Marijuana stocks have been on fire as of late, with four U.S. states -- New Jersey, Arizona, South Dakota, and Montana -- all legalizing recreational marijuana in the November elections. And now that Democrats have won control of the Senate, it is very likely that the nation could be on the path toward decriminalization of marijuana -- or even full legalization at the federal level.
As legalization efforts smolder in the U.S., investors should be on the lookout for well-established cannabis companies that can turn a profit while simultaneously achieving high revenue growth. There's no good reason to buy into marijuana businesses that are bleeding much-needed cash quarter after quarter. Let's take a look at three pot stocks you should definitely avoid.
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1. Cronos Group
Canadian medical and recreational marijuana company Cronos Group (CRON 0.41%) was largely flying under the radar until December 2018, when tobacco giant Altria (MO 0.12%) purchased a 45% stake in it for CA$2.4 billion. In Q3 2020, however, the company only managed to generate $11.4 million in quarterly revenue. While that is a significant improvement over the $5.8 million in sales it delivered in Q3 2019, Cronos is far from profitable.
In fact, the company has yet to turn a gross profit, and it's currently losing $1.5 million per quarter after accounting for labor and cost of goods. Additionally, its operating loss worsened from $30.7 million in Q3 2019 to $41.2 million in Q3 2020.
Over the past two years, Altria has lost 50% of its initial investment; Cronos has approximately $1.3 billion in cash and securities left. Its projected growth from U.S. expansion has also not done well. During Q3 2020, Cronos recorded $1.6 million in U.S. sales -- and it spent $12.2 million in operating expenses to attain that revenue.
Despite its poor financial performance, Cronos is hypervalued, trading at 87 times sales. There are far better alternatives than Cronos for those who are betting on Canadian pot growers with significant potential to expand down south.
2. Canopy Growth
Once a Canadian marijuana industry leader, Canopy Growth (CGC -0.66%) has fallen on tough times due to intense competition. In fact, it no longer holds top market share when it comes to recreational cannabis and pot-infused beverages. These titles now belong to Aphria (APHA) and HEXO (HEXO), respectively.
During Q2 2021 (which ended Sept. 30), Canopy Growth managed to grow its revenue by 77% year over year to CA$135.3 million. While that's very impressive, its sales, general, and administrative costs were very nearly equal to its revenue. Besides, the company is still losing about CA$200 million per quarter in free cash flow -- and that's after it improved the metric by 57% year over year.
Thanks to some aggressive cost-cutting measures, management expects to save up to $200 million within 24 months. However, it is likely that Canopy Growth will remain unprofitable for some time. In the interim, the company has no choice but to burn more of its CA$1.7 billion cash balance to fund operations. Given the company's inability to generate solid net income, I wouldn't pay 31 times revenue to buy shares of this business right now.
3. OrganiGram
Yet another Canadian pot grower, OrganiGram (OGI -1.03%) continues to produce more cannabis than consumers are asking for, and it keeps losing money as a result. During Q1 2021 (which ended Nov. 30), the company's revenue declined by 23% year over year to CA$19.3 million. What's more, its gross losses widened to negative CA$16.7 million from CA$11.2 million a year prior.
Additionally, the company's net loss increased to a stunning CA$34.3 million from CA$863,000 in Q1 2020. Inventory writedowns and asset impairments due to overexpansion were the reasons behind the decline.
To illustrate its problems: OrganiGram recently completed the final stages of expansion for its Moncton growing facility, expanding its manufacturing capacity -- but it's only using about 40% of that space, and management expects to "cultivate less than [its] capacity" for the foreseeable future. . It's trading at just 4.3 times sales for a reason -- the company's accelerating losses and its overcapacity are two things that should signal investors to stay well away.
