In a three-year stretch, marijuana stocks went from being the buzz of Wall Street to nothing short of a buzzkill.
When President Joe Biden took office in January 2021, there was the strong belief that he and a then Democrat-controlled Congress would have no trouble passing cannabis-reform measures. Unfortunately, meaningful reforms have continually fallen flat in the U.S. Senate, and President Biden has done little to advance the legalization of marijuana in the world's most lucrative market for weed.
Despite these ongoing setbacks, which have made life difficult for some marijuana-based businesses, cannabis still profiles as one of the fastest-growing global industries of the decade. According to market intelligence company BDSA, the worldwide cannabis industry is forecast to deliver compound annual growth of 13% through 2027 after generating an estimated $36.7 billion in total sales in 2023.
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But just because the long-term outlook for marijuana is budding, it doesn't mean all cannabis stocks will be winners. What follows are three pot stocks that share one key similarity and should be avoided like the plague in 2024.
Aurora Cannabis
The first pot stock investors can confidently allow to go up in smoke from a safe distance in 2024 is none other than former Canadian highflier Aurora Cannabis (ACB -0.15%).
Five years ago, Aurora was expected to revolutionize the cannabis industry. It had made more than a dozen acquisitions and was sitting on properties with the ability to eventually produce north of 600,000 kilograms (1,322,773 pounds) of cannabis annually. The problem for Aurora and its then-management team is that the company grossly overestimated domestic demand and incorrectly anticipated consumer behaviors.
Canada legalizing recreational weed for sale in October 2018 was expected to be a watershed moment for licensed producers. However, recreational consumers have primarily gravitated to value-based products and dried cannabis flower, which both sport lower margins than derivative products, such as vapes, edibles, and beverages.
Aurora Cannabis has made some operating progress by slashing its expenses and making a concerted effort to focus on medical marijuana. The upside of medical cannabis is that the margins are considerably better, and there's a potentially more robust export opportunity. The downside is that the medical weed market is notably smaller than the recreational side of the equation. Aurora's revenue ceiling will be capped with this approach.
But even with modest operating improvements and a push to positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA), Aurora Cannabis continues to lose money. To ensure it has enough capital to make ends meet, Aurora Cannabis has been issuing stock like it's handing out candy on Halloween. In roughly nine years, Aurora's split-adjusted outstanding share count has ballooned from a little over 1 million to more than 420 million (as of Sept. 30). Serial diluters are typically bad news for shareholders.
The final nail in the coffin is that management is, once again, talking about utilizing the company's net-cash position to "pursue profitable growth opportunities through M&A [mergers and acquisitions]." The last time Aurora employed this strategy, it ultimately wrote off billions of dollars in goodwill.
SNDL
A second pot stock to avoid like the plague in the new year is the Canadian-focused SNDL (SNDL 3.08%).
During the initial cannabis boom in Canada in 2018 to 2019, SNDL (then known as Sundial Growers) was attempting to become a key player in the wholesale marijuana market. The problem is that wholesale cannabis produces considerably lower margins than retail cannabis. While volume can offset margin weakness for wholesale-focused operators, consumer demand for recreational weed failed to live up to expectations.
SNDL has managed to reinvent itself, but it's come at a big cost to its shareholders.
Today, SNDL operates three segments. In March 2022, it completed its acquisition of Alcanna and became the largest private-sector liquor retailer in our neighbor to the north. It's also one of Canada's largest cannabis-dispensary operators. The third segment is its actual cannabis operations, which have pivoted to the retail market in search of juicier margins.
Like Aurora Cannabis, SNDL has made progress with its EBITDA and cash flow. What hasn't happened is a decisive shift to profitability. Though mindful cost cutting and M&A-driven cost synergies are helping to reduce losses, SNDL still lost CA$91.1 million (that's $67.5 million U.S. dollars) through the first nine months of 2023.
The other fatal flaw with SNDL is that it, too, has been a serial diluter of its shareholders. Though issuing stock helped dig the company out of debt, ongoing share issuances to raise cash and fund acquisitions has increased its outstanding share count by more than a factor of five to over 260 million in a span of roughly three years.
Even with the company generating positive free cash flow, there's no guarantee the proverbial dilution spigot will be turned off.
Image source: Getty Images.
Canopy Growth
The third pot stock to avoid like the plague in 2024 is Canopy Growth (CGC 2.41%). To keep with the theme, this is yet another licensed producer in Canada.
One reason for investors to keep their distance from Canopy Growth is the aforementioned lack of progress on cannabis reform in the United States. Though it's always possible a rescheduling of marijuana could benefit vertically integrated operators in the U.S. this year (and beyond), the prospect of federal legalization looks like a pipe dream in 2024. Without full-fledged federal legalization, Canopy won't be pushing into the lucrative U.S. cannabis market anytime soon.
Canopy Growth's operating performance also leaves a lot to be desired. When David Klein, the former CFO of Constellation Brands, became CEO of Canopy in 2020, there was the strong belief that he could eliminate wasteful spending and divest noncore assets in order to achieve profitability. While some progress has been made, the company is still losing money hand over fist four years later.
The company's balance sheet is potentially even more concerning. When Canopy Growth closed a $4 billion equity investment from Constellation Brands in November 2018, it was sitting pretty. As of the end of September, Canopy Growth was down to approximately $201 million (U.S.) in cash, cash equivalents, and short-term investments.
Furthermore, the company's auditors included a going-concern warning with its financial statements. This is to say that the company's auditors believe Canopy Growth won't have enough capital on hand to cover its liabilities over the coming 12 months.
Similar to Aurora Cannabis and SNDL, Canopy Growth aggressively expanded its production capacity without fully understanding consumer behaviors or domestic demand. These poor decisions are likely to continue haunting the shareholders of these three Canadian licensed pot producers throughout 2024.
