Over the next decade, cannabis chronicles as one of the fastest-growing industries in North America. Although estimates vary wildly, as we’d expect from an industry that’s existed for decades in the black market, North American pot sales have the opportunity to reach $75 billion annually by the end of the decade. That’s growth Wall Street and retail investors should rightly not ignore.
However, we also know that not every company in next-big-thing investment industries will be a winner. As the pot industry has matured a bit over the past four years, we’ve witnessed clear separation between the haves and have-nots.
As we move headlong into March and look forward to warmer weather, investors would be wise to avoid the following three pot stocks like the plague.
Among millennial investors, there’s not a more popular marijuana stock than Sundial Growers (NASDAQ:SNDL). This cannabis penny stock has been as high as No. 3 on Robinhood’s leaderboard (a ranking of the most-held stocks on the platform). Unfortunately, there looks to be little substance behind its recent rally.
Sundial has quickly become one of the favorites of retail investors on Reddit’s WallStreetBets (WSB) chatroom. As a refresher, retail traders on WSB are usually looking for heavily short-sold companies or penny stocks that can quickly be driven higher. In few instances are there are genuine fundamental reasons behind a move higher in a Reddit-rally stock.
The biggest issue with Sundial is that management has walked all over its shareholders in an effort to improve its balance sheet. Since the end of September, the company issued more than 1.1 billion shares via a combination of direct share offerings and debt-to-equity swaps. This more than tripled Sundial’s outstanding share count to about 1.66 billion shares. Worse yet, it’s probably not done. Sundial issued new warrants last month, and its board recently OK’d a shelf offering that would allow for the sale of up to $1 billion in new shares. The dilution here is off the scales.
Sundial Growers is also going to be late to the retail party. The company has made the decision to shift its focus from low-margin wholesale cannabis to higher-margin retail. While potentially a smart move over the longer-term, it’s going to produce some ugly year-over-year sales and bottom-line comparisons at a time when most cannabis stocks are turning the corner to profitability.
The only thing driving Sundial higher in recent weeks is social media chatter. Without significant top-and-bottom-line improvements, there’s little reason for it to trade over its cash value (about $0.41 per share).
Another pot stock that should be cordoned offer with yellow caution tape is Canadian licensed producer Cronos Group (NASDAQ:CRON).
Cronos does have some redeeming qualities that have made it a popular selection among young investors. It ended 2020 with close to $1.3 billion in cash and cash equivalents, and it has a powerful equity investor in Altria Group (NYSE:MO). Altria, the tobacco giant behind the premium Marlboro brand, owns a 45% stake in Cronos, and is expected to aid in product development, marketing, and perhaps even distribution efforts.
The bad news for investors is that these selling points are overshadowed by miscues and poor operating performance, as seen in the company’s fourth-quarter and full-year results last week.
Although the company’s sales rocketed higher to $17 million in Q4 (its highest quarter of sales on record), just $1.93 million of its $13.54 million in rest-of-world sales (this primarily means Canada) came from higher-margin extracts. That was only up 3% from the prior-year period, despite the fact that high-margin derivatives were legalized for sale in mid-December 2019. Between regulatory hurdles and poor execution, Cronos Group has badly missed the mark with these higher-margin sales channels.
Cronos is also losing money hand over fist. Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) widened by more than $13 million in 2020 to negative $98.3 million. Further, cash and cash equivalents declined by $216 million last year. This means the $1.8 billion equity investment received from Altria is almost 30% gone because of operating losses and an overpriced acquisition.
Aside from its cash, Cronos simply isn’t the major cannabis player Wall Street has tried to make it out to be. At a valuation of $3.74 billion, Cronos is trading at more than 40 times Wall Street’s sales projection for 2021. That’s insanely high for a company that’s struggling from an operating perspective.
You almost thought I wasn’t going to include Canadian licensed producer Aurora Cannabis (NASDAQ:ACB) this month, didn’t you? You should know by now that Aurora is a veritable fixture in the monthly pot stock avoidance column — and for very good reason.
For a brief period in February, Aurora Cannabis found itself rallying side-by-side with the likes of Cronos and Sundial. Aurora’s short interest made it one of the many candidates the WSB community bought into. Additionally, speculation has been ongoing that the U.S. could legalize cannabis at the federal level, thereby rolling out the green carpet for Canadian licensed producers. But Aurora is a company so poorly managed that even these catalysts can’t hold a candle to its long-running issues.
Before Sundial unleashed a cascade of dilution on its shareholders, Aurora Cannabis was the kingpin of share-based dilution. Between June 2014 and the end of 2020, Aurora’s outstanding share count rose from 1.35 million to about 184.2 million. That’s close to 13,500%. With the company continuing to lose money, its board has had little choice but to approve at-the-market share offerings on a regular basis.
Something else I’ve previously pointed out is that its management team keeps moving the goalposts. Originally, the company was expected to generate positive EBITDA last year. However, this goal has moved a couple of times now. Even with substantial cost-cutting and higher sales, Aurora is nowhere near recurring profitability, and it’s yet to satisfy the covenant (i.e., positive EBITDA) tied to its outstanding debt.
In the company’s December-ended quarter, international sales fell off a cliff, and gross margin was down in all segments. Having to feature value-brand cannabis and compete in price wars with illicit product has wrecked any chance of Aurora being profitable anytime soon.
It’s a popular pot stock among retail traders, but it’s a poor investment.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
View more information: https://www.fool.com/investing/2021/03/02/3-pot-stocks-to-avoid-like-the-plague-in-march/