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TRUTH BE KNOWN

April 22, 2019

 

When buying stocks for the long-term,  fundamentals are the key. You know --- fundamentals like a stock's intrinsic value?  The  term refers to -- what you believe a stock is worth – as opposed to the value at which it is being traded in the marketplace. ... In plain English, this means that a company is worth all of its future profits added together. Indeed, a company’s fundamentals are financial information and management commentary, as reported in quarterly or annual statements, press releases or other public venues. Anecdotal reports from company customers and suppliers, or general information on the company's product markets, are also part of the fundamental picture.

We evaluate all this as part of  SP+GTG algorithm, and called  “fundamental analysis”  such as revenues, earnings, future growth, return on equity, profit margins, and other data to determine a company's underlying value and potential for future growth.


When a company starts accumulating debt, it means that it can no longer rely on the public equity markets to keep floating overpriced stock (paper).
Debt was not a significant issue for many companies in the marijuana space because the general public has been mesmerized by the noise, misinformation and misdirected enthusiasm by investment bankers and promoters. Now public marijuana companies and their barkers are running out of options to float more paper and forced to enter the debt market in a big and dangerous way.   Investors should be worried if you are holding long term paper.

The five companies that operate in the marijuana industry with the highest total long-term debt levels right now are:
Company                                             Total Long-Term Debt
Constellation Brands (NYSE: STZ)     $13.6 billion
Scotts Miracle-Gro (NYSE: SMG)       $ 2 billion
Aurora Cannabis (NYSE: ACB)           $599 million
Tilray (NASDAQ: TLRY)                    $420.4 million
Aphria (NYSE: APHA)                         $46.7 million


Constellation Brands is by far the biggest debtor. The company is also the newest of the five to enter the cannabis market. In 2017, the alcoholic beverage maker bought a 9.9% stake in Canopy Growth. Constellation increased its ownership interest in Canopy to 38% last year with an additional $4 billion investment.
Scotts Miracle-Gro is in a distant second place on our list. The company has a long history in the consumer lawn and garden products business. But Scotts began taking on more debt several years ago to acquire suppliers to the U.S. cannabis industry.

The next three companies on the list are Canadian marijuana producers.

Aurora Cannabis has the highest debt level of this group adding the company's issuing of $345 million of senior convertible notes in January 2019 on top of its debt of close to $254 million at the end of 2018.
Tilray also has a high debt load thanks to its $450 million convertible notes offering in October 2018.

Aphria's total debt is well behind that of Aurora and Tilray right now. However, Aphria recently announced plans to offer $300 million of senior convertible notes.


More important factors
There's something much more critical when it comes to debt than the amount that a company owes: the ability of the company to repay the debt. Suppose, for example, you owe $100,000, and your friend owes $1 million. If you only make $30,000 per year and your friend makes $2 million per year, your debt load is much more concerning than your friend's because you'll have a more significant challenge paying off your debt.
Constellation made $8.1 billion in revenue last year. Scotts Miracle-Gro generated revenue of $2.7 billion in its latest fiscal year. Based on these figures, neither company's debt appears to be too concerning.

Of course, the earnings for Constellation and Scotts were much lower -- $3.4 billion and $63.7 million, respectively. But both companies still should be able to service their debt. Aurora, Tilray, and Aphria will not. The numbers look scary.  None of the marijuana producers were profitable in their last reported quarter. With continued losses, the companies could have to take on more debt to fund operations or issue more shares, causing dilution in the value of existing shares. Neither is an appealing scenario.

Meanwhile, sales are skyrocketing for all three companies. But "sales" don't mean a thing if the cost of products is higher than the revenue gained. As we reported at least a dozen time, the major players in the cannabis space have a fixed product cost in the $3,100 per pound range while the average commodity price is under $2,000, based on the marijuana cultivation sector' numbers.  Trending are lower prices to probably the $500 range in the long term. It means--  current growing facilities were over-built with expensive dollars. And the main reason why public marijuana companies are in the debt market.

SP+GTM algorithm has cut revenue estimates for Canopy Growth because of concerns that are likely to impact Aurora, Tilray, and Aphria. It's possible that Canada won't launch the cannabis edibles market as soon as many expect. International medical cannabis markets could take longer to ramp up than anticipated. If these scenarios become a reality, it's possible that these Canadian marijuana producers with high debt levels could run into major  problems.


If you're reading our pages and have taken our advice, you are not in the cannabis market on the long side and saved "big money." As for the "shortists," keep your short positions and watch the stocks in the sector work lower.

 

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