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Prior to outbreak of COVID-19, cannabis stocks had plummeted from fattened valuations as they failed to find promised profit and seemed at risk of bankruptcy. The global pandemic has made it even worse, and investors now are looking for companies that will simply survive.
There are only two names in the legal-marijuana sector that investors can look to for relative safety. Some of the remaining companies may be safe, too, depending on how much cash they have, their stockpile of pot, retail access and their ability to make more marijuana products.
The two cash-rich companies are the easiest to pinpoint as able to make it through the pandemic. Canopy Growth Corp. CA:WEED US:CGC has long had the most treasure, snatching up a $4 billion investment from Corona distributor and beverage giant Constellation Brands Inc. US:STZ in 2018. Executives have bled the war chest quarter-after-quarter, making questionable acquisitions and losing hundreds of millions on operational expenses. But under the leadership of freshly installed Chief Executive David Klein, Canopy has begun to reign in expenses and curtail operations in a move toward eventual profitability.
Read:From cash to ash: Pot companies have just months to live on average, study finds
Trading close to the cash value of the company divided by the number of shares, Cronos Group Inc. US:CRON CA:CRON is seen by many investors MarketWatch spoke with as a relatively safe place to park money. It has $1.51 billion in cash, in large part due to tobacco-maker Altria Group Inc.’s US:MO investment.
“It’s a great defensive stock,” Raymond James analyst Rahul Sarugaser said in a phone interview with MarketWatch. “Given that it’s trading at just above cash, it’s effectively trading close to its bottom and anything [the company] announces will generate upside for investors.”
Even though Cronos is the second largest cannabis company in Canada, it doesn’t have much in the way of revenue or market share. Referring to Cronos Group’s lackluster sales, Cowen analyst Vivien Azer said it in a recent note: “Who needs revenues, when you have cash?”
In the U.S., where access to capital has been harder fought due to the plant’s prohibited status under federal law, viability is even less certain. Without federal bailout money and operations limited to the 11 recreational markets and 33 medical states, it remains even less clear which companies will survive.
On both sides of the border, companies faces doom before the economic turmoil abates, but on a sliding scale based on how they rate in the following four areas.
Cash and profitability
Unlike many other industries, weed companies struggled to raise money well before coronavirus dried up potential investment. The market upheaval that has accompanied the COVID-19 pandemic makes a bad problem worse, according to Entourage Effect Capital managing partner Matt Hawkins.
“For more than a year now, we’ve had a distressed marketplace, for no other reason than it’s capital-starved,” Hawkins told MarketWatch.
The pandemic will exacerbate the issue, Hawkins said — companies with enough cash on the balance sheet and the ability to continue operations via profitability for 12 to 14 months will be able to weather the storm.
“Cash is king, cash will continue to be king,” he said.
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There are several U.S. names that fit the criteria: Green Thumb Industries Inc. CA:GTII US:GTBIF Trulieve Cannabis Corp. CA:TRUL US:TCNNF and Curaleaf Holdings Inc. CA:CURA US:CURLF, all have relatively strong balance sheets.
Companies that do have cash or a short path to profitability will likely make much safer 12-month investments, Jefferies analyst Owen Bennett wrote in a note to clients this week. Prior to this week’s note Bennett wrote that his team didn’t assign cash too much weight when determining and investment thesis, but, “we think that going into a recession, it can’t be ignored.”
Cash is important now more than ever because it’s hard to get. Bennett pointed to Tilray Inc.’s deeply unfavorable $90 million equity sale in March, which represented a 66% discount to the company’s average price.
According to a hedge fund portfolio manager who invests in the cannabis industry, there are two broad groups of cannabis companies: those with liquidity in their stock, which means they will be able to raise more cash, and illiquid companies, which include many companies listed on junior exchanges. For the second group, the scenario is “worse than ever,” he said.
Stockpiles of weed
Once considered to be an albatross around the neck of Canada’s largest producers, excess inventory is now desirable.
