Cannabis Investors: Tread Carefully Amidst Budding Legalization Talks in the U.S.
As the United States prepares to federally legalize cannabis (or at least recognize States' efforts to end prohibition) investors should be disciplined and informed when deploying capital.
Since Canada legalized sale sof recreational marijuana last October, publicly traded cannabis companies have enjoyed strong growth.
For example, Canopy Growth’s cannabis sales saw a 282% fiscal 3rd quarter surge in 2018 compared to a year earlier.
Now, the Canada-based Canopy intends to dive headfirst into the US market – pending on the 90-month legalization timeline in the US suggested by GMP analysts.
Yes. You read that right. Federal marijuana legalization has never been this close to becoming a reality in the United States. After decades of prohibition, cannabis has grown into a multi-billion-dollar mainstream industry that will soon receive a stamp of approval from Uncle Sam.
However, there are some challenges to be faced with marijuana as it transitions out of the dark and into the light. Primarily, dropping prices have made it hard for recreational cannabis businesses to maintain healthy margins. And as stock prices continue to soar, many experts are questioning whether the marijuana market is a bubble waiting to burst.
While there’s some cause for concern, investor patience is crucial.
Let’s investigate further.
Canopy’s Interest in the US Market Hints at Pending Legalization
In a deal worth $3.4 billion, Canopy Growth recently confirmed its intention to acquire the U.S. vertically integrated cannabis company Acreage Holdings.
From there, GMP analysts upgraded Canopy Growth stock to “buy”, then assigned to it a $54 per share price target.
Canopy is purchasing the rights to acquire Acreage at a different time. More specifically, Canopy wants to take control of Acreage once the US federal legalization of marijuana sales is in place, and NYSE and Toronto Stock Exchange restrictions are no longer a factor.
The expiry date on this potential purchase will be in April 2027, or 90-months, when the GMP believes "there is a high likelihood that federal legalization occurs."
While there is certainly a risk of cannabis not being federally legalized in that timeframe, where there's smoke there tends to be fire.
The U.S. House of Representatives and the Senate are now privy to the 'Strengthening the Tenth Amendment Through Entrusting States' (STATES) act. This would federally recognize legalization of cannabis in states that have approved recreation sales.
Considering that the Democrats control the House, the passing of the STATE act legislation seems all but certain. From there, the GOP may feel the heat and allow for a vote to be held on the STATES Act in the Senate.
The chances for federal marijuana legalization are higher than ever.
It's also worth noting that Canopy has recently received a license from the state of New York allowing it to develop products that contain CBD.
There's no doubt that Canopy has been busy – and for a good reason. The GMP sees Canopy eventually enjoying a 28% share of the Canadian recreational marijuana market and earning 28% EBITDA margin on its revenue if all goes according to plan.
Investors Need to Keep Cool Heads
Canopy's big moves are undoubtedly great on the surface – but upon digging deeper, it’s clear that investors should proceed with caution.
The future might be promising, but GMP's aggressive pricing of Canopy at 118x sales is hopefully speculative at best and downright irresponsible at worst. While Q3 saw a 282% increase in sales from a year prior, it also reported a more significant loss because of increased expenses. With marijuana now legal to sell in Canada, Canopy has had its funds chewed up by marketing, research, and development.
Furthermore, its selling prices for recreational marijuana dropped 12% from a year ago. Canopy's closest rival, Aurora Cannabis, saw prices for dried cannabis and extracts drop by more than 20%. Compared to medical marijuana, recreational pot is cheaper, in part due to the competitive market.
The U.S. wholesale market is equally vulnerable -- prices for products such as topical creams, vaporizers, vape pens, and pre-rolled joints fell 2.7% in February compared to the same month last year.
That's not meant to act as a deterrent for cannabis investors. Instead, it's a call to be careful and strategic. Yes, the sky is the limit for companies like Canopy – but that doesn't mean it can't come crashing down to the ground.
Investor discipline will prevent the cannabis market from becoming a bubble that bursts akin to the dot-com disaster of 20 years ago. Still, with a company like Canopy Growth partnering with a powerhouse like Corona (and many other cannabis companies following suit with similar deals), it's challenging to quell investor enthusiasm.
Interestingly, AdvisorShares COO Dan Ahrens thinks there's big money in the companies whose stocks haven't shot up due to these major partnerships. Given that Canopy and other cannabis companies have yet to report any profits, perhaps there's some sound logic in Ahrens's musings.
It may also be fruitful to consider companies that sell cannabis derivatives, like Valens Groworks. Cannabis derivatives have much better margins than traditional dried flower which can offset the effects of dropping marijuana prices.
Regardless, exciting times for the cannabis industry – and its disciplined investors – lay ahead.
Would you like to request a demo?
We'd love to show you how Best in Grow will revolutionize how you manage your business.Request demo