Canadian Marijuana Stocks: Are They Becoming Too Risky?

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Share values of many Canadian marijuana stocks, including Canopy Growth (TSE:WEED), Aurora Cannabis (CVE:ACB), and Aphria (TSE:APH) have become detached from the fundamentals

Canadian Business | April 18, 2017: It doesn’t take much to move the dial—up or down—on cannabis stocks. The last five months alone have been a roller coaster for Canadian medical marijuana producers and Canadian marijuana stocks on various stock exchanges, whose investors tend to flinch at the faintest whiff of news that’s just off-neutral in tone.

The latest trigger for investors was a recent CBC report that the Liberal government would stick to its plan to table legislation for recreational marijuana production, distribution and use this spring, and have laws in effect by July 1, 2018.

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This information wasn’t actually new; it reinforces the general timeline the government had already talked about. Still, it sent stocks soaring. Canopy Growth Corporation (TSX: WEED), Aurora Cannabis Inc. (TSXV: ACB), and Aphria Inc. (TSX: APH) for example, all shot up about 10%.

Canadian cannabis stocks have been extremely volatile since Canada began its long journey to legalization, but their general trajectory has been upward—a trend that Scott Clayton, a senior researcher at TSI Wealth Network, says is driven by speculation. He thinks it’s a risky sector to buy into.

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“The prices have really become detached from the fundamentals like sales and cash flow,” says Mr. Clayton, who suggests that the market is caught in a cycle of news driving stock prices and stocks fueling news. Take Canopy, for example, the highest-valued Canadian cannabis company and one whose shares move in lockstep with the headlines. The Company has a market cap of $1.77 billion, but its year-over-year gross profits reported in its recent annual financial statement amounted to $20 million in losses.

“The speculative appeal—and why stocks have soared so high—is that investors are looking for a ground-floor opportunity,” says Mr. Clayton. “But the pioneers in industries aren’t always the ones that survive. And there’s a pretty good chance that many of these won’t.”

Mr. Clayton sees the possibility of large tobacco companies moving into the space, pushing out the small startups that currently comprise the industry. It’s possible that some tobacco behemoths would buy up existing cannabis companies, but Mr. Clayton notes that “the chance of a takeover is never really a good reason to buy a stock.”

Another threat to the nascent market is the potential of a post-legalization glut of companies, which could drive down share prices. “Once they’re being judged on their actual fundamentals, they can plunge as fast as they moved up,” says Mr. Clayton.

Read more at canadianbusiness.com

[Editor’s Note: At a recent panel discussion, one of the participants suggested that Canada is expected to be the first G7 country to recreational-ize cannabis consumption and will be the gold standard for compliance. Canadian companies will be the first movers and then spreading to other jurisdictions as they come online. As the market continues to expand there’s incremental cash flow that goes to each of the producers. There’s a first mover advantage for any producer that already has a license in Canada and it’s not just domestic but global. There’s a big gap between demand and supply, which is expected to continue for a number of years. Future demand will come from countries such as Germany, with its population of about 81 million, which will likely see insurance re-imbursement for cannabis. Estimates are for about five to 10 years before supply catches up to demand in the legal market. As new jurisdictions come online, they will likely look to Canada for its experience. Right now there’s just one international producer outside of Canada that is able to ship internationally to countries such as Germany or Australia, and the rest are all in Canada.

Disclosure: Neither any of the principals at Small Cap Power, nor their family members, own shares in any of the companies mentioned above.

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