If you’re in the market for weed stocks, you probably know the past year hasn’t been pretty, but optimism still runs high in the space as cannabis stocks trade at fractions of their fair value.
Investors looking to take advantage of cannabis stocks on sale should consider the reasons behind the deep discounts because they differ by company and country. There has been the impact of a broader downturn, and there is more beta for cannabis stocks, notes sector director Kristoffer Inton, but he sees companies operating in U.S. and Canadian markets facing different sets of challenges.
Contraband Cannabis Persists in Canada, Affecting Legal Cannabis Companies and Cannabis Stocks
In Canada, Inton thinks there was a presumption that legalization meant all of the customers who had thus far been shopping in the black market would shift over to legal sources. “But that hasn’t happened,” says Inton, adding that he thinks this is much more observable in Canada than in the U.S.
He points to prices and cannabis flowers for the persistence of black-market cannabis up North: “The legal market will always be more expensive because of taxes. And in Canada, since most consumers are still buying cannabis flower, you can’t really convince them to come over [to the legal market].”
In the U.S., the black-market situation is different because the products are more downstream, says Inton. “Flower’s still the biggest market, but I believe that people will buy edibles and vapes and be willing to pay a premium in the legal market for the safety and consistency versus flower,” he says. “Quality and safety are harder to demonstrate in a flower market. We have never had that happen in the legal market (for vapes and edibles) because every single product gets tested before it goes out to the public for consumption.”
Different Cannabis Products have Different Problems
Cannabis stocks have benefited from more customers consuming the product where it is legal in the U.S., and Inton feels that federal-level prohibition is not as big a problem for U.S.-based cannabis companies compared to some other issues.
“There is a theory that the U.S. has attracted more customers that were not consumers when it was illegal,” he says. “There’s still prohibition [at the federal level], but in the background, more markets are opening, and those [markets] that are open are still growing. There’s still a lot of growth left. As far as U.S. companies are concerned, issues such as the companies being unable to access banks, or paying 60% tax are more of a problem than federal prohibition.”
“In Canada, because consumers are so focused on the flower, all the growth has been coming from that value part of the market. There have been price wars among cannabis companies, which is the worst thing you want as an investor in the space.” The price wars have hurt cannabis stocks in Canada.
Add on the risks of a recession and there’s a challenging outlook for Canadian licensed producers (LPs). “If we’re going into a recession, this is the first recession for legal cannabis companies. Historically, products like alcohol and tobacco have proved to have been recession-proof. These products tend to be inelastic in the face of downturns. If anything, when times are rough, people tend to consume more.”
At the moment, investors seem to be considering the worst-case outlook for cannabis stocks. “It’s very pessimistic,” says Inton. “There’s been a huge snap back from even three years ago, where there was too much optimism in the sector, and investors were pricing in crazy growth.” Since then, prices have fallen along with expectations. However, Inton also thinks prices might have fallen too far as cannabis stocks are trading at around a fraction of our fair value estimates:
Top 6 Canadian Cannabis Stocks
Let’s look at these stocks in detail:
1. Cronos Stock
Topping our list of stocks Cronos Group (CRON) may have had the best performance year-to-date, but the company’s relatively small size remains a concern. “Cronos' small size adds difficulty to reaching profitability, as it struggles to leverage overhead expenses,” says Inton, however tobacco-giant Altria (MO)’s investment of $1.8 billion into Cronos provides it with capital and a strategic partner with significant product development, branding, and regulatory experience. And Altria may decide to increase its ownership of Cronos or potentially acquire it.
2. Curaleaf Stock
Inton likes the size of U.S. multi-state operator (MSO) Curaleaf (CURA) by comparison. “They’re positioned to do well,” he says, “they continue to get bigger, they’ve reached EBITDA profitability for a while now, and they’re on their way to free cash flow profitability.” Inton says the same thing about the other U.S. MSO in our coverage universe, Green Thumb Industries (GTII), however, Curaleaf is more aggressive when it comes to growth, entering states flush with competitors.
3. Green Thumb Stock
Green Thumb’s approach to growth is focused on states with large populations and limited licenses, including Illinois, Massachusetts, New York, Florida, and Ohio says Inton. Green Thumb “strategically operates in states with robust medical cannabis markets with momentum around future recreational legalization,” says Inton, “Two of its large markets, Illinois and Massachusetts, have already legalized recreational sales.”
4. Tilray Stock
Coming back to Canada with potential consolidation ahead, Inton reminds investors: “size matters right now.” Tilray (TLRY)’s the biggest, says Inton, and “they’re one of the more healthy Canadians,” he says citing their 13th straight quarter of positive adjusted EBITDA. Meanwhile, the company’s shares have collapsed 30% over the past three months - much worse than the 4% decline in the Morningstar US Market Index. “We now see the discount in Tilray as even more attractive, as we see little reason to warrant such a decline.”
5. Canopy Growth Stock
Tilray’s stock has still fared better than the remaining Canadian cannabis companies we cover, Canopy Growth (WEED) and Aurora Cannabis (ACB). Of the remaining two, Inton, prefers Canopy’s size, especially with Canopy having the money of Constellation Brands (STZ) behind it. Canopy’s growth strategy isn't all-Canadian, however, “Canopy has a standing deal to acquire Acreage Holdings, a U.S. multistate operator, immediately upon federal legalization.” The only problem with that is waiting for legalization: “The longer it takes for federal prohibition in the U.S. takes to be removed, the more difficult it becomes for the Canadians to compete,” says Inton, “Their U.S. competition just grows. It’s like an incubator.”
6. Aurora Cannabis Stock
Already exporting to more than 20 countries, but with sales predominantly in Canada, Aurora Cannabis wraps up the list of year-to-date losses with an “extreme” uncertainty rating. When you get to the size of Aurora, the outlook gets “a lot more questionable,” says Inton. It’s a store for a lot of the Canadian LPs, sadly. “Why buy the stock when it’s really likely they’re going to dilute you again later.” At the same time, that risk of dilution is weighed against estimated growth figures of 23% annually for Aurora’s international business going forward, notes Inton: "We anticipate the high growth from exports to help drive a higher companywide average realized price over time.”
Cannabis on the ‘Hype Cycle’
In considering the outlook for cannabis stocks, Inton refers to the Hype Cycle:
“Whenever you see new things introduced, especially technologies, there’s a period where the product (or sector) overly hyped, being presented as ‘the next best thing.’ After that, it snaps to the opposite end, where it has growth struggles,” says Inton, “And then after that, there’s a period of normalizing.” At that point, it becomes an established industry.
But how long will it take for cannabis industries in Canada and U.S. to blossom? “It's going to take longer than initially thought,” says Inton. “But once people stop paying attention before you know it, the market’s grown much more.”