According to a note from Jefferies analyst Owen Bennett, companies with immense inventory will be at an advantage if there are supply shutdowns, in terms of cash flows, much like producers with a large capacity benefited during the early days of recreational legalization in Canada.
Raymond James analyst Sarugaser wrote in a note that his bank has observed a cultivation and processing slowdown across the industry as weed companies implement social distancing measures and spend more resources ensuring clean work places.
“Now, it seems that large accumulated inventories may prove to be an indicator of resilience during the COVID-19 era,” Sarugaser wrote.
| All figures in millions of Canadian dollars | Aurora | Aphria | Canopy | Cronos | Hexo | Organigram | Tilray |
| Finished Inventory | $50.7 | $78.2 | $4.4 | $9 | $18 | ||
| Work in Progress | $129.9 | $472.2 | $29.5 | $28.8 | $54 | ||
| Total Inventory | $205.5 | $225.8 | $622.6 | $38 | $93.5 | $113.4 | $87.9 |
Source: Jefferies
Production capabilities
If you don’t have a lot of product in your inventory, you have to make it. Growing pot, processing it and transforming it into products, whether that means packing flower for smoking or making products such as edibles or vapes, is now more complex because of the different way companies must operate during the pandemic.
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Few major producers have made public disclosures or reported financial results since March. Aurora Cannabis Inc. US:ACB CA:ACB has long touted the level of automation at its flagship Aurora Sky facility in Alberta, though when asked a company spokeswoman said, “The level of automation at Sky-class facilities is definitely an asset at all times in terms of increasing the reliability and efficiency of our operations.” Other cannabis companies have said little about the effects of social distancing and other safety measures on their cannabis production.
Baruchowitz says that the larger U.S. multistate operators such as Cresco Labs, Green Thumb and Curaleaf already have a fair amount of automation and have an advantage over smaller operators who still rely on human labor for various aspects of cannabis production. One advantage that cannabis companies have over other industries is because companies are forced to operate wall-to-wall within states, businesses tend to source production inputs such as soil and other raw goods from local vendors, Baruchowitz says.
In Canada, as second generation of cannabis product sales beginning in January in earnest — including edibles, vapes and drinks — companies that already have products on the market are at a distinct advantage, according to Sarugaser. In a note, he writes that weed businesses that were formulating new products will be significantly delayed because it will be impossible for companies to set up production lines, refine the products and complete quality assurance testing, among other things, while the emergency measures are in place across the country.
Read:Aphria yanks forecast due to coronavirus after strong increase in cannabis sales
Retail channels
One of the longstanding excuses for lackluster sales that Canada’s largest cannabis companies have given to investors has been the fact that bricks-and-mortar pot stores have been slow to open. Ontario has received the lion’s share of the criticism, but other provinces have had their issues too. As Canada responded to the pandemic, Ontario again befuddled investors: across most of the country and in the U.S., weed is considered an essential business, but Ontario shut down stores, only to reverse course days later and allow curbside pickup or delivery for the 52 open stores — though the online government run pot store was always open for business.
“In sum, we see the stalling of in-person cannabis retail as one of the key mechanisms holding the Canadian cannabis market back from expending toward market equilibrium and further accelerating the attrition of the poorer operators,” Sarugaser, the Raymond James analyst, wrote.
While curbside pickup presents its own complications for cannabis retail operators, Canopy Growth has shut down its corporate-owned pot stores in an abundance of caution, other retailers remain open.
See also:Pot smokers stock up for pandemic on ‘the vice of choice when alone’
In the U.S., in every state where recreational pot is legal, cannabis is considered an essential business and sales continue to hum along — albeit with the required social distancing, delivery, or various click and collect systems in place. Except in Massachusetts. There, the governor has shut down all recreational cannabis operations, saying that because it is one of the few states in the northeast with legal pot, he is concerned people will travel from out of state to buy weed and potentially spread the virus. The decision doesn’t look likely to change, as a legal challenge to the governor’s order was defeated this week.
Companies with exposure to Massachusetts retail such as the Illinois-based Cresco Labs Inc. CA:CL US:CRLBF, Green Thumb and Curaleaf stand to suffer.
