Green rush fever is back, once again. Following a roughly six-month lull, investors can't seem to get enough of marijuana stocks, as evidenced by the more than tripling in the North American Marijuana Index over the trailing year.
The reason for this bullishness is most clearly related to the imminent legalization of recreational marijuana in Canada, which is set to occur on Oct. 17, 2018. Adults being able to purchase cannabis recreationally should result in billions of dollars flowing into the Canadian cannabis industry, once it's operating at full capacity. And as you can surmise from the four-digit percentage moves higher in many popular pot stocks since 2016 began, it's expected to result in significant long-term profits.
But as we often witness with the "next-greatest thing" on Wall Street, investors' emotions and expectations tend to get well ahead of themselves. This could very well be the case with a handful of marijuana stocks. Here are three pot stocks that I would strongly suggest marijuana stock investors keep their distance from, for the time being.
Image source: Getty Images.
The Tilray (NASDAQ: TLRY) roller-coaster ride has been well documented, and my suspicion is that it won't end well.
Having priced its initial public offering at $17 per share on July 18, shares of Tilray wound up hitting $300 on the nose during this past Wednesday's trading session. That's a better than 1,600% return from its offering price in two months' time. Not too shabby, and almost cryptocurrency-like.
Mind you, there are tangible factors that make Tilray a business that investors can grow to like and appreciate. As one of the first growers to receive a cultivation license from Health Canada, Tilray has some history and branding power that many of its competitors lack. It's also a trendsetter, becoming the first pot stock to be allowed to export both dried cannabis and cannabis oils into Germany, and getting an OK to import medical weed into the U.S. to run a clinical study on essential tremor at the University of California, San Diego.
But not everything makes sense with Tilray, such as its valuation, which peaked at more than $26 billion. Even at full capacity, which would include close to 3.6 million square feet of growing space, it's unlikely that Tilray generates much more than 300,000 kilograms of pot per year. Meanwhile, Canopy Growth (NYSE: CGC), at less than half of Tilray's peak valuation, can produce more weed annually (around 500,000 kilograms) at peak capacity, and it has just as much branding power, if not more.
It also seems abundantly clear, at least to me, that much of its recent rally is due to high-frequency trading (HFT) programs. HFT programs run by institutional investors are designed to operate within well-defined parameters and provide liquidity to the market. But in instances like Tilray, where the trading algorithms go haywire due to volatility, these HFT programs could simply choose to shut down, leaving Tilray with significantly reduced liquidity, and exposing it to a potential crash.
Fundamentally and historically, Tilray is a marijuana stock you'll want to avoid.
Image source: Getty Images.
Another popular pot stock on the dreaded "avoid" list is Ontario-based Cronos Group (NASDAQ: CRON).
Cronos has seen its share price more than double since mid-August predominantly on speculation that it would soon find a beverage, tobacco, or pharmaceutical partner. After all, Molson Coors Brewing Co. formed a joint venture with HEXO Corp. in early August, and Constellation Brands announced a $3.8 billion megainvestment in Canopy Growth in mid-August. Partnering with Cronos would mean buddying up with perhaps the fifth- or sixth-largest grower in Canada, by peak yield potential.
But there's a lot not to like about Cronos. In particular, the company is late to the capacity expansion game. In mid-July, the company announced that it had formed a joint venture (known as Cronos GrowCo) with a group of investors to build an 850,000-square-foot facility capable of 70,000 kilograms in peak production. That's fine, but it's going to take time to construct this facility, as well as continue build out its wholly owned assets. In other words, Cronos Group will probably take longer to reach its full grow potential than its peers, which could mean losing out on lucrative long-term supply deals.
Fundamentally, Cronos is also a bit of a train wreck. Because it'll be spending so heavily on capacity expansion and brand building so late in the cycle, it's liable to see higher expenses than many of its peers. Whereas profits could disappoint across the industry as a result of dilution and a persistent black market presence, Cronos could simply struggle to turn a profit, period.
Unless Cronos Group snags a whale of a partner, this is not a pot stock I'd suggest you go near.
Image source: Getty Images.
Aurora Cannabis (NASDAQOTH: ACBFF) is arguably the most popular marijuana stock with retail investors, but it's the third and final pot stock that I'd strongly suggest you avoid.
What investors tend to like about Aurora is the company's no-nonsense approach to capacity expansion. It's spent a fortune to become the expected leader in annual yield, once at full capacity. It organically built Aurora Sky and is constructing the Aurora Sun facility; has partnered with Alfred Pedersen & Son in Denmark on the Aurora Nordic project; and acquired CanniMed Therapeutics, MedReleaf, and is in the process of buying ICC Labs. Add all of this up, and the company could near 700,000 kilograms a year, assuming ICC's assets are fully built out. With that sort of production and scale, Aurora Cannabis should be a target for brand-name beverage and/or tobacco companies.
This issue, though, is that Aurora's expansion strategy has come at the expense of its shareholders. Many of its deals are paid for by common stock issuances, with capital raises also conducted by selling stock, convertible debentures, stock options, and/or warrants. Once the ICC Labs deal closes, its share count will have risen from just 16 million to north of 1 billion in less than five years. And a higher share count means it'll be even tougher for the company to generate a meaningful per-share profit.
There's also little guarantee that Aurora will be able to cohesively mesh all of these acquisitions efficiently. We witnessed 3D-printing companies go acquisition crazy a few years ago in an effort to secure market share, and then ultimately struggle to streamline those buyouts. I'd be concerned that something similar could happen to Aurora Cannabis, which is valued at a triple-digit forward price-to-earnings ratio.
The marijuana industry may have Wall Street seeing green, but my suspicion is these pot stocks will have investors seeing red in the not-too-distant future.
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