Over the long run, legal marijuana could prove to be a big-time moneymaker for investors. After logging $10.9 billion in legal global sales in 2018, according to Arcview Market Research and BDS Analytics, the legal pot industry could see annual worldwide sales soar to anywhere between $50 billion and $200 billion in a decade’s time. That’s plenty of growth to get Wall Street and investors excited.
Of course, the past couple of months have been anything but exciting. The Horizons Marijuana Life Sciences ETF has shed more than a third of its value, and pretty much every major marijuana stock has face-planted. Everything from supply chain issues in Canada to resilient black markets in the U.S. are to blame for this persistent retracement in pot stocks.
While this pullback has created a buying opportunity in some cannabis stocks, others should remain cordoned off from investors. Consider the following three pot stocks as ones you’d be best off avoiding like the plague in September…
On one hand, I do understand why investors are attracted to Cronos. Even after its acquisition of Redwood Holdings, it’ll likely have close to $1.5 billion in cash and cash equivalents, which gives Cronos Group a reasonable valuation floor. The company also has a major equity investor in tobacco giant Altria (NYSE:MO), which owns a 45% non-diluted stake in Cronos. Presumably, Altria will use its industry expertise and ties to vaping device Juul — Altria is a 35% stakeholder in Juul — to aid Cronos in its push to launch high-margin vape products by mid-December.
While this is all well and good, there are three pretty sizable problems. First of all, supply issues affecting the Canadian marijuana landscape are unlikely to be resolved by the time derivative products (e.g., edibles and vapes) launch in mid-December. This means the ramp-up in expected sales will take longer than expected.
Secondly, Cronos Group’s operating results haven’t been that impressive. Strip out the revaluation of derivative liabilities tied to its Altria warrants, as well as fair-value adjustments, and Cronos is decidedly losing money on an operating basis. Since earnings actually matter now, Cronos has shown little to inspire confidence that it’s nearing operating profitability.
Third and finally, with Cronos Group heavily focused on high-margin vape products, it could be negatively impacted by growing concerns of mysterious lung diseases that may be associated with vaping. More than 200 people have reported vaping-related lung problems, and that could have a direct impact on vape-focused stocks.
In short, Cronos may have a lot of cash and a well-known investor, but it’s not worth buying.
22nd Century Group
Next up is small-cap plant biotechnology company 22nd Century Group (NYSEMKT:XXII), which happened to be the top-performing marijuana stock in August. Shares of 22nd Century Group gained 23% last month after the company’s second-quarter operating results featured a narrower operating loss and a reduction in equity-based compensation. The latter not only reduces profitability, but it can balloon a company’s outstanding share count, leading to dilution.
Though 22nd Century Group gets its association with the cannabis industry from its potential to control tetrahydrocannabinol (THC) or cannabidiol (CBD) content in a plant, the company is arguably best known for its attempt to bring Very Low Nicotine Content (VLNC) cigarettes to market. These are cigarettes with at least 95% less nicotine than the top products on store shelves today, with the goal being to provide users with a nonaddictive nicotine product. While this probably sounds like a novel idea, I foresee two drawbacks.
The first is that tobacco and vape users purposely seek nicotine products for their “buzz.” It’s unclear if these users would consider switching to a nonaddictive VLNC product that doesn’t provide the legal high they’re looking for.
The other problem is that former Food and Drug Administration Commissioner Scott Gottlieb was really heralding the charge against big tobacco, and it’s unclear, following his resignation earlier this year, if his successors will fight those same battles. In other words, while 22nd Century Group appears to have a novel idea on paper, it’s still a big risk as to whether it’ll translate into real-world sales. With any shot at profitability still a long way off, I’d consider taking August’s run-up as a gift and head for the sidelines…
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