Why This Fund Manager Wants to Avoid Cannabis Stocks


Dec. 20 2019, Published 10:25 a.m. ET

On December 19, as reported by Cantech Letter, fund manager Norman Levine warned against investing in cannabis stocks in the current environment. The fund manager believes the cannabis sector to be a viable investment option. However, he is concerned about the current lack of profitability of the industry. He believes that even the industry leaders do not have good visibility about the timeline by which cannabis companies may turn profitable.

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Levine is skeptical about the business fundamentals driving valuations of cannabis companies. He is also finding it very challenging to value the cannabis stocks and anticipates a further downtrend in valuation multiples. He also highlighted the intense competition in the cannabis sector. Levine believes that none of the cannabis brands has managed to garner significant customer loyalty.

Against this backdrop, the fund manager has suggested that investors opt for a “wait-and-see” approach.

Jim Cramer has also lost faith in the cannabis sector

On November 21, as reported by CNBC, Jim Cramer claimed that “the marijuana industry is just not what it was cracked up to be.” He accepted his mistake in considering the cannabis sector an “incredible opportunity.” The former hedge fund manager has asked investors to reduce their exposure to the cannabis sector. He is also disappointed with his once-favorite stock, Canopy Growth (CGC).

Cramer believes that the cannabis industry could witness a shakeout due to companies closing down, M&As (mergers and acquisitions), and capital crunch. He also claimed that the cannabis opportunity might be much smaller than previously projected. He expects intensified pricing pressures in the cannabis industry due to increasing supply and the lack of significant differentiation.

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Jefferies analyst Owen Bennett is cautious about cannabis stocks

Cannabis stocks perked up in late November after the Democratic-controlled House Judiciary Committee voted in favor of the MORE (Marijuana Opportunity Reinvestment and Expungement) Act. The news of Ontario planning to open more stores also pushed up cannabis stocks.

On November 25, MarketWatch reported that Jefferies analyst Owen Bennett called out both these factors as supportive but not material in the near future for the cannabis sector. He noted that the cannabis sector rally was partly driven by shorts covering their positions. He also expects the cannabis industry to continue to face a liquidity crisis in the coming months. Bennett added that there was no real change in consumer sentiment for cannabis stocks.

Bennett gave Organigram (OGI) and Aphria (APHA) “buy” ratings based on robust business fundamentals and expectations of near-term profitability.

MKM’s Bill Kirk doesn’t agree with consensus estimates of cannabis stocks

On November 25, MarketWatch reported that MKM analyst Bill Kirk highlighted the mismatch in consensus estimates for revenues and operating expenses of cannabis companies. He disclosed that analysts expect the five largest Canadian cannabis companies in MKM’s coverage to grow sales at an average rate of 82%. However, they have assumed only an 8% average growth in operating expenses for these companies.

Kirk believes that such high revenue growth cannot be attained without a significant increase in costs. He believes that the consensus profitability estimates of Aurora Cannabis (ACB) and CGC are most likely unattainable.

Kirk highlighted several other challenges in the cannabis industry. He anticipates lower profit margins once flowers and extracts production becomes commoditized like other agricultural products. He remains concerned about pricing pressures, the black market, and declining same-store sales.

GLJ Research’s Gordon Johnson considers ACB stock to be worthless

On December 17, TipRanks reported that GLJ Research founder Gordon Johnson initiated coverage for ACB with a “sell” rating and target price of $0. The analyst expects ACB’s equity to become worthless by the end of 2021.

Johnson pointed out the company’s mounting debt and restrictive covenants on its debt as key challenges for ACB. He expects ACB to violate these covenants, which would result in banks asking for repayment of loans. He believes that banks may refuse to refinance ACB’s loans, which occurred with The Green Organic Dutchman.

The analyst also raised concerns about ACB’s continuing equity dilution. Johnson doesn’t expect ACB to become profitable in 2020 due to oversupply pushing down cannabis prices.


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