The First Tradable Cannabis ETF Has Now Lost Half Its Value

(The Motley Fool) According to estimates from Wall Street, as well as an assortment of independent reports, marijuana is the greatest growth trend to come along since sliced bread. Having generated just shy of $11 billion in global sales last year, worldwide revenue is forecast to catapult to between $50 billion and $200 billion by the end of next decade. That would appear to make cannabis a no-lose long-term investment.

Unfortunately, no matter how robust the growth figures are, there is no such thing as a no-lose investment opportunity.

To say that the past six months have been rough on marijuana stock investors would probably be an understatement. We need look no further than the Horizons Marijuana Life Sciences ETF as evidence of this fact.

The first-ever marijuana ETF is plunging

Since hitting an all-time intraday high of $20.86 on Oct. 16, 2018, the day prior to the launch of recreational pot products in Canada, the first exchange-traded fund focused on cannabis, which currently holds more than five dozen pot stocks of various weightings, has shed more than half of its value -- and that's including dividends paid. As of this past Thursday's close of $9.86, the Horizons Marijuana Life Sciences ETF had lost about 53% of its value since peaking nearly a year ago.

How does the hottest investment on Wall Street just suddenly go up in smoke? Let's take a closer look.

1. Supply and tax issues throughout North America

The 800-pound gorilla in the room is that the North American marijuana industry has been contending with supply issues and/or tax problems galore.

In Canada, supply shortages of dried cannabis flower has been ongoing since day one of legalization (Oct. 17, 2018). Health Canada has been contending with a gigantic backlog of cultivation, processing, and sales license applications, with select provinces also being slow to approve physical dispensary licenses. Despite implementing fixes to these issues, Canada is still likely many quarters away from making significant headway on its supply shortage.

Meanwhile, certain legalized U.S. states have struggled with high tax rates. In California, residents in certain locales could be shouldering a tax burden of up to 45%, which doesn't take into account ancillary fees, such as laboratory testing and compliance costs that are also being built into cannabis pricing. This has allowed black market producers to easily undercut legal-channel marijuana on price, thereby seriously curbing sales growth.

2. Poor operating results

As you might imagine, constrained sales results have led to a number of really poor operating results from cannabis stocks. That's a problem now, because operating results actually matter.

Take Canopy Growth (NYSE:CGC), the largest marijuana stock in the world by market cap, and the Horizons Marijuana Life Sciences ETF's largest holding (10.06% of assets), as a perfect example.

In the fiscal first quarter, Canopy Growth reported minimal sequential cannabis sales growth, but delivered a charge-laden net loss of 1.28 billion Canadian dollars. Yes, billion! Even if Canopy's unsightly CA$1.18 billion charge regarding warrant extinguishment is taken out of the equation, the company produced a gross profit of only CA$13.2 million on CA$90.5 million in net sales, yet had operating expenses more than triple on a year-over-year basis to CA$229.2 million. While most pot stocks aren't profitable, it's disturbing just how far from profitability the leading marijuana stock is at the moment. 

For the time being, all of marijuana's biggest names look to remain in the red.

3. Goodwill galore

Another issue among pot stocks is rising goodwill -- i.e., the premium an acquiring company pays above and beyond tangible assets.

Since August 2016, Aurora Cannabis (NYSE:ACB) has made well over one dozen acquisitions. The company has made clear that these inorganic purchases are critical to its production, portfolio, and international expansion strategy. Unfortunately, in Aurora's haste to gobble up early-stage market share, it appears the company may have grossly overpaid for a majority of its purchases.

According to Aurora Cannabis' fiscal fourth-quarter results, ended in June, it has racked up CA$3.17 billion in goodwill, which represents 58% of its total assets. The hope is that Aurora will recoup this value by expanding the utility of its acquired assets and monetizing their patents. But the reality of recouping this much goodwill is slim in an underperforming industry. What's become increasingly likely is that Aurora Cannabis may take a significant writedown in the not-too-distant future.

4. Ongoing share-based dilution

Marijuana stocks have also been guilty of diluting the daylights out of their shareholders.

Not to purposely pick on Aurora Cannabis again, but it's financed virtually all of its acquisitions by using its common stock as capital. With the exception of the CanniMed purchase in 2018, every other major deal has been financed by issuing its stock. As a result, Aurora's outstanding share count has risen from 16.2 million shares at the end of fiscal 2014 to 1.02 billion by the end of fiscal 2019. Increasing the company's share count by 1 billion has consequences, which is a big reason why its share price is nearing a 52-week low.

Aurora Cannabis is the Horizons Marijuana Life Sciences ETF's second-largest holding.

5. Little progress on legalization in the U.S.

There's also been very little progress made when it comes to legalizing marijuana on the U.S. front. In spite of record approval numbers from the American public, lawmakers have stood firm on their view that cannabis is an illicit drug.

Worse yet, there doesn't look to be any hope that this view will change anytime soon. Republicans have historically had a more adverse view of weed than Democrats or Independents, and they're currently in control of the Senate and Oval Office. Additionally, Senate Majority Leader Mitch McConnell has halted every previous attempt to get cannabis legislation to the Senate floor for vote.

The United States is viewed as the crown jewel of the pot industry, and Canadian growers know it. That's why Canopy Growth acquired Colorado-based intellectual property company ebbu late last year, and is spending $150 million on a hemp-processing facility in New York State. But without federal change, the prospect of big bucks in the U.S. market remains a pipe dream for Canadian cannabis stocks.

6. History repeats itself

Finally, it's worth noting that all previous next-big-thing investment bubbles have eventually burst.

If we were to look back on the rise of the internet, business-to-business commerce, genomics, blockchain, 3D printing, or any variety of next-big-thing investments, we'd see that all parabolic upward moves were eventually met by a backbreaking downtrend. Marijuana stocks may very well be in that downtrend right now. The fact is that all industries need time to mature, and the legal cannabis industry is no different. Mind you, this doesn't mean there won't be winners in the marijuana industry. But it does suggest that it'll be some time before we know the identity of these winners.

Popular

More Articles

Popular