VIDEO: Analyst Dmitry Zaytsev Discusses Investment Strategies in an Uncertain Cannabis Market
Analyst Dmitry Zaytsev shares his thoughts on the recent economic downturn. Specifically, he addresses the current slide in the cannabis space and suggests investors aligned themselves with the growing opportunities in the US cannabis space. Zaytsev believes Organigram Holdings Inc (CVE:OGI) (OTCMKTS:OGRMF) (FRA:0OG) is a bargain at its current price and is personally interested in HEXO Corp (TSE:HEXO) (OTCMKTS:HYYDF) (FRA:74H) and CannTrust Holdings Inc (TSE:TRST) (OTCMKTS:CNTTF) (FRA:C9S) because both have potentially lucrative partnership deals. He believes the next industry catalyst will be when Canadian recreational sales numbers are released in a few months. Zaytsev also explains investing strategies and indicates the current market would be a good time to write puts and calls.
James West: Hey, welcome back! My guest in this segment is actually not technically a guest anymore; he’s kind of part of the home team, Dmitry Zaytsev is our in-house resident analyst and Chief – I’m going to call you a Millennial, I hope you don’t mind. He’s our Millennial in Chief, and today Dmitry is going to walk us through some of the thinking that he employs in construction of investment strategies, which have been uniformly successful; I can say that will full conviction because I’ve been following what he’s been saying to me, and it turns out that he’s right more often than he’s wrong – one of the critical elements of success in any investment program.
So Dmitry, welcome back.
Dmitry Zaytsev: Glad to be here.
James West: So let’s start with your first slide. You’ve got technical here on weed.
Dmitry Zaytsev: Yeah, so this is just something, this is just from my brokerage, I pulled it up. So I remember we were discussing back when Canopy was up here, not sure if we can get the mouse up here or not, but it’s okay – we were talking about how there’s a couple of supports in terms of the 200-day moving average. And so that’s sort of where we landed. Remember that little bet that we had in terms of 100 versus 40? I mean, it didn’t quite hit 40 –
James West: I wondered if you were going to run that in. so you haven’t won yet, and I haven’t lost yet, but it came close.
Dmitry Zaytsev: But it came close, and I mean for me, that’s good enough, at this point. But look, let’s really discuss big picture what happened. There was a lot of excitement from this Constellation deal; a lot of people bought in, you know, with this run-up, and a lot of them now are holding positions that are underwater. And so this big downdraft with a seldom news event like we discussed on our last program, there was also a lot of negative news that came out at the same time.
James West: Right.
Dmitry Zaytsev: So you had Sheer, the Conservative leader, talk about maybe rolling back or regulating a lot of cannabis-related things there…
James West: Now your mouse should show up, there. Let’s see if that works.
Dmitry Zaytsev: Wonderful. Yeah, headline risk, the OCS was not really efficient with their rollout.
James West: I still don’t have my marijuana.
Dmitry Zaytsev: Wow. What order number were you?
James West: I was actually order number 36,000 and some odd, I think it was.
Dmitry Zaytsev: Got it, got it.
James West: And I ordered –
Dmitry Zaytsev: That’s like the morning of, or overnight, right?
James West: It was midday. So I ordered two different packages of pre-rolls, which were supposedly coming from aurora, and then one jar of the super premium Edison brand from Organigram, which also hasn’t arrived – and I haven’t had any conversation with them. So I wonder how this is going to impact the balance sheets of these companies, going forward.
Dmitry Zaytsev: Yeah, I mean, the income statement, the revenue, is going to be really important, and for me a big surprise was that there’s a private producer called Redecan, I was not even all that familiar with them, but guys like that are going to take market share from these big LPs.
In BC, you only have one store, and I’ve heard, you know, from people that live there, they’re all going to the black market. So, you know, revenues may be really impacted, and I think that’s what you’re kind of seeing here.
Another thing, just before we continue talking about the cannabis stocks, we have to talk about the global macroeconomic backdrop. So this is just a chart of Fed funds rate. So the market, the climb that we’ve been having since around October 3rd, it was all triggered by this.
James West: Okay.
Dmitry Zaytsev: So, something we have to understand is the cannabis companies, they’re extremely high-growth; a lot of their revenue, a lot of their cash flows, are way in the future; it’s a big opportunity. But the problem is, as rates rise, your discount rate on your investment rises as well. And so the market had an expectation that the Fed would probably stop around 2.5 to 3 percent. Right now they’re at 2 percent, the Fed funds rate. And so Jerome Powell, the current guy that decides this, came out with a quote where he said ‘interest rates are still accommodative, but we’re gradually moving to a place where they’ll be neutral’. We may go past neutral, he said; so, we may go higher than 3 percent. And so –
James West: We may go inflationary.
Dmitry Zaytsev: Well, the problem is, there’s not that much inflation going right now. And so this would actually be a very restrictive instead of accommodative. And so what that means is, this is the tenure, and on the right you have a chart here where he made that announcement, and that spooked markets, because we just have this kind of move in fixed income is very significant.
