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Despite Doubling, These Cannabis Stocks Are Bad News

If you think the stock market has had a wild go of things lately, take a gander at marijuana stocks over the past three years.

Until the end of the first quarter of 2019, pot stocks were virtually unstoppable. Promises of increased capacity, partnerships, and high-margin derivatives fueled upside, with Wall Street seemingly blind to the potential for growing competition. It was not uncommon for cannabis stocks to have delivered triple-digit or quadruple-digit gains to their shareholders.

Then reality sunk in during April 2019. Over the next 12 months, ended March 31, 2020, the vast majority of cannabis stocks declined by anywhere from 50% to 90%. Supply issues in select Canadian provinces, high tax rates on legal product in the U.S., financing concerns throughout North America, and even the coronavirus disease 2019 (COVID-19) pandemic, ravaged the industry.

However, pot stocks have again found new life since the broader market bottomed out on March 23. Some of these rebounds make perfect sense, as in the case of Trulieve Cannabis and Innovative Industrial Properties, which are two of the most profitable pot stocks on the planet. But some cannabis stocks, despite doubling in price, remain bad news for investors and should be avoided at all cost.

Aurora Cannabis

As if it weren't already a polarizing marijuana stock, Aurora Cannabis (NYSE: ACB) is attracting all sorts of attention after rallying 127% over the trailing month, through this past weekend. Aurora's fiscal third-quarter operating results have served as the upside catalyst, with the company reporting a reduced cash burn rate, better-than-expected sales, and confidence that the company will reach positive adjusted EBITDA in the fiscal first quarter of 2021 (ended Sept. 30, 2020). 

But there's a veritable laundry list of things not to like about the most popular pot stock among millennial investors. For instance, the company that was once touted as the biggest weed producer is now scrambling to reduce its operating expenses. This has meant more than halving its peak production potential and laying off workers, all while gaining virtually no traction in overseas sales.

Furthermore, Aurora Cannabis is what investors might call a serial diluter. Aurora has financed almost every aspect of its growth process by issuing or selling its stock. Taking into account the recently enacted 1-for-12 reverse split that kept Aurora from being delisted off the New York Stock Exchange, its outstanding share count has skyrocketed from around 1.3 million shares in June 2014 to perhaps 113 million shares six years later. And Aurora's not done -- it has a $350 million at-the-market offering at its disposal to issue additional shares in order to raise capital.

Investors who dig into the meat and potatoes of Aurora Cannabis will also find an ugly balance sheet. More than half of the company's total assets are classified as goodwill -- an indication it grossly overpaid for its numerous acquisitions. Between rising inventory levels and idled facilities, it's my contention that more than half of Aurora's total assets may need to be written down. That makes this stock one that investors should rightly avoid.

Tilray

Another seemingly unstoppable cannabis stock of late is Tilray (NASDAQ: TLRY). Over the trailing three-month period, Tilray has rocketed higher by 109%. Similar to Aurora, Tilray's recently ended quarterly results fueled these big gains. The British Columbia-based licensed producer delivered 126% year-on-year sales growth, a 16% reduction in sequential quarterly loss, and more than tripled its overseas medical marijuana sales from the prior-year period. 

But these figures don't mask what a major disappointment Tilray has been since its astronomical post-IPO run in September 2018. Management has been clear that it prefers focusing on markets outside of Canada. However, shifting the company's strategy just six months after Canadian weed sales commenced hasn't exactly worked out. Significant capital outlays beyond Canada have drained Tilray's once bloated coffers and sent it scrambling for capital.

Aside from being devoid of a clear strategy, Tilray's foray into the U.S., via its Manitoba Harvest acquisition, hasn't worked out all that well. Manitoba's hemp food operations are considerably lower margin than Tilray's cannabis operations. What's more, cannabidiol (CBD) failed to take off as expected in the United States after the U.S. Food and Drug Administration put its foot down on the use of CBD as an additive to food and beverages. Thus, a big chunk of Tilray's year-on-year gains derives from a low-margin hemp foods business.

Lastly, the company's cash position remains precarious, even after a huge capital raise during the height of the coronavirus sell-off. Having $174 million in cash and cash equivalents might sound like a lot, but Tilray lost $71.3 million on an operating basis in just the most recent quarter. This cash isn't going to last long with the way Tilray is losing money.

HEXO

Keeping with the Canadian theme, Quebec-based licensed producer HEXO (NYSE: HEXO) has also been on fire of late. Over the trailing month, ended this past week, HEXO's share price had risen by a cool 128%. As with its peers, HEXO's rapid ascent can be attributed to its most recent earnings report, which in its case featured better-than-expected revenue and a reduction in the company's operating expenses. 

But like Aurora and Tilray, HEXO is its own form of train wreck. This is a company that permanently closed its Niagara facility, which was acquired in the Newstrike Brands acquisition last year, and is now looking to sell Niagara to raise capital. HEXO has also reduced output at its primary Gatineau facility and laid off workers to conserve capital. In essence, it's yet another licensed producer that's shrinking in an effort to simply survive.

Commentary from CEO Sebastien St-Louis late last year provides another reason for concern. St-Louis, in speaking with Wall Street analysts following the release of the company's operating results, noted that HEXO would need to acquire 20% market share in Canada simply to move to recurring profitability. Even after signing the biggest wholesale provincial agreement in 2018 with Quebec, HEXO is no position to gobble up market share -- let alone 20% of Canada's cannabis market share.

With HEXO issuing stock via at-the-market offerings and continuing to dilute its shareholders, there's simply no reason for investors to be excited about this cannabis stock.

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