U.S. cannabis stocks closed higher today, buoyed by excitement over the all-stock transaction between Ianthus Capital Holdings and MPX Bioceutical Corp. But while merger & acquisition activity generally delivers such boosting effects, a bigger question is starting to emerge: are investors beginning to overweight U.S. cannabis equities and underweight their Canadian peers? It’s early still, but the post-legalization price action paints a convincing picture.
Getting right into the charts, it’s abundantly obviously that capital flows have been favoring U.S. operators since the open on October 17th. While both U.S. and Canadian cannabis stocks were equally affected by a nasty gap-up reversal at the open, the former has recovered more vigorously than the latter:
As indicated, today’s IAN/MPX transaction undoubtedly gave American cannabis stocks a boost, but is there more to the story? I believe there could be, owing to better aggregate valuations and early-stage catalysts south of the border.
Regarding the latter, Alan Brochstein is perhaps the preeminent SME on the valuation dichotomy between both equity classes. In a piece titled American Cannabis Stocks Offer Compelling Relative Value, Brochstein lays out a detailed case why U.S. cannabis stocks are undervalued, even accounting for inherent risk factors federal cannabis illegality entails. While the article was published in May, Brochstein has been expounding on this narrative ever since. He might be onto something.
The founder of 420investor.com, Alan Brochstein, is back on Midas Letter LIVE to provide his commentary on the future direction of North American cannabis companies
While American cannabis stocks have kept pace since his article was published on May 28th, 2018 (Horizons Marijuana Life Sciences Index ETF (HMMJ): ↑35.92%,United States Marijuana Index [USMI]:↑43.50%), the valuation gap has remained persistently wide. Of that 7.58% difference between benchmark indexes, 4.40% of that amount has transpired over the past two days. Coincidence? Perhaps not.
With Canadian legalization a reality, it appears the U.S. has more potential catalysts in its golf bag. Yes, tier-1 Canadian LPs have potential cannabev partnerships to look forward to—perhaps some domestic M&A as well. But with chatter of possible spring 2019 cannabis reform coming to America, why would multinational beverage and tobacco companies jump into a deal now? Corporate taxes, power costs, supply chain—everything will be cheaper to operate and produce down south. It makes perfect sense that multinationals might sit on their hands and gauge how U.S. legislative winds are blowing come winter.
Irrespective of the cannabev deal pipeline, the U.S. cannabis sector mirrors the Canadian market’s early genesis in many respects. There’s still impending cannabis legislation to look forward to, subsequent ratification by Congress/POTUS, and a future date where federal legalization becomes law. Canada has experienced all those things already, meaning Canadian LPs will now be judged more on income statements than promises of what could be. Investors tend to bid up the dream, not the stark post-dream reality.
That isn’t to say Canadian cannabis stocks won’t go higher or experience stretches of relative out-performance. It just means that latent potential for price appreciation may be tilted, on aggregate, towards American weedstocks.
While much more data is needed in order to corroborate any possible U.S.-Canada paradigm shift, the timing and strength of U.S./Canadian weedstocks divergence is awfully coincidental. This is understandable, given that latent valuation-boosting catalysts are stacked in U.S. operators’ favor in a post-legalization world. We cannot definitive draw conclusion yet, but it sure feels that way. There’s simply more space for iAnthus or Green Thumb Industries or Liberty Health Sciences to grow, should the dominoes fall into place. If America unlocks, they will already be established in the world’s biggest cannabis market, bar none.
Keep in mind however, that Canadian LP access to major U.S. exchanges is a major catalyst working in its favor. Most funds simply cannot stake positions of companies trading on the OTC or CSE, irrespective of circumstances. Until that changes, fund buying will continue flowing towards Canopy Growth, Cronos Group and others. Aurora Cannabis and Aphria will be entering the fray shortly, as well.
It will be interesting to see how the relative performance between HMMJ and USMI plays out in the coming weeks. Is the two day post-legalization valuation dichotomy a temporary blip, or a prelude to something bigger? I cannot answer that question, but if the rumors of impending spring cannabis reform are true, I suspect being overweight U.S. equities is the right side of the trade.
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