Before the 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 the situation 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. /zigman2/quotes/202205609/delayed CA:WEED +7.36% /zigman2/quotes/200603886/composite CGC +7.93% has long had the strongest balance sheet, snatching up a $4 billion investment from Corona distributor and beverage giant Constellation Brands Inc. /zigman2/quotes/207737284/composite STZ +0.05% 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 rein in expenses and curtail operations in a move toward eventual profitability.
Trading close to the cash value of the company divided by the number of shares, Cronos Group Inc. /zigman2/quotes/206842762/composite CRON +6.27% /zigman2/quotes/202715342/delayed CA:CRON +7.01% 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 /zigman2/quotes/208895754/composite MO -0.02% 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 in a recent note: “Who needs revenues, when you have cash?”
In the U.S., where access to capital has been harder due to the plant’s prohibited status under federal law, viability is even less certain. Without federal bailout money and with operations limited to 11 recreational markets and 33 medical states, it remains unclear which companies will survive.
On both sides of the border, companies face 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 other industries, weed companies were struggling 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 or a road to profitability for 12 to 14 months will be able to weather the storm
“Cash is king, cash will continue to be king,” he said.
There are several U.S. names that fit the criteria: Green Thumb Industries Inc. /zigman2/quotes/206151134/delayed CA:GTII +2.00% /zigman2/quotes/200716694/composite GTBIF +4.12% Trulieve Cannabis Corp. /zigman2/quotes/210560499/delayed CA:TRUL +1.02% /zigman2/quotes/207658767/composite TCNNF +3.50% and Curaleaf Holdings Inc. /zigman2/quotes/203485866/delayed CA:CURA -0.07% /zigman2/quotes/205334348/composite CURLF +0.28% , all have relatively strong balance sheets.
Jefferies analyst Owen Bennett agreed. Until now, Bennett and his team did not assign cash too much weight when determining an investment thesis, but, “we think that going into a recession, it can’t be ignored.”
Cash is also important now 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.