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Are Marijuana Stocks Expanding Too Quickly?

The marijuana industry is in its early-growth stages and many companies are staking out positions in various parts of the country — and the world. With the U.S. currently off limits until cannabis is legalized federally, companies like Canopy Growth Corp. (TSX:WEED)(NYSE:CGC) have had to look to other parts of the world for expansion opportunities.

The latest market attracting the attention of cannabis companies is South America, with Canopy Growth recently announcing the acquisition of medical marijuana company Spectrum Cannabis Colombia S.A.S. There could be many more acquisitions on the way, as Aphria Inc. (TSX:APH) has also expressed interest in the region.

As more and more countries opt to legalize marijuana, we’ll start to see more acquisitions, especially as companies look to gain first-mover advantages. This could create significant challenges for companies, however, putting even more strain on their financials.

Why investors should be concerned

Canopy Growth has turned a profit in just one of its last five quarters, and in the trailing 12 months has netted a loss of $70 million on sales of $78 million.

Aphria has fared better, with a profit in four of the last five quarter. In the past year, it has posted a profit of $32 million on $31 million in revenue. However, the company has gotten a boost from other income and non-operational items; when we look at operating income, Aphria has also been in the red in four the past five quarters.

If these companies are already struggling to stay in the black, further expansion will only make that even more difficult. Coordinating operations across many countries around the world is no small thing, especially when you still have to focus on and prepare for legalization in Canada.

While some investors may not be concerned with a profit at this stage, the danger lies in letting that slide over the long term. Without profitability and strong free cash flow, companies will need to raise funds for expansion either through debt or share offerings, neither of which is particularly attractive for investors.

Plenty of challenges ahead

Cannabis companies in Canada already have plenty on their plate, with marijuana sales set to begin in October of this year. In an aggressive market with lots of competition and significant restrictions on what a company can do from an advertising perspective, pot stocks will have their work cut out for them.

Having to worry about operations halfway around the world while dealing with domestic concerns won’t make it easy for companies that may already be spread pretty thin, especially if resources need to be diverted.

Bottom line

Expansion can be great when it makes sense to do so. However, I’m not convinced that it’s the right strategy for cannabis companies when the market in Canada is still a long way away from proving its potential. All this expansion is looking like a race to build potential and expected growth numbers in an effort to help pump up stock prices rather than a prudent strategy investors would expect from an established company.

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Fool contributor David Jagielski has no position in any of the stocks mentioned.

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