These Pot Stocks Could Go Bankrupt in 2020

The great capital crunch of 2019 has continued into 2020, and there are a couple of cannabis companies that are on the verge of running out of money, now.

2019 was meant to be the year that pot stocks flourished. Canada had legalised recreational use late in 2018, and in the US, Massachusetts had just gone recreationally legal and there were hints that potentially game-changing legislation could be passed that would officially open up the biggest cannabis market in the world.

US Cannabis Industry

But that enthusiasm and cognitive dissonance soon evaporated as the Global Cannabis Index (as managed by New Cannabis Ventures) lost almost 80% of its value in 2019! Supply shortages and a lack of brick and mortar stores in Canada led to a very underwhelming recreational market.

Without the right products (initially only flower and low potency oils were legalised) the black market continued to thrive, while the big Licensed Producers (LPs) reported less than average results, with almost all of them missing their guidance…big time.

In the US, legislative changes were slow, and although over 67% of the US population is in favour of legalising cannabis at the Federal level, this certainly didn't even come close to panning out in 2019. High taxes on legal cannabis and a resilient US black market made life very difficult for many of the Multi-State Operators (MSOs).

Add to that the "Vaping Crisis" that swept through the US in the latter half of last year, and the industry was decimated. In fact, it was anything but what was expected at the beginning of the year.

Since then, things have started to look brighter. Canada has now legalised edibles and extracts, and both Ontario and Alberta have committed to opening more brick and mortar stores. In the US, Illinois opened its doors for recreational cannabis on January 1, and in the first 10 days, the State recorded over USD$40m in retail sales.

But one huge overhang on the industry remains – the capital crunch. According to data from Viridian Capital Advisors, overall capital raises for public and closely held weed companies fell 20.3% in 2019 from 2018, for a total of $11.3 billion.

The Ello Capital Report

Earlier in the month, Ello Capital put out a report of a study they undertook on 13 of the largest US cannabis companies, and 7 of their Canadian counterparts. Ello provided an estimate of how many months of runway (read how many months of cash) they had left. And the results…were frightening.

These companies are in a liquidity crunch, they're all needing capitalEllo Capital Chief Executive Hershel Gerson

According to the report, US cannabis companies – on average – have about 14 months of available cash to support their working capital requirements.

If that sounds crazy, then consider the Canadian companies, who Ello estimates will have—again on average—around 6.5 months of runway left. Basically, some of the Canadian pot stocks will be bankrupt well before Labour Day.

The following stocks have less than 7 months runway (per Ello Capital Report):

  1. Aurora Cannabis (NYSE:ACB): 2.3 months
  2. Tilray (NYSE:TLRY): 3.7 months
  3. The Green Organic Dutchman: 3.9 months
  4. MedMen Enterprises (CSE:MMEN): 6 months
  5. HEXO (NYSE:HEXO): 6.5 months

However, in fairness to the above companies, the report doesn't take into consideration short-term investments or cash used in acquisitions. 

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

Aurora Cannabis

Aurora Cannabis is in dire financial shit. No other way to put it. According to the Ello Report, the company is set to run out of cash before the calendar year moves past the halfway mark. Again, in fairness to Aurora, the report does not take into account the CAD$39.4 million in marketable securities on the company's balance sheet.

Still, Aurora burnt nearly CAD$100 million in the last quarter, and with only CAD$141 million in the bank at the end of that quarter, it is clear that the company is going to have to find funds, and fast. In order to stop the bleed, the company has put a halt on any further cultivation facilities, including Aurora Sun and the planned sale of a facility the company acquired with its 2018 acquisition of MedReleaf.

In the recent quarter, Aurora's sales also declined, while operating expenses increased, and the company wrote off nearly CAD$1 billion in goodwill from its balance sheet. The only hope for Aurora in the current capital crunch environment will be to go back to the market and raise capital through the issue of shares. This will further increase dilution and does not bode well for investors and/or shareholders.

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

MedMen

MedMen listed on the Canadian Stock Exchange in mid-2018 at CAD$4.10 and peaked at CAD$8.50 on the 19th October 2018. From there it has been one long, long downhill run.

The company, once valued at north of USD$2 billion, is now worth a paltry USD$82 million. And no, that's not a typo. No one burns cash quite like MedMen, and while the capital markets flowed like wine in 2018, those halcyon days are well behind us. Now, in the current environment, cash is king, and MedMen has none of it.

The company is literally operating on borrowed time, with recent news stories indicating the company wrote to creditors and asked if they could be paid in stock and instead of cash. This is despite the fact that Gotham Green Partners committed USD$280 million. The company was only able to access around $165 million of that, as the balance was only to be triggered on a rising stock price.

With less than half a year's cash remaining, the CEO stepping down, and the company now selling core-assets in order to survive, the writing is on the wall for the one-time US market leader.

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

HEXO

HEXO is another example of a disaster waiting to happen. The company has raised just over $100 million since October last year, and yet still does not look like it has nearly enough capital to execute on its strategy, never mind simply survive. 

The company recently laid off over 200 workers as a means of reducing operating expenses, yet it still only has just under 7 months left before the lights will need to be turned off.

We believe HEXO to be one the riskiest Canadian LPs and would advise investors to stay on the sidelines until such time as the company can shore up its balance sheet, and get real revenue runs on the board.

The Bottom Line

Although one cannot take the Ello report as gospel, there is certainly merit to the data. We firmly believe that 2020 does offer significant opportunities for companies that have a strong balance sheet, small operating losses, and a clear path to profitability.

However, for the rest of the pack, the future looks very bleak indeed. Will any of the above potentially go bankrupt in 2020? We think so. Every new and developing industry goes through this process. There were many, many car manufacturers in the '20s and '30s but few of them survived. The same analogy could be applied to the tech industry that went through this cleanup in 2006. 

If the capital crunch continues, and access to capital for cannabis companies continues to dry up, then expect things to get far worse before they get better. Investors should look for companies that have strong balance sheets and solid operating leverage.


Here's a company with cash in the bank that presents 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 dragging this company's share price down with it, the current price could well be a bargain-basement one.

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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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