Should You Avoid Pot Stocks in 2020?

Marijuana stocks were all the rage in 2016 and 2017. During that time, investor enthusiasm flowed like wine at the last supper, and stocks went from strength to strength. But that all changed – big time – in 2018 and 2019.

The growth of 2016 and 2017 was driven by a very simple mantra: "we will be the biggest."

The biggest producer, the biggest manufacturer, the biggest extractor and the biggest brand in cannabis. All of this drove a capital frenzy with investors pouring billions and billions of dollars into the speculative market, and companies spending, spending, spending.

In mid to late 2018, capital was flowing into the sector and deals were flying. However, those heady days are now a distant memory, as the capital crunch of 2019, put a grinding halt to crazy valuations, massive capital-intensive projects, and M&A deals.

Capital investments in the cannabis industry
Source: Bloomberg
Disclaimer: Past performance is not an indicator of future performance.

Pre-Canada's legalisation of cannabis in October 2018, cannabis companies were valued on what they "could do" and not what they were doing. And it was all about scale. Companies like Canopy Growth, Aphria and Aurora Cannabis burnt billions in their crusade to be the largest producer with the greatest annual cultivation capacity. 

However, once legalisation passed, and the hype of what could be was met with the reality of what was, it became a whole different ballgame and many of the companies simply weren't ready to actually deliver on analysts' and investor's expectations.

The industry benchmark is the Horizons Marijuana Life Sciences ETF (HMMJ:CN). Currently boasting nearly $1.5 billion funds under management, the world's largest cannabis ETF is a perfect barometer of the industry's health and investor sentiment.

HMMJ v SPY 6 months to Jan 2020
Source: Bloomberg
Disclaimer: Past performance is not an indicator of future performance.

Consider the performance of the HMMJ against the S&P500 for the last 6 months and you get a very clear idea of just how weak cannabis stocks have been. With all the weakness, pullbacks and declining stock prices, many investors feel now is the best possible time to start investing in pot stocks again. After all, what goes down should come up…right? 

Well, maybe not, as there are still many issues facing the industry that aren't going to go away overnight, and investors need to be reticent of them.

Snap, Crackle and Pop!

The current capital crunch combined with the lowest levels of investor sentiment towards the industry have made this an incredibly difficult time to raise capital. Companies that have light balance sheets have found it nay impossible to raise capital, and when they have managed to do so, it has been characterised by very high levels of interest rate on debt, and incredibly low-priced equity rounds leading to significant shareholder dilution.

HEXO is a clear example of this. The company's share price tanked by over 50% in 2019 and has fallen an additional 20% over the Xmas/New Year period after they announced a heavily discounted capital raise of US$25 million on the 26th of December (trying to hide something?)

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

The company issued 15 million shares at a 14% discount to the closing price on Xmas eve. This was on the back of the company laying off over 200 staff in October 2019, and shocking the industry when they announced they would be selling low-cost flower (called Stash) at 50% below market value! All of this…to conserve cash!

Even with all of these efforts, the company continued to burn cash. The December earnings announcement delivered a net loss of over $60 million for the quarter (ended October 31). This was over four times more than they lost in the previous corresponding quarter ($12.8 million) while only increasing sales by 2.5x over the same period.

Supply Supply Supply

At the time of writing, there are over 200 cannabis companies in Canada that are cultivating, processing and/or extracting cannabis for domestic consumption. The issue is, that Canopy Growth alone, has enough capacity to supply Canada's complete demand. 

To make matters worse, Canada's Legalisation 1.0 (the recreational legalisation of flower and low-potency oils) was a disaster, at best. Almost all of the low-potency oils were sent back to the Licensed Producer's by the Provinces as consumer demand for them was limited at best. And add to this the fact that there were almost no stores open to the retail consumer on Day One, and you had the perfect storm.

However, during this time, the multitude of LP's continued to grow their cultivation footprint and pump millions of dollars into the 'next' high-tech hybrid-greenhouse. The result is that many of the LPs have delivered very average quarterly results that have panicked investors and sent them running for the hills.

2.0 Beverages Might Not Pave the Way

In October 2019, Canada finally legalised edibles and extracts, and with it, beverages. The beverages market has long been touted as the "big one" in Canada. It's why there was so much excitement around the first Canopy-Constellation deal and HEXO's joint venture with Molson Coors.

Tilray, Canopy and HEXO have all sunk significant time, energy and capital into this form factor, on the basis it is going to be the consumption mode of choice amongst the booming 2.0 addressable market.

But to understand this, you need to understand the limits of the opportunity. Yes, there is no doubt that having a bottle of cannabis-infused water, with zero calories, that could give a user a meter-dosed buzz for an hour or two would be awesome. The issue arises in the fact that they would not be able to have these in a bar, or restaurant that serves alcohol. This means that the expected market size is most likely to be based on the home-consumption market. And this may not be as big as some of the companies (and analysts) believe it to be.

should you avoid pot stocks

Should you avoid pot stocks in 2020?

Understand that due to the capital crunch, cannabis oversupply, and an over-reliance on beverages to save the day, some pot stocks are going to be in real trouble in 2020. On the other hand, these three factors do not apply to all areas of the globally booming industry. 41 out of a possible 198 countries have legalised medicinal cannabis at the federal level. In the next 24 months, that number is projected to be 82. The total addressable market for medicinal cannabis is set to double in 24 months.

And not all pot stocks are chasing the recreational high. Indeed, many are focussing entirely on the medicinal industry.  The real question is not whether you should avoid pot stocks in 2020,  as there is too much potential for that.

Instead, the question to ask yourself is; which pot stocks should you avoid in 2020?

This 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.

Get the Latest Marijuana News &
Content in your Inbox!

All your support helps The Green Fund keep writing content for all you
marijuana enthusiasts and potential pot stock investors

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.

Leave a Reply

Your email address will not be published. Required fields are marked *