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Here’s Why Cannabis Stocks Will Fall Even Further In 2020

Outside of a couple of good months to start the year, cannabis stocks have seen little bullishness since. Whether it's been scandals or disappointing results, there's been plenty of reasons for investors put the brakes on the once high-flying industry. And that's led to some big corrections. 

Aurora Cannabis (NYSE: ACB), one of the top pot stocks in the industry, has fallen more than 30% since the beginning of the year, and those losses are nearly 60% when looking at the past six months. Other companies have incurred even bigger losses along the way. But as bad as things have been this year, 2020 could be a whole lot worse.

Cash flow problems could put companies on the brink

A lack of cash has been a big problem in the industry. Companies have been burning through lots of it in the name of growth as they build out their operations domestically and all over the world. Aurora has been no exception to that. In its most recent fiscal year, the company used up 192 million Canadian dollars in cash from its operations. That's up from CA$82 million the year before. And with cash flow and short term investments totaling just CA$316 million, it's easy to see how it could be a problem for Aurora if things don't improve. 

Normally, that would be OK as the company could just issue shares to help account for any shortfall. And while it could still do that, the problem is that with its stock having fallen as much as it has this year, it's going to need to issue a lot more shares than it would have if its share price was stronger. That means more dilution for investors who have already experienced a lot of it. 

Investor holding his head as market is headed down

Image Source: Getty Images

The reality is that Aurora is still nowhere near as bad as other pot stocks are. Many cannabis companies could shut down their operations over the next 12 months, and that's going to make investors even more wary of the industry, and the bearishness could send Aurora and other pot stocks down even further.

More competition isn't going to make things easier

Another challenge for cannabis companies is the sheer amount of competition that they face. Not only are they competing with low-priced products from the black market, but there are also more companies entering the legal market as well. Some IPOs have been shelved for now but could decide to go public next year. Not only are companies going to be pressured to come up with more competitive products, but they'll have to be cheaper too. It certainly isn't going to help that cannabis producer HEXO is planning to try to undercut the black market in a bid to win more market share. 

Looking back to Aurora as an example, in fiscal 2019, the company incurred a net loss of more than CA$290 million. And if the company is going to need to squeeze its margins in order to keep customers, that's not going to make getting to breakeven any easier. While it may seem like Aurora's gross profit of CA$159 million was a strong 64% of its revenue, that doesn't tell the whole story. Fair value gains added CA$24 million to gross profit and without those adjustments, Aurora's gross margin would be 55%. That's still good, but investors need to be aware that those fair value gains can quickly become losses and have the opposite effect on a company's financials. 

Either way, things could be a lot more challenging for Aurora and its peers if consumers have more options and more pressure put on price.

What does this mean for investors?

Investors need to be a lot more diligent in reviewing cannabis stocks before deciding to invest in them. Whether it's Aurora or any other marijuana stock, poor financials are going to make it difficult to face what could be more adversity headed the industry's way. A company like Aphria that has had some success turning profits lately could be a much safer option for investors.

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David Jagielski has no position in any of the stocks mentioned. The Motley Fool recommends HEXO. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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