Use This Simple Checklist to Choose Cannabis Stocks With the Best Chance of Surviving in the Post-Apocalyptic Market
Just when you think you’ve seen it all and the worst was over for marijuana stocks, the market got absolutely throttled this week after companies like The Green Organic Dutchman (TSX: TGOD) (OTCQX: TGOF) announced it was having issues securing traditional financing in addition to analysts slashing price targets on TGOD Stock. HEXO Corp. (TSX: HEXO) (NYSE-A: HEXO) also released bearish news reducing its Q4 revenue forecast and withdrawing its fiscal 2020 guidance due to slower than expected sales. Both companies saw its share price plummet yesterday by roughly 20% dragging the entire sector with it.
It seems one sentence from HEXO’s press release is taking the brunt of the blame for the market collapse. Here’s what it said:
This single sentence sent Canadian cannabis stocks through the floor and even pulled the majority of U.S. pot stocks down with it.
Marijuana stocks that are profitable or very close to it include U.S. multi-state operators (MSO) Trulive (CSE: TRUL) (OTCQX: TCNNF) and Green Thumb (CSE: GTII) (OTCQX: GTBIF). These stocks still took a hit this week but held up much better than the rest of the sector. This is a sign investors are gravitating towards these financially stronger companies. On the Canadian side, Aphria (TSX: APHA) (NYSE: APHA) in its last quarterly earnings reported a surprise profitable quarter. This is also a sign that some Canadian stocks could be closer than expected to producing strong bottom-line numbers.
The cannabis financial market is in a state of disarray fueled by CannTrust’s regulatory issues, the recent Vape Crisis and now a slew of analyst downgrades. For the average investor, it may look like the game is over but in reality, we’re still in the early innings with massive markets like the United States yet to fully open up. The saying “We’re an inch into a marathon” still rings true today and I believe we’ll look back at today’s market as a ridiculous buying opportunity for select stocks.
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This market shakeout has been a violent one and many companies won’t make it out alive. Use the following checklist to scan the market to look for cannabis stocks with the highest probability of emerging from the wreckage to produce large ROIs over the next couple of years.
- Cash on Hand: After the recent TGOD news, it seems raising capital from banks or through the equity markets may be a challenge for most companies in the short term. Look for companies with strong balance sheets that won’t need to raise additional funds to continue operations anytime soon. Avoid companies that are burning through cash too quickly. Cannabis stocks with strong cash positions include Canopy Growth (TSX: WEED) (NYSE: CGC) and Cronos Group (TSX: CRON) (NASDAQ: CRON) which as of its most recent quarterly reports held $3.15 billion and $2.32 billion respectively. The majority of Canopy’s funds came from its $5 billion investment from Constellation Brands (NYSE: STZ) while Cronos got most of its cash from its $2.4 billion deal with Marlboro maker Altria Group (NYSE: MO).
- Burn Rate: Look into the company’s cash burn. How much cash are they spending each month? How long will the company’s cash reserves last them should it be unable to raise new money at reasonable terms? A company with a large burn rate may not be able to make it through the tough times. Aurora Cannabis (TSX: ACB) (NYSE: ACB) is a good example of a company with a large burn rate. Because of this, it’s highly likely the company will need to raise new money sometime in early 2020 which means either asset sales or more dilution to an already bloated share structure.
- Past and Present Financings: If the company has raised money recently or in the past, what were the terms and is there cheap stock coming into the market soon? If there is, then it’s highly likely these shareholders will be sellers the moment the shares are free trading due to poor market conditions. Profits are hard to come by right now so you can bet these investors will take the money and run putting increased pressure on the individual stock.
- Bottom-Line: Is the company profitable now? If not, how close to profitability is the company? The recent market correction was partly fueled by weaker than expected earnings. The days of blowing money like a drunken sailor and the company’s stock still rising are over. Investors are demanding to see profitability. Stick to companies that are currently profitable or very close to it. A good chunk of stocks won’t make it out of this market shakeout alive and the ones that do will likely be profitable.
- Management/Insider Holdings: Make sure the company you are investing in has a strong and proven management team that has experience navigating the ups and downs of the cannabis sector. Adapting to changing market conditions is crucial to surviving the recent cannabis market cataclysm. You’ll also want to make sure management has a lot of skin in the game. This way it’s in their best interest to make fiscally responsible decisions as it will affect their net worth as well. Executives without skin in the game may be more inclined to take on toxic financing to fund the management team’s salaries.
- Gross Margins: How much money does the company make on the sale of its products after subtracting its cost of goods sold (COGS)? The higher the gross margin, the more cash a company can retain on each dollar of sales in brings in. Will a drop in cannabis prices or an increase in production costs wipe them out? Value-added products such as extracts, edibles and beverages offer better margins than plain flower and will protect a company’s bottom line should the price of flower take a large hit. Avoid companies focused solely on cannabis flower products as it will be a commodity soon.
- Strategy: What is the company’s game plan? Is the company’s strategy a profitable one? For example, we’ve seen Wall Street show consumer packages goods (CPC) focused companies a much higher degree of positive attention compared to companies with retail only models. Marijuana stocks like Curaleaf (CSE: CURA) (OTCQX: CURLF), Green Thumb (CSE: GTII) (OTCQX: GTBIF) and Cresco Labs (CSE: CL) (OTCQX: CRLBF) all received praise from Wall Street’s top cannabis analyst for their CPC strategy. New U.S. MSO Red White & Bloom (CSE: RWB – IPO Soon) also falls into the CPC category and will likely be a Wall Street favourite with its focus on profitability from the onset. Companies like MedMen (CSE: MMEN) (OTCQX: MMNFF) are a good example of the retail-only model receiving poor analyst reviews due to the company bleeding money at an alarming rate. Dig into the company’s strategy and make sure it’s one that’s sustainable and has the potential to be profitable sooner than later.
- Catalysts: Determine the market catalysts that each stock could benefit from and make sure you’re aware when important industry developments may occur. Use the Google Alerts service and set it up so you receive email notifications whenever the catalyst you are tracking is mentioned in the news. For example, you could create Google Alerts for the keywords ‘SAFE Act’, ‘Legalization 2.0’ and ‘Cannabis Legalization’. This can really help you with timing your future trades. U.S. cannabis stocks currently have the SAFE Banking Act and potentially cannabis rescheduling/descheduling to look forward to while Canadian stocks have the less impactful Legalization 2.0 of edibles and extracts. The strength of each catalyst will determine the boost your stock and its peers receive in the market. You’ll want to place your bets long before the catalyst occurs. Buying too close to or after the catalyst occurs won’t do you any good as a lot of times we see a ‘Sell the News’ type reaction in the market. Remember, no risk, no reward.
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Make a list of companies you like then run each company through this 8 step checklist to see how they make out. If they don’t check most of the boxes, consider passing on them until the company makes the appropriate adjustments.
The cannabis industry isn’t coming to an end, its simply resetting valuations across the board. Recently we’ve seen new funds created by former Wall Street bankers pop up whose sole focus is to acquire cannabis investments and assets on the cheap.
These bankers are no dummies and they’re ready to deploy billions of dollars into the market to take advantage of the current meltdown. They see this is an opportunity to buy strong companies at a discounted price and so should you.
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