Legal marijuana projects as one of the fastest-growing industries for the next couple of years. It generated $12.2 billion in global sales in 2018, and the team of Arcview Market Research and BDS Analytics have forecast worldwide revenue of $31.3 billion by 2022. This works out to a compound annual growth rate of 26.6% over the next four years.
Yet, despite this growth, we witnessed a strange occurrence during the first few months of 2019. Namely, profit projections (or loss estimates for some marijuana stocks) for the following year, fiscal 2020, have been worsening. While it's not uncommon for Wall Street's consensus estimates to be all over the place for nascent but fast-growing industries, the expectation had been that this decline in 2020 profit projections would ebb after a few months. Unfortunately, that's not been the case.
Marijuana's most popular stocks are turning into fundamental nightmares
A quick examination of the three most popular pot stocks -- Canopy Growth (NYSE: CGC), Aurora Cannabis (NYSE: ACB), and Cronos Group (NASDAQ: CRON) -- reveals that Wall Street's fiscal 2020 consensus estimate for these companies continues to plunge.
Three months ago, Canopy Growth, Aurora Cannabis, and Cronos Group were respectively expected to deliver (all figures in Canadian dollars) a loss of CA$0.24, a profit of CA$0.03, and a profit of CA$0.16 in fiscal 2020. But as of this past weekend, those estimates had plunged to a consensus loss of CA$0.42 for Canopy, a loss of CA$0.06 for Aurora, and a mere CA$0.04 profit for Cronos. At the rate things have progressed, all three may lose money in 2020 after pretty much every pundit called for healthy profits by 2020 for a vast majority of marijuana stocks.
This is a problem, given that earnings results actually matter now. With Canada having legalized recreational marijuana in October, more than 40 countries in the world now allowing some form of medical cannabis use, and a fifth of the U.S. market soon allowing adult-use weed sales (once Illinois kicks off sales on Jan. 1, 2020), marijuana stocks no longer have any excuses to mask their premium valuations. As a result, we've seen a number of high-profile pot stocks, including Canopy, Aurora, and Cronos, taken to the proverbial woodshed in the second quarter.
Here's why profit projections keep falling
What's to blame, you ask?
Part of the problem rests with regulatory red tape to our north. Regulatory agency Health Canada has been contending with a backlog of more than 800 applications, many of which are for cultivation. The agency recently announced a change that will require growers to complete production facilities prior to submitting a cultivation license application. This should remove underfunded growers from the application backlog and potentially expedite a process that can take months, or even more than a year, in some cases, to complete. Perhaps in 12 months, or a bit longer, this cultivation application backlog will be no more. Unfortunately, the sales license application backlog is another story altogether.
Canada has also been contending with a shortage of compliant packaging solutions. Health Canada laid out a laundry list of regulations that growers would need to abide by if they want their product to make it onto dispensary store shelves. This demanding list has kept a lot of cannabis sitting on the sidelines for the time being.
But you can also place some of the blame on the growers themselves. For starters, growers weren't exactly willing to boost production well in advance of the Cannabis Act becoming law. Since capacity expansion is costly, companies like Canopy, Aurora, and Cronos waited until very late 2017 or early 2018 before really getting to work on production expansion. This relatively late start has left many operating at nowhere near their peak capacity.
These aforementioned popular pot stocks haven't exactly been putting their shareholders first, either. In order to facilitate their expansion, these companies have been issuing shares of their stock like it's going out of style. Although these share issuances have successfully raised needed capital, a ballooning outstanding share count has a tendency to weigh on profits, since it means net income is divided into a greater number of sharers. Between Aurora issuing roughly 1 billion shares in less than five years, and both Canopy and Cronos ballooning their share counts through bought-deal offerings and somewhat recent equity investments, these companies aren't exactly putting themselves in the best position to grow their bottom lines right now.
Long story short, sales are expected to rise significantly for Canopy, Aurora, and Cronos, but nothing suggests that they'll be ready to turn the corner to recurring profitability before the end of 2020. That makes these three popular pot stocks potentially risky investments.
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