After a nearly two-year hiatus, marijuana stocks are again one of the hottest investments on Wall Street. In the U.S., 36 states have waved the green flag on medical marijuana, and 15 of them also allow adult-use consumption and/or the retail sale of recreational weed. Meanwhile, Canada opened its doors to recreational cannabis sales on Oct. 17, 2018.
Following a slow start, monthly pot sales in our neighbor to the north are hitting all-time highs. North America represents a potential $75 billion opportunity for the cannabis industry by the end of this decade.
But not all pot stocks have Wall Street professionals convinced of their success. Three marijuana stocks are forecast to lose at least 47% of their value, as measured by Wall Street's one-year consensus price targets.
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HEXO: Implied downside of 47%
As you're about to see, Wall Street investment banks aren't thrilled about Canadian pot stocks. It all begins with Quebec-based HEXO (HEXO), which would need to fall by 47% to reach Wall Street's one-year price target.
I'll be the first to admit that HEXO fooled me big time. It signed what's still the largest wholesale agreement to date in 2018 -- a 200,000 kilo-in-aggregate agreement with Quebec over five years -- and laid out plans to focus on higher-margin derivative production (i.e., edibles, vapes, topicals, concentrates, and infused beverages). On paper, HEXO looked like a winner -- but that's not been the case.
HEXO made a big mistake by acquiring Newstrike Brands in 2019 when it didn't need added production capacity. It's also been leaning on value-based dried cannabis flower to create a loyal base of customers. Unfortunately, this value-focused cannabis is crushing its margins and ensuring that HEXO continues to lose money.
Even more concerning is the company's precarious cash situation. Despite selling its Niagara cultivation facility that it acquired when it bought Newstrike, shuttering some capacity at its flagship Gatineau facility, and laying off hundreds of workers, HEXO continues to burn through its cash on hand -- and its costs are still too high. The only effective way to raise capital has been to sell its stock and dilute the daylights out of its shareholders.
These issues make HEXO a pot stock worth avoiding.
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Cronos Group: Implied downside of 53%
Another cannabis stock Wall Street dislikes is Ontario-based Cronos Group (CRON -1.66%). Based on the closing price of Cronos last weekend, the consensus among analysts is that the company could fall 53% over the next year.
The biggest positive for Cronos is that it's a cash-rich company. In March 2019, it closed a $1.8 billion equity investment from tobacco behemoth Altria Group -- the company behind the premium Marlboro brand of cigarettes in the United States. This deal gave Altria a 45% stake in Cronos, as well as a means to potentially diversify its growth prospects away from tobacco. This allayed Cronos' cash concerns and gave it an established partner to help with developing and marketing cannabis vape products.
The problem for Cronos Group is that the launch of derivatives in Canada was delayed until mid-December 2019, and it's been plagued by supply bottlenecks for about a year. With only 40,000 kilos in annual production potential at Peace Naturals, Cronos is banking on derivatives to carry the company. This bet simply hasn't paid off as of yet, as analysts expect the company to generate only $33.8 million in sales in 2020. That's a staggeringly low number for a company with a nearly $4 billion market cap.
The other issue for Cronos Group is that its cash pile is whittling away. The company spent $300 million ($225 million in cash) to buy the Lord Jones cannabidiol-based beauty line in 2019, and its abysmal operating results have led to a constant cash burn. What was once $1.8 billion in cash has now been reduced to $1.3 billion.
With the exception of this cash, Cronos doesn't have much going for it.
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Sundial Growers: Implied downside of 58%
However, the biggest potential train wreck, based on Wall Street's consensus price target, comes courtesy of cannabis penny stock Sundial Growers (SNDL 1.91%). Sundial has more than quadrupled from its lows in less than three months, but Wall Street is expecting it to lose 58% of its value over the next year.
The recent surge in shares of Sundial can be traced to Joe Biden's victory in November and both Democrats winning in Georgia's U.S. Senate seat runoff election in January. With Democrats in control of the legislative branch of the U.S. government, it's now much likelier that cannabis will be legalized at the federal level. In other words, investors are front running the possibility of Sundial entering the U.S. market.
There seems to be two reasons behind Wall Street's blatant skepticism. First of all, Sundial Growers is in the process of transitioning from a low-margin wholesale model to a higher-margin retail model. This shift isn't going to happen overnight and has resulted in ongoing losses for the company.
Secondly, but maybe more importantly, Sundial has been drowning its existing shareholders in new share issuances and debt-to-equity conversions to raise capital and reduce debt. Even though this is a bona fide penny stock with a $0.71 share price, it has a market cap of more than $700 million. That's an insanely high figure for a company that's nowhere near profitability and isn't guaranteed long-term survival at this point.
In fact, you might also add to the list that Sundial's sub-$1 share price is insufficient to maintain its listing on the Nasdaq. Similar to what HEXO recently did, Sundial Growers may be forced to enact a reverse split to avoid delisting. A reverse split is almost universally viewed as a sign of weakness by the investment community.
