from the New York Stock Exchange by as soon as mid-December. The company could choose to enact a reverse split, but this is often perceived as a corporate action of weakness by the investment community.
The fact is that HEXO's long-term survival is very much in question at this point, which makes it a wholly undesirable investment in October and well beyond.
The big lure to Cronos Group has been its tie-ins with tobacco giant Altria Group (NYSE:MO). In mid-March 2019, Altria closed an equity investment into Cronos Group that saw it take a 45% stake in exchange for $1.8 billion in cash. This cash alleviated Cronos' near-term capital concerns and, presumably, gave Altria a pathway to expand sales beyond just tobacco in the United States. This sounded like a match made in heaven, but excitement surrounding this investment has since gone up in smoke.
The expectation had been that Altria would assist Cronos Group in developing and marketing cannabis vape products. However, the duo has run into serious issues on this front. In Canada, Quebec and Newfoundland and Labrador have banned vape sales. Additionally, the U.S. was hit with a vape health-scare around this time last year that was eventually traced to vitamin E acetate. Though many of the products in question were purchased from the black market, a small number of troublesome vape products also derived from legal channels. Suffice it to say, there are persistent concerns about vape safety.
Another problem is that new users appear to be choosing dried cannabis flower over more expensive derivative products. A recently released report from the Brightfield Group found that derivative use in the second quarter among new users was relatively unchanged from the first quarter. By comparison, there was a marked uptick in cannabis flower use. That's bad news for a company like Cronos that has relatively minimal dried flower production capacity and is focused almost entirely on derivatives.
The reality for Cronos is that its big cash position isn't going to provide much protection if consumers aren't buying derivatives and the company keeps losing money. Investors would be wise to keep their distance in October.