Investing in Cannabis? Don't 'Write Off' This Item

Cannabis-deal tracking company Viridian Capital Advisors believes that more publicly traded cannabis companies will be taking big write-offs. Often for cannabis companies these include dropping the value on inventory or destroying the inventory altogether. It can even include unpaid accounts receivables or loans.

The largest write-offs by cannabis companies are as follows:

Aurora Cannabis (ACB) : $1.8 billion, per fiscal fourth quarter

Canopy Growth (CGC) : $545 million, per fiscal fourth quarter

TILT Holdings  (TLLTF) : $500 million, per 2018 annual report

Tilray (TLRY) : $112 million, per the 2019 annual report

Aurora wins the prize, as it recently warned investors that there would be a number of balance sheet adjustments to recognize market realities that would range between $1.6 billion and $1.8 billion. The stock fell to a four-year low on the news.

“These adjustments include previously announced fixed asset impairment charges, now expected to be up to $90 million, due to production facility rationalization, and a charge of approximately $140 million in the carrying value of certain inventory, predominantly trim, in order to align inventory on hand with near term expectations for demand,” the company wrote, noting that almost 40% of the inventory is going through a fair-value adjustment.

Canopy Growth said it was going to take a pre-tax charge during its fourth-quarter earnings after it announced that it was laying off 500 employees and closing two facilities. The company also reported inventory write-downs in the amount of $132 million. About $76 million was related to old, obsolete, or unsaleable cannabis inventories and packaging within Canada. In the company’s filings, it noted that inventory write-downs in the second quarter of fiscal 2020 totaled $29 million and were related to excess, finished recreational cannabis inventory and trim inventory. The company estimated that “on-hand provincial and territorial inventory levels compared to forecasted ‘sell-in’ rates of certain oils and softgel products led to the conclusion that a portion of this inventory may not be sold within a reasonable timeframe.”

The stock tumbled on the news.

Who’s Next?

The announcement by Aurora caused Viridian to wonder if there were more companies ahead, so it decided to look at companies with a high percentage of intangibles and low market-to-book ratios as likely candidates for write-offs. Intangibles are described as things like licenses and goodwill. Companies who have booked a lot of intangibles over the years have a higher potential to write them down. This led Viridian analyst Frank Colombo check out the companies who may have made a lot of acquisitions and built up a lot of goodwill. He also looked at the market to book ratio, which is a calculation to determine a company’s value.

“Not all your assets are worth what you have them priced at,” said Colombo.

Viridian, though, realized that no one had calculated the high intangibles and low market to book. Once that was created, he divided and then started to screen through the Viridian universe. The deal tracker database has over 300 companies and is divided into 12 sectors. The No. 1 on the list was Aurora, which had already said it was writing off a huge amount.

Colombo then asked, “How can we get an even better indication?”

His answer was to look at poor profitability. A low market-to-book indicated that there may be assets that aren’t earning a reasonable return and the market isn’t judging them favorably. That would make them ideal candidates to mark down.

High on ratio and below market profitability, which is below the yellow line on the chart, highlighted the companies with potential write down assets. Colombo was quick to point out this doesn’t indicate he has any inside information or is forecasting these companies could write down assets. He just wanted to see which names would pop up.

“No one, though, would be surprised if MedMen  (MMNFF) did write down some assets,” he said. He also noted that the chart equally highlights companies that are in a much more positive position.

Since companies typically experience stock selloffs when they do write down assets it is certainly good information to consider when make investment decisions.