James West: Actually, I’m just going to point out to you, just for your own sake, that the cursor that you see here is not the cursor that you see up there.
Dmitry Zaytsev: Got it, got it.
James West: And so it’s actually not good to use the cursor –
Dmitry Zaytsev: I’m watching up here. But anyway, so where you see the blue arrow right there, it’s a shorter data chart – it’s like a one-month chart. And so you see that big run-up there in the yield. And so this is just people in the market saying Oh wow, he might actually do it. Because expectation-wise, he wouldn’t.
And so what that meant for high-flying, growth, technology, weed stocks is pretty negative. But it didn’t really catch up to, you know, the weed space, until after October 17th. So going back here, this is why we saw such a big sell the news event, and why I was even surprised at how quickly we dumped.
As you know, I had a bunch of puts that I’ve been building up, you know; I added many more right before legalization, and I covered probably where you see this purple line. So right as it got there to that purple line, which is the 100-day moving average, I covered them, because I said Wow, this is a big move; we might actually bounce back up, but because the markets were in such doldrums, it actually just flatlined, and then you had another big selloff after where you had moves of 15 to 20 percent on a lot of these names. And that was really damaging to investor confidence, I think, longer term.
James West: Sure. But do you think the bounce back is – you know, we’re looking at it, and it seems to be resolving towards the upside, or is it still a little bit soft for you?
Dmitry Zaytsev: I think it’s soft, and I think today, I mean, this chart is up to this morning, right? So today we had US equity markets kind of roll over today. I know you’ve been very busy today, but on the back of apple earnings, and so you might have a re-test where it actually tests that 200-day moving average again, potentially. Who knows.
But at the same time, everyone’s been also waiting for a bounce, right? Like, I got in, in a bunch of positions; other traders got in on a bunch of positions for Canopy and others, and they’re sort of waiting to unload. They’re waiting for that big bounce. And if you look historically, I mean, you’ve had much bigger bounces previously when it came to huge selloffs. So id you looked at January, February 2018, you had one-day selloff, huge rebound. Later on, you know, two, three days of selloff, you almost got that full move coming back.
James West: Right.
Dmitry Zaytsev: So, you’re not seeing the same thing, which is very worrying, I think. And for a lot of people that bought way up there at the tops, and as the excitement kind of dies down and reality sets in, that might cause a bit of consolidation. So –
James West: So you’re saying you might yet collect on your $40 weed bet?
Dmitry Zaytsev: Yeah. I don’t know what we’re betting, but I guess I might.
James West: Just a gentleman’s bet! Okay, interesting. So what’s the play, here? How do you deploy capital and protect it at the same time, in such an uncertain market?
Dmitry Zaytsev: Yeah, so I think I covered my puts, so made good money there, but right now the option premium is very high. The implied volatility is very high, so in most cases, unless you’re very certain about a direction, I wouldn’t play options; I would just have very tight stops. So, have a game plan for your trades. You buy something, if it doesn’t go your way, you cut your loss ASAP, because as we know, things can sink a lot faster than we expect.
But generally, I think the next move we have now is towards the US. So you know, I’m looking at names like Charlotte’s Web, iAnthus, Green Thumbs and other guys, and I’m sure many investors are too, because there, you’ll have a state legalizing recreationally every six to twelve months, and that’s interesting. That builds excitement. You have Michigan voting on November 6th, I believe, for recreational cannabis there; no one’s really positioned there, but new markets are opening up in a very large market, that is the US.
And I think something else that starts happening now is, a lot of these names start trading on valuations more so. Or, at the very least, you start seeing divergence in terms of certain names. So I put together a really rough, you know, little comparables table; it’s very simple. You know, I quickly went on SEDAR before my shower after my workout this morning and pulled the fully diluted numbers, kind of made some estimates for Canopy with their Constellation deal, but this is what I came up with: So in essence, I have a market cap just based on the closing prices, I have current capacity; obviously for Canopy, they don’t report, so I just eyeballed it. And according to, you know, SEDAR, their most current MD&As, this is the current capacity for all these producers.
James West: So this is all in thousands, I guess?
Dmitry Zaytsev: Yeah, so thousands. So obviously, no units here. But the current capacity in thousands, and then capacity in 2019. And so if you look at it, if you multiply that their capacity by 2019 by $5, just an up there sort of number, these are the revenues you get. And so if you take their enterprise value, which in Canopy’s case I subtracted 10 billion from their enterprise value, and divided by sales, that’s the multiple you get. So the higher the multiple, the more richly valued a company is; the lower the multiple, the more conservatively valued it is. So what you see is, Canopy is at five; Aphria’s a little lower, it’s at 3.1, Aurora is at 12.4, HEXO is at 2.1, CannTrust is at 1.8, and Organigram is 1.4.
James West: So by this metric, the bargain is obviously Organigram, and the dramatically overvalued stock, most overvalued in this universe, is Aurora.
