Cannabis stocks have been stagnant or declining due to cash burn and regulatory challenges. Despite this, many bulls have once again begun expecting a resurgence in this sector. This shift has come as leading companies are showing profitability potential, with many anticipating positive free cash flow. This should, in theory, flow through to stock price growth over time. Additionally, the expected federal legalization of cannabis is a key catalyst many are anticipating providing a boon to this sector.
However, there are concerns that continue to arise when looking at even the best cannabis stocks. For one, legalization is a nice concept, but one that may take much longer to materialize than supporters think. Secondly, the experiment with legalization in the Canadian market (where these three companies are currently focused) has shown that demand has not really kept pace with expectations. Thus, as the sector built out an incredible amount of supply to handle the expected boom, prices of raw flower and other cannabis products have declined.
Let’s dive into three of the most overbought cannabis stocks I think could have more room to decline from here.
Canopy Growth (CGC)
Canopy Growth (NASDAQ:CGC) stands out as one of the most prominent players in the Canadian cannabis market. The company has also been making inroads into the U.S. market, with its recent acquisition of Jetty Extracts.
That said, the company remains mired in uncertainty, with previous stock price surges tied to expectations of U.S. legalization during the Biden era fizzling out. The company’s fundamentals have also taken a hit, with Canopy’s loss-generating business continuing to provide enough uncertainty for growth investors to steer clear.
In particular, Canopy’s cash reserves have dwindled to very low levels, driven by an acquisition spree in recent years. Like other major cannabis players, size and consolidation was what mattered in previous years. Capturing higher market share was more important than profitability, something the market clearly doesn’t agree with right now.
My view is that Canopy’s fundamental woes may only be alleviated by capital raises in the near-term. Whether that’s in the form of share issuance or debt raises, Canopy’s balance sheet isn’t likely to improve meaningfully, at least in my view. That’s reason enough to sell for the fundamental investor.
Tilray Brands (TLRY)
Tilray’s (NASDAQ:TLRY) business model and current fundamentals are similar in many ways to that of Canopy. The Canada-based cannabis producer has seen inconsistency in most areas of its business, with the only consistent area being net losses. That’s never great for investors.
The fact that TLRY stock now trades around $2.07 per share is notable, when one considers this stock traded above $140 per share in 2018. In other words, Tilray has lost more than 98% of its value for investors who bought at the top.
While some deep value investors and speculators may now be looking at Tilray as a way to play this volatile sector and trade around the edges, I think that’s a risky strategy. There’s plenty of potential for further declines, given the company’s recent results.
In fiscal year 2023, Tilray reported a slight year-over-year revenue drop of 0.20% to $627.1 million, with cannabis accounting for 38% of this revenue, facing fierce competition in Canada.
Additionally, the company’s history of missing quarterly EPS estimates raises concerns. Tilray’s $56 million Hexo buyout may affect its financial performance, and investors lack clear revenue expectations from this acquisition.
Overall, if you want exposure to the cannabis industry, Tilray Brands is too high risk. It might be safer to avoid cannabis producers, especially with U.S. legalization still uncertain. While Tilray’s future isn’t predetermined, it’s advisable to avoid the stock until it achieves profitability. Buying it should be considered only after it demonstrates sustained profitability.
Green Thumb Industries (GTBIF)
Green Thumb Industries (OTCMKTS:GTBIF), while known for cannabis sector profitability, faces challenges. Indeed, the company’s Q2 2023 results highlighted certain notable contractions. Revenue came in basically flat, down 0.8% year-over-year. However, the company’s net income sank more than 45%, with earnings per share down 50% and net profit margin down 45% over the same period the year prior. This indicates that Green Thumb is seeing significant margin contraction as a result of increased competition and diminishing demand across its core business.
Green Thumb faces challenges in the volatile cannabis market. Down 15.29% year-to-date, GTBIF stock has been plagued by negative results in key indicators like return on equity. While this stock currently trades near its 52-week low, there aren’t really any catalysts I can point to that would suggest this stock should rally from here.
There are certainly reasons why some investors may consider this stock, but it’s just not for me. Until these cannabis companies can show improving fundamentals, it’s probably best to steer clear of this option in cannabis stocks.
On the date of publication, Chris MacDonald did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.