Following a rather ugly 2018 for marijuana stocks that saw 10 prominent cannabis companies lose at least half of their value, the industry has come roaring out of the gate in 2019. And it’s not hard to understand why Wall Street and investors are so bullish.
This quarter we’re getting our first glimpse of post-legalization recreational marijuana sales. Earlier this week, Atlantic-based grower OrganiGram Holdings (NASDAQOTH:OGRMF)announced that its sales more than quintupled from the prior-year quarter, and that its sequential second-quarter sales would be around double what it just reported for the fiscal first quarter. To boot, the company reported its first-ever quarter of positive free cash flow. This is why the investment world is so excited.
On a broader basis, a co-authored report from Arcview Market Research and BDS Analytics calls for global weed sales growth of 38% in 2019 to $16.9 billion. Mind you, worldwide sales are expected to nearly double again to over $31 billion by 2022. There’s clearly plenty of money being thrown at this industry, and the thesis is that it has to end up somewhere. This is a big reason why pot stocks as a whole have been unstoppable in recent weeks.
Avoid these very popular pot stocks in February
But as we enter February, I’m reminded of every next-big-thing investment that’s come before cannabis and how every surefire company has struggled at some point to meet lofty expectations set by Wall Street and investors. Currently being priced for perfection, the pot industry is nowhere near perfect. This makes three of the most popular marijuana stocks highly avoidable this month.
As I made pretty clear recently, the one marijuana stock valuation that I understand the least is Cronos Group (NASDAQ:CRON).
Cronos has been riding high since tobacco giant Altria (NYSE:MO) announced in early December that it would take a $1.8 billion equity investment in the company, which, when closed, would equate to a 45% stake. Factoring in the warrants that Altria also receives and it could bring its equity investment in Cronos Group up to 55%. Aside from the possibility of the duo creating cannabis vape products or Altria simply buying Cronos Group down the road, I struggle to find any reason to be bullish on Cronos Group with its market cap approaching $3 billion ($4.8 billion if we assume the Altria investment goes through).
Aside from Cronos GrowCo, the company’s flagship joint venture grow farm which will span 850,000 square feet and yield 70,000 kilograms annually at peak capacity, and Peace Naturals, which can produce up to 40,000 kilograms a year, Cronos Group has just scraps left over. With perhaps 120,000 kilograms in peak yield, a nearly $3 billion valuation is insane. You could get nearly the same amount of yearly production from HEXO, CannTrust Holdings, or OrganiGram, which have market caps of $1.1 billion, $750 million, and $690 million, respectively.
Not to mention, HEXO, CannTrust, and OrganiGram are all expected to be substantially more profitable on a per-share basis in 2019 and 2020 than Cronos Group. Rife with cash when the Altria deal closes, Cronos will be busy spending on product differentiation and international expansion — the latter on which it’s lagged its larger peers. Cronos’ forward price-to-earnings ratio of 409 (not a typo) is what nightmares are made of. This is absolutely a stock to avoid in February.
Canopy Growth (NYSE:CGC) might be a marijuana darling — shares are up nearly 90% year to date through Jan. 28 — but the largest pot stock in the world and its $17 billion market cap are no longer appealing to this investor.
Let’s get one thing straight: Canopy Growth has done a lot of things right. It’s secured a mammoth $4 billion equity investment from Constellation Brands that’ll give it plenty of capital to expand internationally, make acquisitions, build and market its brands, and diversify its product portfolio. It also has some of the most well-recognized weed brands in its product portfolio and clearly defined sales channels. It very much deserves to be the world’s most valuable pot stock.
What doesn’t make sense is a $17 billion valuation for a company with virtually no chance of being profitable in 2019 or 2020. Canopy’s expenses to lay its massive foundation in international markets pretty much ensures that it’ll be losing money for the next couple of years. Through the first six months of fiscal 2019, the company has lost almost 422 million Canadian dollars, CA$245 million of which is its operating loss.
This valuation also assumes that every aspect of Canopy’s ramp-up will go perfectly, and that’s rarely an astute assessment. The company is nowhere near its peak production potential of 500,000-plus kilograms; it still needs more than 20% of its growing capacity to be licensed by Health Canada, which happens to be drowning in cultivation license applications; and it will be contending with a very crowded field of growers that could adversely impact margins. Long story short, I’d seriously consider taking profits into this recent rally.
Lastly, I’d suggest that keeping away from GW Pharmaceuticals (NASDAQ:GWPH), arguably the most popular ancillary company, would be a smart idea.
GW Pharmaceuticals’ stock is up more than 40% year to date through Jan. 28 on the idea that its lead drug, Epidiolex, a cannabidiol-based oral solution that the Food and Drug Administration (FDA) approved to treat two rare types of childhood-onset epilepsy, would roar out of the gate. Although it was approved by the FDA in June, it took a few months for the U.S. Drug Enforcement Agency (DEA) to schedule Epidiolex, so it wasn’t launched until early November. Also noteworthy is the fact that Epidiolex was given a Schedule V classification, which is the least restrictive of any classification the DEA could have doled out.
While there are positives here, there’s also plenty of uncertainty surrounding the first cannabis-derived drug to get the thumbs-up from the FDA. For instance, even though its $32,500 annual list price is in line with other seizure-reducing epilepsy treatments, it’s a pretty penny to pay for a cannabis-based therapy. Gaining insurance coverage and ensuring that patients can pay for this medicine aren’t assured.
We’ve also seen synthetic cannabis therapies flop big time. Insys Therapeutics‘ oral dronabinol solution Syndros (dronabinol is a synthetic form of THC, the cannabinoid that gets a user high) was initially expected to generate $200 million or more in peak annual sales. For 2018, it might be lucky to hit $3.5 million in sales. It’s been a monumental disappointment and has shown that “cannabis medicines” aren’t going to be given a free pass to success.
Finally, GW Pharmaceuticals could soon face competition from Zogenix in Dravet syndrome. Supporting a market cap that might be eight to nine times Epidiolex’s peak sales doesn’t make sense.