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Weekly Cannabis Report: Balance Sheet To Dictate Fate In 2020

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Includes: ACB, APHA, CRLBF, CRON, CURLF, HEXO, HMLSF, HRVSF, KSHB, MJ, MO, SPRWF, STZ, TCNNF, TLRY
by: Cornerstone Investments
Cornerstone Investments
Long/short equity, long-term horizon, cannabis industry
Summary

Cannabis stocks dropped last week in both Canada and the U.S. led by Aurora which was hit by two analyst downgrades.

Supreme dropped 23% after CEO left abruptly; Cresco Labs fell after closing the long-awaited acquisition of Origin House.

We highlight the diverging fortunes of Canadian cannabis firms based on their cash balance as liquidity will dominate the conversation in 2020.

Welcome to our Weekly Cannabis Report, a reliable source for investors to receive the latest developments and analysis in the cannabis sector.

Trading Summary

The Horizons Marijuana Life Sciences Index ETF (HMLSF) dropped 3.2%, the ETFMG Alternative Harvest ETF (MJ) fell 1.7%, and the Horizons U.S. Marijuana Index ETF fell 2.5%.

(Source: Bloomberg)

Canada: Aurora Cannabis (ACB) plunged 18% after two research analysts downgraded the stock citing balance sheet risks; we already sounded the alarm on Aurora's cash problem back in December. HEXO (HEXO) continues to drop in the aftermath of its recent financings. Supreme Cannabis (OTCQX:SPRWF) fell 23% after the sudden departure of its CEO.

(Source: Author, based on public data)

The U.S. and International: Harvest Health (OTCQX:HRVSF) fell 10% after it filed a lawsuit against Falcon, a company it agreed to acquire last year. Curaleaf (OTCQX:CURLF) rose another 7% as it outperforms most peers so far this year. Cresco Labs (OTCQX:CRLBF) fell 9% after closing its acquisition of Origin House. Trulieve (otcpk:TCNNF) dropped 10% after it released a detailed rebuttal to the short report. KushCo (OTCQB:KSHB) dropped 3% after reporting a weak fiscal 2020 Q1 was sales dropped 26% QoQ.

(Source: Author, based on public data)

Industry News

Looking Ahead

Aurora shares suffered heavy losses last week after two research analysts downgraded the stock citing balance sheet concerns. In fact, we already highlighted Aurora's cash problem in "Aurora Cannabis Is Running Out Of Cash Fast" published in December 2019. We saw the company struggling to sustain itself after it canceled two major greenhouses which must have been a difficult decision given the significant capital already invested. Additionally, Aurora recently listed its MedReleaf Exeter facility for sale at C$17 million and it has been aggressively issuing stock via its ATM program. All signs are pointing to a very difficult 2020 that could see Aurora facing major liquidity issues.

We think the struggles at Aurora highlight a key issue for investors to review when analyzing cannabis companies. It is becoming increasingly important to focus on a firm's staying power in light of the current difficult financing market. We think balance sheet and staying power will dictate the competitive landscape in 2020, especially important for the struggling Canadian firms. We believe Canopy, Cronos (CRON), and Aphria (APHA) are among the strongest while Aurora, Tilray (TLRY), and HEXO could face difficulties. We would generally divide the Canadian players into three categories on this matter:

  • "Sugar Daddy": With billions of investments into from Constellation (STZ) and Altria (MO), Canopy and Cronos enjoy the peace of mind that comes with their impeccable balance sheet. No matter how much volatility there is in the financing market, these companies won't need to worry about raising capital anytime soon. That is not to say that things will stay like this forever, as Canopy's cash balance has already dropped from C$5 billion to only C$2.7 billion after a slew of acquisitions and facility buildout.
  • Self-Sufficient: After going through a turbulent period, Aphria probably has the best balance sheet in the industry among those without a major outside investor. We think Aphria's management has prudently secured attractive financings including the most recent $80 million financing on its Diamond facility. The company had C$465 million of cash at the end of August 2019 which provides ample runaway for execution.
  • Walking A Tightrope: The other players are all facing certain financing uncertainties given their cash position. Aurora, Tilray, and HEXO all have low cash balance with Aurora being the most vulnerable given its excessive capacity building. Tilray is better off relatively given its modest footprint in Canada and smaller cash burn. HEXO has been a little nervous with two financings in recent months while shares are hitting multi-year lows. Overall, we think these players will be cash-strapped in the foreseeable future and dilutive financings could push share price further down. Also, several players have issued sizeable convertible debts that are deeply out of the money. We expect many of these players to follow Aurora and convert them at lower prices in order to avoid cash repayment, which is another negative event for equity shareholders.

(Source: Public Filings; as of latest published quarter)

We think investors should avoid companies with weak balance sheets going into 2020 as several potentially negative events could occur. Dilutive financings, as we've seen at HEXO and TGOD, could crush share price in a short amount of time. Upcoming maturity of out-of-the-money convertible debt could force companies to lower conversion price and significantly dilute existing shareholders. We think Canopy, Cronos, and Aphria will have the most financial flexibility in 2020 which affords them more opportunities to pursue opportunistic acquisitions, expansions into new markets, and, most importantly, the crucial staying power while the industry consolidates.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.