The cannabis sector was scorching hot in 2018.
HEXO Corp. (NYSE: HEXO) rocketed from a $93 million stock no one had ever heard of, to a $630 million rock star.
Cronos Group Inc. (Nasdaq: CRON) had a similar story. It was a $134 million junior in 2016 and hit nearly $2 billion in market cap by the end of 2018.
But the market got ahead of itself.
It turns out that creating a retail market out of an illegal substance is harder than it looks.
On March 31, two leading cannabis companies reported their fourth quarters. As my colleague Anthony Planas reported in this Marijuana Market Update, they weren’t great.
Both Cronos Group and Hexo surprised analysts in a bad way.
Analysts expected Cronos to generate $10.7 million in revenue for the quarter … but the company only managed $7.3 million. Cronos also had to amend earlier filings. It cut its first and third-quarter earnings from what they reported.
It’s a bad look. But they weren’t alone.
HEXO lost C$298 million for the quarter. Analysts expected them to only lose C$19.4 million.
Those losses caused a huge backlash. These negative surprises and the bad press sent shares plunging. Cronos shares fell 18%. HEXO’s shares fell 27%.
And their performance dragged down the entire marijuana sector. That’s because these two companies make up 16% of the Horizons Marijuana Life Sciences ETF (TSX: HMMJ). As you can see below, the exchange-traded fund (ETF) recently collapsed to its lowest point since its launch:
The problem is that the Canadian pot rollout is going slower than analysts expected.
The same analysts that cheered its aggressive start are now backing down. As costs mounted and sales stalled, they are singing a different tune today.
Add to that the complications from the coronavirus. Retail shops are struggling. Aurora Cannabis Inc. (NYSE: ACB) and Canopy Growth Corp. (NYSE: CGC) both cut staff to make up for slow business growth.
In addition, Aurora, Canopy, Tilray and Cronos cut production capacity going into 2020.
There are more hurdles for the industry coming in 2020. Analysts are downgrading the big names, no longer listing them as a “buy.”
And it’s clear that the worse news is coming. The lockdown will have a dramatic impact on the first half of 2020. I expect to see the HMMJ ETF to make a new low, before going higher.
As a contrarian, that’s what I want to see. And that’s when I’ll be interested in buying this sector again. Right now, there’s too much optimism across most of the market, particularly in cannabis.
Keep sitting on cash for now. It’ll serve you better later.
Editor, Real Wealth Strategist