Investment Thesis
In my Seeking Alpha article of 8/29/19, I expressed my base case that the cannabis sector is "littered with more potholes than Boston's Financial District" and that I was very pessimistic going forward given the many headwinds facing this volatile segment. My caution was acquitted in this regard, as my "10 stocks to watch" have decreased by an average of 65.6% since the publication of the article. Until there is much more clarity in terms of the long-term outlook for this sector, I believe that investment in the cannabis sector should be considered "mad money" and only by investors with a high risk profile. Let's take a look at whether any of these stocks are now worthy of investment consideration, shall we?
Jim Cramer's "Mantra"
The main man of "Mad Money" investing is CNBC's irrepressible Jim Cramer. One of his oft-repeated phrases (apologies that my google search did not provide me with the exact words) is that it doesn't matter where a stock has been, but where it is going. So let's take a look where these 10 stocks have been and try to figure out where they may be going for the remainder of 2020.
My List Of 10 "Stocks To Watch"
Based on the top holdings of 3 ETFs (ETFMG Alternative Harvest ETF (NYSEARCA:MJ), Amplify Seymour Cannabis ETF (NYSEARCA:CNBS), and Spinnaker ETF Series ETF (NYSEARCA:THCX)) that I consider best represent the cannabis sector as a whole, I developed the following list of 10 "stocks to watch" for future investment consideration:
Company Symbol 8/28/19 7/2/20 % |
Cronus Group Inc. OTC:CRON $11.14 $6.17 46
TilrayInc. TLRY $27.20 $6.96 74
Aurora Cannabis Inc. ACB $66.96 $12.27 82
MediPharm Labs Corp. OTCQX:MEDIF $3.68 $0.92 75
Charlotte's Web Holdings, Inc. OTCQX:CWBHF $16.68 $3.80 77
OrganiGram Holdings Inc. OTC:OGI $4.26 $1.62 62
Aphria Inc. OTC:APHA $6.22 $4.30 33
HEXO Corp. HEXO $3.95 $0.72 82
Canopy Growth Corporation OTC:CGC $29.20 $6.45 44
The Supreme Cannabis Company, Inc. OTCQX:SPRWF $1.03 $0.18 83
As the above data indicates, three of these stocks - The Supreme Cannabis Company, Inc. (OTCQX:SPRWF), HEXO Corp. (NYSE:HEXO) and Aurora Cannabis, Inc. (NYSE:ACB) - have decreased by more than 80% since 8/28/19. However, before we look at my current take on each of them, I would like to stress that the overarching focus of my analysis is based on my background in accounting and auditing. I am a firm believer that "cash is king" especially in this topsy-turvy COVID-19 environment. Now, let's try to "crystal ball" the future of these three underperformers.
The Supreme Cannabis Company
SPRWF has a paltry market capitalization of $66.6M (a caveat in itself) and breached the $1 trading level on 9/25/19. The stock has since trended down to $0.18, and based on its lackluster performance, SPRWF is no longer a top 10 holding of the three ETFs that I used to develop my list. The company's press release of 5/15/20 stated that it has a "strong liquidity position," which is curious since the cash balance of C$23.128M at 3/31/20 is less than 50% of the cash balance of C$48.705M at 12/31/19. This C$25.577M decrease in cash had a significant negative effect on SPRWF's working capital balance, current ratio and working capital ratio and is indicative of sub-optimal financial stewardship and a troubling metric going forward. Based on the company's constrained financials, I do not believe that SPRWF is worthy of investment consideration at this time.
HEXO Corp.
Since my "Code Blue Alert"article of 1/8/20, HEXO has sharply decreased as shown here:
The company, which has a market capitalization of $313.6M, has made some headway of late in terms of an increase in sales and gross margins, and it has implemented ambitious cost-cutting measures to control expenses. But HEXO's management has an atrocious history of missed milestones, and dilutive share offerings have ballooned the number of shares outstanding by more than 100% since 4/30/19 to 446.8M according to YCharts. There may some swing-traders out there who sense an opportunity, and stocksnewswire.com issued a "strong buy" on 7/5/20, but I'm on the sidelines until there is much more clarity regarding HEXO's ability to execute its business plan. The company's fiscal year ends on 7/31, and I intend to write an updated review after the company files its audited financial statements at sedar.com.
Aurora Cannabis
ACB is one of the behemoths of the cannabis sector with a market capitalization of $1.37B. There have been 14 articles written about the company since Q3 earnings were announced on 5/14/20, almost evenly split between bullish, bearish and neutral ratings. What is of grave concern to me is the massive amount of intangible assets and goodwill on ACB's 3/31/20 condensed consolidated statement of financial position as shown below:
This amount represents ~62% of the company total assets and it appears to me will result in a material write-down when ACB issues its audited financial statements for the fiscal year ended 6/30/20. Any impairments would further hamstring ACB's financials and limit its access to the capital markets, and therefore I am maintaining my neutral rating at this time.
- Continues to execute on corporate restructuring and facility rationalization plan aimed at margin improvement and profitability.
- Exiting fiscal Q4 2020 at an SG&A run rate of approximately $42 million.
- Remains on track for positive adjusted EBITDA in fiscal Q1 2021.
In my view, it is worth noting that Vivien Azer of Cowen and Company downgraded ACB on 2/24/20. Ms. Azer was the first senior Wall Street analyst to cover the emerging cannabis sector, resulting in notable global press coverage across media outlets such as CNBC, The Wall Street Journal, The Economist, Barron's, and Forbes. To "borrow" the iconic E.F. Hutton commercial: "When Vivien Azer talks, people listen." As of now, I'm maintaining my neutral rating on ACB, as the new CEO (to be announced) has to "earn their wings" in a challenging cannabis market.
Conclusion
My due diligence in the preparation of this article included reviewing company news releases, financial filings, and the 14 Seeking Alpha articles written since Q3 earnings were announced on 5/14/20. Based on this work, I believe that there are lingering financial and operational questions regarding the emerging and volatile cannabis sector as whole, and the three stocks that I profiled in this article are especially vulnerable for the reasons I enumerated. Based on my Darwinian mantra, the survivors will be those that are able to differentiate themselves from their competitors and are financially fit, so to speak. I firmly believe that "caveat emptor" is critical for investors who may consider cannabis stocks as worthy of a portion of their speculative portfolio.
