This Is a Huge Red Flag for the Cannabis Industry

Cannabis companies used to be focused solely on growth at all costs. But that's not the case anymore. Investors are growing weary of businesses that aren't generating profits, and that's putting pressure on them to be more financially responsible. Marijuana companies are normally chomping at the bit to jump into new markets that have recently legalized cannabis use, but that trend could be changing.

There have been recent developments involving marijuana businesses slashing costs and laying off staff, but what really got my attention was when a top cannabis company dropped a bombshell: that it would be exiting not one but three states.

Curaleaf to close up the majority of its operations in California, Colorado, and Oregon

On Jan. 26, multi-state marijuana operator Curaleaf Holdings (OTC: CURLF) announced that it will be shutting down most of its operations (production and cultivation) in three top markets: California, Colorado, and Oregon. The company says that the move is "part of its continued effort to streamline its business." It also said that it would consolidate its operations in Massachusetts.

It's not hard to see why Curaleaf may be motivated to trim its expenses given the business hasn't been growing much lately, and its bottom line remains firmly in the red:

© YCharts CURLF Revenue (Quarterly YoY Growth)

The company mentioned "price compression and lack of enforcement of the illicit market" as some of the main reasons for its decision to exit its production and cultivation facilities in these states.

Why this is significant

Curaleaf has been a growth machine over the years, and over the trailing 12 months, it has generated $1.3 billion in revenue. It's a leading company in the industry, and so if it's pulling out of some of the top markets, investors shouldn't be ignoring these developments. The business reported that it had 142 dispensaries across 22 states back in November when it released its third-quarter earnings, which is one of the largest footprints in the industry.

What was most surprising about the announcement was that Curaleaf said that the markets it was leaving generated less than $50 million in revenue for the company in 2022. That's an awfully small number given that California and Colorado are among the largest marijuana markets in the country. It underscores the competition and the challenges that companies face in those areas, and it's a reminder that just because a marijuana specialist is entering a new market, it doesn't mean that it will have a positive impact on both sales and profits.

Curaleaf says the moves will help it achieve positive free cash flow of at least $125 million this year. That's a big goal given that the company doesn't even consistently generate positive operating cash flow, let alone free cash flow, which incorporates operating cash and deducts capital expenditures.

Should investors steer clear of cannabis stocks?

Although growth investors see significant potential in the cannabis industry in the long run, many are banking on the likelihood that federal marijuana legalization will happen soon in the U.S., and that can be a dangerous assumption to make. And due to the uncertainty that's still ahead for the industry, for many folks, it may still be too early to invest in cannabis. 

Cannabis companies like Curaleaf are only starting to pay attention to cash flow and having sustainable operations. In the long run, that will make them more tenable investments and better buys. But right now, it's shaping up to be a bumpy ride for cannabis stocks. Unless you have a high risk tolerance, you're better off avoiding marijuana stocks, because this remains a treacherous industry to invest in.

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David Jagielski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.