For several years now, the cannabis industry has made history on several occasions. In 2018, we saw Canada become the first industrialized country to legalize the sale of recreational pot, and the United States Food and Drug Administration approved the first-ever cannabis-derived drug. Meanwhile, in 2019, Illinois became the first state to legalize drinking. and the sale of weed for adult use entirely at the legislative level.
This year, we’re likely to see even more stories. For example, by the end of April, Mexican lawmakers are expected to pass legislation that would establish a retail market for recreational cannabis. We will also see South Dakota become the first state to vote on medical and adult weed in the same election next November.
However, 2020 will also be a year filled with undesirable trends for marijuana stock investors. Here are three pot industry trends that investors should be prepared for throughout the year.
Delisting from a major US stock exchange
First, investors may have to watch a handful of marijuana stocks pull back from major U.S. exchanges.
In the previous three years, more than a dozen cannabis stocks have either floated on the stock exchange, gone through the initial public offering on the New York Stock Exchange (NYSE) or Nasdaq. Being listed on one of these major exchanges means increased visibility, improved liquidity based on volume, and the likelihood of increased Wall Street coverage and/or investment. You could also say that this is a big step in the process of maturing marijuana stocks.
But in 2020, a few pot stocks that moved from the OTC exchange to the NYSE or Nasdaq might have the upper hand.
Take CannTrust Holdings (OTC: CNTTQ), for example. CannTrust was found to have illegally grown cannabis in five unlicensed rooms at its flagship Niagara property for a period of six months (October 2018 to March 2019). This led the regulatory agency Health Canada to suspend the company’s cultivation and sales licenses in September. Although the door has been left open for CannTrust to reclaim its licenses, the company is unable to sell product or plant additional crops at this time.
Meanwhile, CannTrust received a warning from the NYSE in early December for failing to maintain the required minimum listing price of $1. Even though CannTrust has since climbed back above $1 per share, it has also not released its operating results since last May. In other words, it looks like a shoo-in to show the door in 2020 – and other popular pot stocks could follow in its footsteps.
Then, marijuana stock investors should be prepared for a myriad of lawsuits, whether or not there is much substance behind the allegations made.
You see, cannabis stocks have struggled mightily in 2019 to retain investor confidence, which opens the door for lawyers to attack any possible signs of wrongdoing in the future. For example, canopy growth (NASDAQ: CGC), the world’s largest marijuana stock by market capitalization, must defend against class action lawsuits alleging it made false or misleading statements about its line of capsules and petroleum products. The lawsuits suggest those claims led Canopy to incur a C$32.7 million charge related to yields and excess inventory in the second quarter of the fiscal year, contributing to the company’s substantial share price losses l last year.
And Canopy is not alone. Quebec producer HEXO (NASDAQ:HEXO) also faces a myriad of class action lawsuits stemming from the company’s fourth-quarter about-face on its forward guidance. Having previously forecast C$400 million in sales for the year ahead, HEXO withdrew its sales guidance for the year ahead and significantly reduced its sales outlook for the fiscal fourth quarter in October. HEXO also announced that it would completely decommission its Niagara campus, acquired in the Newstrike Brands purchase, and lay off 200 workers from various departments.
Simply put, investors don’t have much faith in marijuana stocks right now, and law firms will look to exploit that as soon as any potential wrongdoing emerges. Expect lawsuits to be a constant theme for cannabis stocks in 2020.
Finally, investors should expect writedowns to become a fairly common theme this year, especially after the mountain of goodwill stocks has piled up over the past two years.
Goodwill, or the premium that acquiring companies pay over and above tangible assets, is generally common during an acquisition. The objective of an acquiring company is to use the assets of the acquired company to fully recover any goodwill. But for cannabis stocks, that’s incredibly unlikely given the exorbitant price of most deals.
As a perfect example, Aurora Cannabis (NASDAQ:ACB) ended up buying Ontario-based MedReleaf for C$2.64 billion in mid-2018. Part of the lure of this deal was the 1 million square foot Exeter facility, which is set to be upgraded to grow up to 105,000 pounds of weed per year. Aurora announced just a few weeks ago that it would put Exeter up for sale for just C$17 million. This means that Aurora Cannabis purchased MedReleaf for perhaps C$2.62 billion (net), but will only have received 35,000 kilos of annual production in return from MedReleaf’s Markham and Bradford campuses. This is a grossly overvalued trade that is likely to lead Aurora to take a huge writedown.
We will likely see a depreciation of Aphria (NASDAQ: APHA), also. Aphria’s purchases of Nuuvera and its Latin American assets in 2018 brought its goodwill to nearly C$670 million. This represents approximately 28% of its current total assets. What you might not realize is that this number already includes a C$50 million writedown related to its Latin American assets last year, which Wall Street and investors don’t have too much appreciated. Pot stocks like Aphria with more than 20% of their total assets tied up in goodwill should raise a red flag for investors in 2020.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.