An exciting year has led to juicy returns for most Canadian marijuana stocks
David Bar | May 11, 2017 | SmallCapPower: It has been an eventful last year and a bit for the marijuana industry in Canada and specifically for Canadian marijuana stocks. Since Justin Trudeau was elected in the fall of 2015, there has been a surge of optimism and investor interest in the space. With stock prices soaring into the thousands of percent over the past year, I wanted to take some time to review which companies have performed the best and the worst from a stock performance standpoint. The following list (Table 1) is comprised of not just producers and applicants, but also companies that offer marijuana services and other products, however, it is not completely inclusive.
Table 1: Marijuana Industry Stock Performance
Source: Data pulled from Thomson Reuters Eikon
Largest Gainer
When you first look at this table you can see that there are some impressive returns. Considering that this is a large portion of the marijuana-related companies that currently trade on Canadian exchanges, if you simply picked a couple last year, chances are that you are sitting on a nice return.
From this table it is easy to pick out that International Cannabis Corp. (TSXV: ICC) has been the largest winner from a stock performance standpoint. After completing its qualifying transaction last year and commencing trading on the TSXV on November 29, 2016, ICC has positioned itself as the largest licensed producer in South America, being the first recreational marijuana producer to list on the TSXV.
With an MOU signed with Emblem to import CBD products into Canada, 270kg of recreational cannabis currently in stock, and the sale of recreational cannabis in Uruguay commencing in July 2017, I wouldn’t be surprised to see this stock continue its momentum. Even though it might be a little discerning that they have an off-take agreement that only pays them $0.90/ gram, remember that it’s a lower cost geography to operate in, and the off-taker is the Uruguayan government and it’s negotiable after the first year. Additionally, the export agreement should boost revenues and provide larger margins. If everything goes smoothly (i.e hits indoor production targets, executes on its outdoor plans of producing 11,250kg), by this time next year, ICC will be presenting some staggering growth.
Biggest Loser
Although the above list is not comprehensive of all marijuana-related companies, there was only one company that provided a worse return than Gold Leaf Holdings (CSE: GLH). That company was Veritas Pharma Inc. (CSE: VRT), which has posted a 27.1% loss over the past year. However, as they have started to climb back, gaining 38.7% YTD. I chose to leave them off and focus on GLH. I also did this because the Company is a perfect example of how concentration can kill a business, and it also shows you how vulnerable the marijuana sector is in the United States. Although still not a terrible year-over-year loss at 10.6%, the performance of Gold Leaf underpins what so many have been talking about and is, I believe, the reason why you have seen a recent pull back in most marijuana stocks.
One of the biggest concerns with the marijuana industry, like most industries, is regulation. In Oregon, starting in March 2016, the Oregon Health Authority (OHA) announced that unlicensed production of marijuana oils used to make concentrates and edibles is a Class B felony. A Class B felony comes with a maximum prison sentence of 10 years, and a fine of up to $250,000. Needless to say, this effectively shut down the oil extraction industry for approximately eight weeks. Furthermore, on June 1, 2016, the OHA released a list of 59 new pesticides that are required to be tested for and on October 1, 2016, implemented new packaging and labelling restrictions (Figure 1 below).
Figure 1: Example of Packaging and Labelling in Oregon
Source: Oregon health Authority Presentation
As you can imagine, all of this severely hurt Golden Leaf’s revenues, which dropped 22.8%. As the production of oils ceased at the beginning of the year, and the new pesticide testing made it difficult to find clean bud and trim, product was hard to acquire for sale. On a side note, even though this was bad for the short-term operating results of GLH, it means that moving forward, the product will be safer, so it’s a good thing to get out of the way now.
Lessons to be Learned
The biggest take away from all of this is that none of the issues that caused the bad performance were GLH’s fault, as GLH’s management actually reduced operating expenses by 25%. However, it highlights the vulnerability of the industry, especially in the United States. As marijuana is still illegal at the Federal level, the Cannabis industry is very segmented and so a company is confined to the state(s) in which they operate in. If a company operates in only one or two states and the laws are changed, that company will be hurt significantly. This is where Canada does have the advantage, from a risk perspective, as the industry is set to be legal on a national level. Even though Canada’s market is still susceptible to regulation, I think the risk is lower considering the public perception is not as polarized, and we have a majority government to help push it through.
With that in mind, when looking to invest in a marijuana company, look for those with diversified operations. A company with only one production facility, or one brand in a concentration location is inherently riskier than one with multiple. Even if the company has multiple small facilities, the company is probably a safer bet to achieving steady returns compared to a company with one large facility.
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David Bar is an MBA Candidate at the DeGroote School of Business. With an interest in the mining and marijuana industries, he hopes to work in the investment industry focusing in these sectors.
Disclaimer: The author has holdings in some marijuana companies (Aurora Cannabis, Cannabix Technologies, Supreme Pharmaceuticals, Maple Leaf Green World).
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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