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This is truly a memorable year for the marijuana industry. The biggest event of the year is undoubtedly the legalization of the recreational pot in Canada on October 17, 2018. After promising to give the green light to the adult grass, Prime Minister Justin Trudeau held his promises. When the sector is fully operational at the beginning of the next decade, it could generate more than $ 5 billion in additional annual sales.
But it's far from the only news that has hit the headlines in 2018. We have witnessed the creation of medical marijuana in two new states – Utah and Missouri – and the first drug derived from cannabis has been approved. US Food and Drug Administration (FDA). And based in Canada Tilray became the first stock of marijuana at the IPO in a reputed US market.
Source of the image: Getty Images.
Everyone forgets these risks
As I said, this year has been busy – and this is reflected in the rise in pot market share prices since the beginning of 2016.
However, despite their incredible growth prospects, marijuana stocks are not without risks. Many of these risks have been well documented, but some are flying so far from the radar that hardly anyone is talking about them. Here are three of these main risks under the radar.
1. Fair value adjustments go back and forth
All investors should be aware when investing in Canadian-based marijuana stocks that they report their income statements using International Financial Reporting Standards (IFRSs), which are different from Canadian standards. Traditional US GAAP that US investors are accustomed to.
As agricultural corporations presenting IFRS-compliant financial statements, marijuana growers are required to recognize the fair value of their biological assets (ie, cannabis plants) throughout their growing cycle. Do not forget that cannabis plants may have different values depending on whether they are growing, blooming, or that they have been harvested and / or processed. It is up to producers to value this value, as well as the estimated cost of selling these assets. That's right … the jar stocks have to guess what their cost of the products sold will be before selling their product.
Source of the image: Getty Images.
As you can imagine, this can result in significant fluctuations in the fair value of these assets from quarterly to quarterly. In recent quarters, increased capacity has increased the recognition of fair value, resulting in an arbitrary increase in profits from marijuana stocks. For example, Aphria (NYSE: APHA) recently announced a gross profit of CAN $ 8.5 million, which included sales of C $ 13.3 million and production costs of approximately C $ 4.8 million. However, fair value adjustments to inventories and biological assets ultimately resulted in a $ 5.3 million increase in Aphria's gross profit.
The fact is that fair value adjustments can go both ways. Although the expansion of capacity has favored positive adjustments in the valuation of biological assets, this will not always be the case. Downward revisions could eventually thwart the rapid growth in potstock sales. Companies such as Aphria have not yet generated operating profit, and a downward adjustment in fair value could come back to investors.
2. prosecutions
It goes without saying, but lawyers love Wall Street. Whenever there is even question that the management team or the board of directors of a publicly traded company is not acting in the best interest of investors, this is Is an invitation to attack, so to speak. Lawyers especially like high-flying bubbles, and the marijuana industry could very well be one of them.
To be perfectly clear, the marijuana industry is now a viable business model. In a few years, there will be winners who should continue to succeed in the long run.
Source of the image: Getty Images.
But for now, all investors have promised to produce an "X" amount of cannabis during peak production or to have "Y" partners and unique "Z" products. One could argue that the bulk of marijuana stock gains so far is based almost entirely on promises – and that promises are easy to break or fail to meet in the financial world.
If marijuana stocks do not meet expectations, it would not be surprising to see them deflate significantly. Every "next big thing" before cannabis – for example, Internet business-to-business, genomics, blockchain technology, and 3D printing – has seen its bubble burst and pot stocks should follow suit. When this bubble burst, lawsuits could ensue. The long-term extra costs and expenses associated with lawsuits could be devastating for marijuana-producing companies that attach importance to their money.
3. Long-term dilution
Finally, and finally, you've probably heard skeptics talk about the impact of stock dilution on marijuana stocks, but you've probably paid little attention to their long-term impacts.
For example, yours has been regularly harp on Aurora Cannabis (NYSE: ACB) for his aggressive expansion efforts. Since the beginning of the year, Aurora has announced the construction of a brand new 1.2 million square foot building project in Medicine Hat, Alberta. The company also concluded the two largest cannabis transactions in its history: the purchase of CanniMed Therapeutics for $ 852 million and the purchase of more than $ 2 billion from MedReleaf, an Ontario company.
Source of the image: Getty Images.
To fund these projects, Aurora Cannabis generously used its common shares. The transaction with CanniMed was primarily in-stock, with the MedReleaf transaction fully stocked. Such a decision immediately inflates the number of outstanding shares of the company, which weighs on the stock price and makes it much more difficult for the company to generate a significant earnings per share. Between June 30, 2017 and September 30, 2018, the number of outstanding shares of Aurora rose from 366.5 million to 961.8 million.
But here's the thing: it's not over to increase. In addition to financing its acquisitions primarily with equities, the company has engaged in several takeover bids aimed at raising capital. The sale of shares creates an immediate increase in the number of shares outstanding, but offering convertible debentures, stock options and / or warrants may result in an increase in the number of shares outstanding outstanding shares of the company over several years.
At the end of the first quarter, Aurora had outstanding convertible debentures of approximately C $ 200 million and approximately 22.9 million share purchase warrants still available at the 2020 or 2023 maturity dates. The number of shares in Aurora Cannabis will increase significantly, which will have a negative impact on the company's earnings per share potential.
Of course, the marijuana industry is growing like a weed, but many neglected risks could hurt investors.
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