Cannabis investors banking on profitability in the second half of the year may have another thing coming: More losses at best, and maybe a surprise stack of writedowns.

Although pot stocks have enjoyed a heady start in 2019 due to global marijuana legalization efforts and the burgeoning use of CBD as a wellness product, backers are starting to judge their investments by profitability instead of hype, and patience is wearing thin. Of the five largest Canadian pot companies, only Cronos Group Inc. is expected to report adjusted net income by the final quarter of the year, according to Bloomberg data.

Instead of profit, writedowns related to unfinished inventory may be in the offing for some Canadian companies. That has some investors voting with their feet, moving out of Canada and into the U.S., where the marijuana companies are generally performing better despite a patchwork of state-by-state regulations.

“It’s symbolic that the Canadian guys have really not been able to deliver on some of their expectations and the American companies have,” said Greg Taylor, chief investment officer at Purpose Investments Inc. and manager of the Purpose Marijuana Opportunities Fund.

Until recently cannabis companies could get away with losing large sums of money as long as they said the right things about their future growth prospects. But the abrupt firing last week of Bruce Linton, co-chief executive officer of Canopy Growth Corp., indicates that things have changed.

Canopy Chief

Linton’s departure came after the company lost $323 million in the quarter ended March 31, prompting frustration at alcohol giant Constellation Brands Inc., which owns about 36 per cent of Canopy and holds a majority of its board seats. Constellation CEO Bill Newlands said publicly he was “not pleased” with the results.

“Now investors are starting to judge the companies a little differently,” said Charles Taerk, CEO of Faircourt Asset Management, which runs the cannabis-focused Ninepoint Alternative Health Fund. “They’re starting to say, ‘Wait a second, how are they profitable and you’re so far from profitable?’”

A few standouts like Organigram Holdings Inc. have proven that it’s possible to achieve positive earnings before interest, taxes, depreciation and amortization as the one-year anniversary of legal recreational use in Canada approaches. Aurora Cannabis Inc. also recently reaffirmed its expectation of positive Ebitda in the second quarter of calendar 2019.

Still, those that have achieved positive Ebitda aren’t being rewarded yet. Organigram trades at a price-to-sales ratio of 25, well below Canopy at 65 and Cronos at 197. Overall, cannabis stocks have outperformed so far this year, with the ETFMG Alternative Harvest ETF adding 24 per cent, and its Canadian counterpart, the Horizons Marijuana Life Sciences Index ETF, rising 23 per cent.

Writedown Worries

There’s also the fear of writedowns related to inventory not ready for sale, which could be of low quality and ultimately not usable for either the dried flower or extraction market, said BMO analyst Tamy Chen.

Some companies -- including Canopy, Aurora and Aphria Inc. -- also carry high levels of goodwill due to their “aggressive pace of acquisitions at prices above book value,” increasing the likelihood of a writedown, said Bloomberg Intelligence analyst Kenneth Shea.

This year could also see a rise in the amount of litigation related to “loose corporate governance” at pot companies, said Morgan Paxhia, co-founder of cannabis hedge fund Poseidon Asset Management LLC. CannTrust Holdings Inc. is the subject of several class-action lawsuits after it was found by Canadian regulators to have grown marijuana in unlicensed spaces. Its stock has lost 39 per cent since Monday’s open.

It’s not all bad news. The second half of the year will involve a few catalysts for Canadian pot companies, including the addition of up to 50 more stores in Ontario and the legalization of edibles and vapes. However, analysts say the impact of these changes won’t be felt in a meaningful way until 2020.

That’s one of the reasons Taylor of Purpose Investments is making a play outside of Canada. He’s been buying U.S.-focused pot stocks like Harvest Health & Recreation Inc. and Curaleaf Holdings Inc.

“We’ve moved our portfolio more to the U.S.,” he said. “They’ve been coming at it more as operators and they’re putting up much better numbers."

Cannabis Canada is BNN Bloomberg’s in-depth series exploring the stunning formation of the entirely new – and controversial – Canadian recreational marijuana industry. Read more from the special series here and subscribe to our Cannabis Canada newsletter to have the latest marijuana news delivered directly to your inbox every day.