Dmitry Zaytsev: Right. And the question, the kind of the pushback against what I’m saying now is, you know, aurora has a bunch of capacity they’re going to have in 2020, and Aurora Sun, and etcetera, etcetera,. I don’t think it’s actually going to be needed. I think there’s going to be way more capacity just in the se six names, to be honest with you, with black market, with home grow, with private enterprises that are also doing this, o r the ones that aren’t listed, the other 100-soething LPs, it won’t actually be needed. So that’s my view, at least.
And at the same time, a multiple, we’re just comparing, you know, very rough numbers here. So maybe some of these guys can have better EBITDA margins, for example. Maybe Organigram, because they have their indoor, you know, multi-story thing, production, they’ll be able to get higher EBITDA margins because they have a lower cost, for example.
HEXO, they have a Molson deal, so maybe that’s worth something, right? Because they’ll actually have a partner to develop their beverages. CannTrust has Apotex. Canopy has $10 billion to deploy, and they have Constellation Brands. Like, Constellation Brands is really married to Canopy.
So you have to sort of pick and choose, and that’s why I’m not too bearish on Canopy, because even though their valuation is second-highest, right, their multiple is second-highest, they have these partnerships and capital which is very valuable. They’ll never need to do another raise. For a lot of these other guys, we’ll see.
James West: They might run out of money.
Dmitry Zaytsev: They might run out of money, yeah.
James West: Very interesting. Okay, so what’s your – I mean, so if I was to look at this, I would say, okay, so you must be really highly interested in Organigram and CannTrust.
Dmitry Zaytsev: Yeah, so my names, personally I’m more interested in HEXO and CannTrust, and I like Organigram, don’t get me wrong. I’ve held them before, they’re a great company. I just like the partnership possibilities with Apotex and Molson. But that’s just me. But I still think it’s a great company, not to knock it or anything like that.
But at the same time, I’m also, I’m looking towards the US, like I mentioned. So these would be less than half of my position, and the majority would be looking into the US. And so, what are we looking at? The next catalyst we’re going to have is, you have quarterly earnings next month, and then three months from now you’re actually going to get to see rec numbers for a lot of revenues for these companies. And if you loo, the reason why I put the current capacity up, because I think that’s going to make a difference.
So for example, you know, CannTrust having 50,000 kilos, that’s going to make a difference, versus Aphria, who had 34 or so.
James West: Right, right, interesting. Well, so then, it’s really still a case of wait and see; align yourself with the growing US opportunity, and align yourself with the ones that are trading at least a discount relative to their peers, and –
Dmitry Zaytsev: Yeah, we see what happens there, for sure. And on the options front, I mean, I’ve been writing lots of puts and calls, as well. So this is why I have this chart here. So this is just Canopy, and just because it’s been the most liquid stock, it’s best for this illustration, but you have something called an option-implied volatility. So that’s the 4blue line you see there.
So in simple terms, the higher that line is, the more expensive 4the options are, and the lower it is, the cheaper they are. So as an option buyer, you’re disadvantaged; you’re really hoping for a really big move if you’re buying at the tops of these levels. so that’s why I’m a seller right now, because implied volatility is a lot higher. I think you’re not going to have as many big swings anymore; even to the downside, I don’t think there’s going to be as many big swings. Maybe I’m wrong, who knows; deals could change that, who knows, right? But I think they’re going on now, you’re going to have much smaller moves day to day, so that’s going to compress the volatility, and that’s going to make those options worth a lot less.
I’ll give you an example. I was able to write a Canopy put for a $30 strike, and I got it for February, and I got paid $2 for it. So what does that mean? I’m willing to buy Canopy at $30, and I’m forced to buy no matter what, and for that, you know, contract, me being forced to buy it, I’m receiving $2 a premium.
So the math on that kind of works; okay, if I have to put up, if, you know, if I write ten contracts, it’s 1,000 shares, I get $2 a share, that’s, you know, that’s $2,000, right? If I do that and my margin is only about $10,000, right, let’s say, for this trade, that’s a 20 percent return in four months, if it never hits 30.
If it hits 30, I’m okay with buying it, because they have $10 billion of cash, and as we saw earlier, on their, you know, this very rough numbers will be updated, you know, their enterprise value is all cash, pretty
James West: So then if you end up being forced to buy it, you’re basically buying it as a value investment.
Dmitry Zaytsev: Yeah, pretty much. Because I’m getting the business for $10, or actually $8, because I got $2 a premium. And do I think Canopy is worth $8? Yeah. Between the 20 and the 30, yeah, I think so.
James West: Wow. All right. Let’s leave it there again, Dmitry. That was very enlightening and confusing for me, as well.
Dmitry Zaytsev: I hope not. I’m trying to –
James West: It’s very simple, but I have a very unmathematical brain – multiplication and subtraction are my strongest and weakest suits. So we’ll leave it there for now; we’ll come back to you, hope to have you back again next weekend. Thanks for the participation.
Dmitry Zaytsev: Always happy to be here, James.
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