The US is seeing a surge in cannabis legalization, with 39 states allowing medical use and 21 states permitting recreational use. Despite this, the cannabis industry has been grappling with economic and industry challenges, such as oversupply and inflation, which have created a tough environment for the industry in 2022 and beyond. As such, it has created some cannabis stocks to avoid.
Oversupply issues triggered a sharp fall in wholesale and retail cannabis prices in the US and Canada last year. This led to a saturated market, causing a steep drop in adult-use cannabis prices in Massachusetts and other states. In 2022, Canadian wholesale prices also fell by more than 40%.
Moreover, in November 2022, Canada saw a 4.3% decrease in adult-use sales of recreational cannabis products. This was the second monthly decline in a row.
Given these circumstances, it’s wise to avoid investing in fundamentally weak cannabis stocks. Here are three such stocks that I’m steering clear of at the moment.
Sundial Growers (SNDL)
Sundial Growers, (NASDAQ:SNDL), a Canadian cannabis company, has often been seen as a meme stock in past rallies. Some view this cannabis stock as undervalued, trading below its tangible book value. However, those who bought the stock due to its low valuation have been disappointed. The company’s business strategy hasn’t produced profitability, leading to a steady drop in share price. This makes it one of those cannabis stocks to avoid.
SNDL’s stock price plummeted from $20 to less than $2. The cannabis industry faced a setback when the expected U.S. federal decriminalization of marijuana didn’t happen, despite a favorable political climate.
SNDL’s stock has fallen significantly from its peak and might seem to have hit rock bottom. Yet, the trend of the stock getting cheaper could persist. A short-term rally might occur due to positive earnings reports, but small improvements by management may not ensure long-term stability.
Tilray Brands (TLRY)
Tilray Brands (NASDAQ:TLRY) has experienced a significant correction this year, with its stock dropping around 37% year-to-date in 2023. The recent decline can be attributed to the company’s $150 million convertible note offering. However, I believe that the stock is oversold and poised for a reversal rally. Positive news regarding the marijuana banking bill could trigger a strong upward movement.
In the latest earnings report, Tilray Brands was disappointed with a 4% YoY decline in revenues, reaching $145.59 million, below the analysts’ expected $151.02 million. The company also reported a significant net loss of $1.19 billion, in stark contrast to the previous year’s profit of $52.47 million. Moreover, its cash and cash equivalents have plummeted to $164.99 million from $415 million in just nine months.
Despite Tilray’s expansion efforts through acquisitions, including Montauk Brewing Company and Hexo Corporation, the company lacks a solid foundation to sustain these growth initiatives.
Innovative Industrial Properties REIT (IIPR)
Innovative Industrial Properties (NYSE:IIPR) is a successful real estate investment trust (REIT) that addresses the market demand for cannabis cultivation facilities. With the federal ban on marijuana restricting access to traditional banking, IIPR provides financing for greenhouse construction, filling a gap left by banks.
Innovative Industrial Properties initially thrived by raising funds, constructing greenhouses, and leasing them to cannabis growers. However, the current situation has changed, as the cannabis industry is facing financial challenges, leading to delayed rent payments from tenants. This impacts IIPR’s cash flows and raises concerns about its dividend sustainability. Finding a solution is difficult, as repurposing the greenhouses or reducing rent significantly may be the only options available.
Currently, Innovative Industrial Properties has a limited cash reserve of approximately $37.6 million. As it continues its business model of acquiring marijuana properties, it will require additional debt financing. However, due to recent interest rate hikes by the Federal Reserve, borrowing will be more expensive for IIP in the future. This increased cost will impact shareholder returns and reinvestment for growth, potentially leading to a slower expansion rate. Despite the possibility of continued growth and rising dividends, this situation is viewed as bearish for the stock.
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.