2 Cheap Cannabis Stocks to Avoid in October | The Motley Fool

Cannabis stocks aren't exactly in vogue right now. All of the biggest public marijuana companies massively underperformed the market over the last 12 months, with nearly all of them losing a lot of their value, and there may not be relief in sight.

For the bargain-hunting investor, now is the ideal time to be on the lookout. But not every bruised stock is a genuine opportunity, and many are likely to lose even more value, at least in the near term. Therefore, here are two inexpensively valued cannabis stocks you should probably steer clear of even if you're looking for a deal. 

1. Canopy Growth

Canopy Growth (CGC -3.79%) is a Canadian cultivator that looks cheap and appears to be exposed to a lot of upside from cannabis legalization in the U.S., but it's a trap. First, take a look at this chart:

CGC PS Ratio data by YCharts

As you can see, Canopy's price-to-sales (P/S) multiple of 1.5 is significantly lower than its peers like Tilray Brands, Curaleaf and Green Thumb Industries. But that does not mean it is priced at a bargain. Its quarterly revenue of $81 million is 20% lower than it was three years ago. Furthermore, its quarterly gross profits are down 77% in the same period, reaching over $4 million. The culprit for the decline is the collapse of the Canadian recreational marijuana market, which saw an overabundance of supply crash against a deficit of demand. 

Since then, the company pivoted to focus on the U.S. market, scaling down its Canadian retail operations in favor of wholesaling. It's selling off a handful of its properties to pay down its long-term debt load of $789 million, generate more cash, and cut its expenses. It's also ceasing operations of money-burning business units, like BioSteel sports drinks. But those strategic shifts have yet to pay off.

Management expects to reach positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) by the end of its 2024 fiscal year. Still, it's hard to see why investors would be happy about that, as its quarterly cost of goods sold (COGS) has grown as a proportion of sales since three years ago, meaning that unit economics are still a major impediment to growing the bottom line. There's simply not much reason to buy shares of a company that's downsizing while also continuing to struggle with the same problems as it did in the past while additionally shifting its market focus simultaneously. 

2. Aurora Cannabis

Aurora Cannabis (ACB -1.94%) is another stock worth avoiding for the moment despite its P/S of 1.3, and its story is quite similar to Canopy's. Hit hard by the Canadian cannabis market's decline, the business grew its quarterly revenue by only 10% in the last three years, arriving at $56 million in Q1 of its 2024 fiscal year. The last two quarters saw its sales in the European medicinal marijuana market skyrocket.

But that belies the bigger problem: its quarterly gross profits of $18.6 million are still 29% lower than three years ago. In short, Aurora massively overbuilt its supply capacity to attempt to capture a large slice of the Canadian medicinal market, and its task over the last couple of years has been to unwind that ambition and reach a sustainable scale for its operations. Earlier this year, it sold off one of its cultivation facilities in Canada, reducing its ability to serve demand in exchange for cutting overhead. And management has plans to continue slashing other expenses in hopes of reporting positive free cash flow (FCF) for its 2024 fiscal year.

Much like Canopy Growth, reaching that goal belies its sketchy unit economics, in which its quarterly COGS has risen as a percentage of revenue compared to where it was in 2020. It's possible that Aurora will manage to rectify its operations and become profitable in the long run. For now, investors should be concerned that it still isn't profitable despite three years of transformation, cost-cutting, and shifting of its markets. It's a bit too risky to approach, so avoid it. 

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