2 Cannabis Stocks to Avoid in 2020

Not all pot stocks were created equal, and here are two you might want to avoid.

Canada should see an uptick this year as "Legalisation 2.0" comes into effect. When Canada became the first G-7 nation to legalize cannabis for recreational use in October 2018, it was limited to flower and low-potency oil only, and was mostly available online, with only a handful of brick and mortar stores open on day one.

However this is changing, with an array of edibles and extracts now available, and with more stores opening in Ontario and Alberta, Canada's recreational market should see significant growth in 2020.

With the German market starting to show considerable growth, and the UK – which legalized for medicinal use in November 2018 – also growing at a rapid pace, we continue to see progress in Europe. And with countries like Luxembourg and the Netherlands looking to fully legalize cannabis for recreational use, Europe should see significant growth in 2020.

In the US, where cannabis is still illegal at the federal level and is classified as a Schedule 1 drug, the winds of legislative change continue to blow. With bills such as the MORE Act (which would decriminalize cannabis at the Federal level), and the SAFE Banking Act (which would allow cannabis companies access to normal commercial banking opportunities (currently denied to them), the future looks very bright in the US for 2020. Never mind the November Presidential elections that could well spark a run on cannabis legislation.

But make no mistake, right now the hangover of 2019 is still being very strongly felt. The primary issue facing cannabis stocks is the lack of access to capital and commercial funding. Known as the "capital crunch", the opportunity for cannabis companies to raise cash are now few and far between. Cannabis companies with low cash balances, huge levels of debt, and short working capital runways are really going to struggle in 2020.

In this regard, here are two stocks that we feel investors should stay well away from in 2020.

Disclaimer: Past performance is not an indicator of future performance.

Aurora Cannabis (NYSE:ACB)

A week or so ago, Aurora Cannabis announced their Q2 2020 financial results. In fairness, they had already alerted the market that it was going to be a shocker, and in this case (and for once), a cannabis company's guidance was actually met!

Aurora's net revenue declined by 26% against the previous quarter and included over CAD$10m in provisions related to stock returns (mostly low-potency oils) and pricing adjustments. This adjusted lowered their net revenue from CAD$66m to CAD$56m. They also gave guidance that Q3 could also be a flat quarter (in terms of growth). Not a great outlook at all.

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One item that startled investors was the fact that Aurora's cash cost to produce a gram of cannabis actually rose during the quarter to CAD$0.88 per gram (up from CAD$0.85 per gram in the previous quarter). With all the noise around technology-driven greenhouses that should create economies of scale and reduce production costs, it is simply baffling to understand the increase.

International sales plummeted, due in principle to the temporary suspension of imports to the German market (that has since been resolved), which is critical when one considers the amount of investment Aurora has put into the European market. This is something for investors to watch carefully in the coming quarter.

The company also announced that its annual cannabis production capacity is expected to be around 150,000kg. Whilst this may sound impressive, this is a long, long way off the 625,000kg the company had initially forecasted to be able to produce by the end of June 2020. The company has significantly scaled back production capacity and is now well behind both Aphria and Canopy Growth in this department.

The company has been trying to cut costs to meet its "guidance" of CAD$40m in selling, general, and administrative (SG&A) expenses per quarter. However, this quarter saw SG&A rise to just shy of CAD$100m – a huge 23% increase over the previous quarter.

With their cash balance down to only CAD$114m and Goodwill accounting for over 50% of their balance sheet assets, the company is in deep financial trouble. Access to capital will be very limited for Aurora and their only option would be to issue more shares, and intensify what has already been massive shareholder dilution over the past couple of years. 

Investors should stay well away from Aurora until they can bring their costs in line, increase revenue and somehow sort out their horrific bank balance.

Disclaimer: Past performance is not an indicator of future performance.

MedMen (CSE:MMEN)

Often nicknamed the "Apple" of the cannabis world, in terms of performance over the past two years, nothing could be further from the truth. MedMen listed on the Canadian Stock Exchange (CSE) in late 2018 to much fanfare and promise.

The company boasted the most visible and recognisable brand in the US. And with most of their operations centred around California, and having the largest market share of the biggest recreational state in the US, the future certainly looked bright.

But no other company (aside from Canopy Growth) has burnt the kind of cash that MedMen has. Operating losses have been piling up, and the company has been doing "desperate" financing deals (like the one they did with Gotham Green late last year) in order to try and stay afloat. 

Just recently, MedMen announced that the CEO – Adam Bierman – was stepping down with immediate effect. It's rare that a stock increases in value when the CEO steps down, however in this case, the market appreciated this move and the stock ended the day up 7% (after being up as much as 16% intraday).

MedMen Cannabis Industry
The MedMen dispensary on 5th Avenue in New York City

One positive for the company is the fact that their stores (very Apple-esque in design and layout) have been performing very well, and are located in some of the most desirable real estate locations across the US. However, even with strong sales, its the costs that have been rising more than the sales.

Although the company has been actively trying to reduce costs through staff layoffs and the sale of non-core assets, the losses are still significant.  With profitability still well off and the share price in free-fall, this is a very dire situation for both the company and its shareholders.

In fairness, here at the Green Fund, we were very bullish on MedMen when they first listed. With solid brand recognition and a strategic business plan, the future looked very bright for California's dominant player. 

However the cracks soon started to appear, with lawsuits being filed against senior management, the departure of key C-suite staff, and the crazy remuneration packages Bierman and Andrew Modin (co-founder and COO) were on, shareholders soon realised this could well be a house of cards, and the subsequent stock decline began.

While the departure of Bierman is a good thing for the company, its financial situation given the current state of play in the cannabis industry makes MedMen a very risky investment. We would suggest investors sit on the sidelines on this one, as MedMen could well end up the pets.com of the cannabis industry.

Over the past 12 months, the stock price has fallen by nearly 90% (yeah, you read that right) and it doesn't seem like the bottom is in just yet. You've been warned!


However, here is one stock that could be one of the best investing opportunities of 2020

Legislative changes are blowing through the US, and with it, an ever-increasing number of states legalising cannabis for recreational use.

With the success seen in Illinois, which legalised for adult-use on January 1 and saw products moving off the shelf at an unprecedented rate, this company is primed to take advantage of the booming US recreational market.

They have secured partnerships with the biggest cannabis companies in the US, and their portfolio is second to none.

And with the sector-wide pullback of 2019, this company is now at a bargain-basement price.

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Mark Bernberg
Mark Bernberg

Mark Bernberg is a long-time cannabis investing enthusiast and founder of The Green Fund, Asia Pacific's preeminent media house, positioned at the forefront of the global cannabis industry.

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