Horizons ETFs Management (TSE:HMMJ) on Recreational Cannabis Revenue Trajectory
Horizons ETFs Management (TSE:HMMJ) (OTCMKTS:HMLSF) SVP Mark Noble likes the trajectory of recent financial reporting in the Canadian cannabis space. Noble believes earnings are moving in the right direction because the reporting shows investors that adult use cannabis sales are real and that companies are meeting targets. Which is great news for holders of Horizons Marijuana Life Sciences Index ETF (TSE:HMMJ). Noble credits OrganiGram Holdings Inc (CVE:OGI) (OTCMKTS:OGRMF) (FRA:0OG) with initiating the current run for cannabis stocks. OrganiGram was the first to report calendar Q4 2018 revenue and the company “knocked it out of the park.” He suggests Canopy Growth Corp’s (TSE:WEED) (NYSE:CGC) (FRA:11L1) recent deal with retailer Alimentation Couche-Tard Inc (TSE:ATD.A) (TSE:ATD.B) provides Canopy with an advantage over its competitors given Couche-Tard’s global footprint.
James West: Joining me now, Mark Noble, Senior Vice-President of Horizons. Mark, welcome back.
Mark Noble: Good to see you, James.
James West: Yeah, you too, for sure.
Mark Noble: What people want to see is, they want to see with these Q4 earnings that retail marijuana, adult use sales, are real and they’re meeting expectations. And what we’re seeing is, yes, they are. The big guys are able to sell.
So even though Canopy had a bit of a restatement on Friday, and that hit them yesterday, what we’re seeing is, they were so far ahead of the rest of the market, everybody else is starting to catch up. And there’s a little bit of euphoria now starting to happen, because there was very lofty expectations for adult use sales in terms of these companies generating revenues, and they’re meeting those revenue expectations. Aurora is up 400 percent, Canopy is up 300 percent.
So from a fundamental perspective, when we look at earnings, you know, we want to see that grow, and while those are growing, what people are really looking at is revenue. And the revenue is really what’s driving sort of what we’re seeing, so now it’s a question of, can everybody else do monkey see, monkey do and generate revenue growth in, you know, the double-digit multiple 200, 400 percent.
James West: Yeah. So 50 percent of the cannabis sales in Canada occurred under the banners of Canopy Growth and Aurora.
Mark Noble: Right.
James West: Which means that there’s a whole bunch of smaller ones fighting for that other 50 percent. Do you think that’s going to change over time, or do you think that Aurora and Canopy are ideally positioned to defend that 50 percent market share?
Mark Noble: I think Canopy and Aurora are in a really good position. I mean, technically I don’t have too much of an opinion on the stocks, but what we’re seeing is, they seem to have created a product mode and a branding mode around their sub-brands. Canopy really surprised on there was the amount that came in from recreational sales. So Aurora is still maintaining a very strong footing in their medical, and we know that they want to go global medical; Canopy has a huge footprint in the recreational.
When you turn that on its head a little bit, what that means, though, is there’s not a huge pot for the other guys. So what investors need to be aware of is, while companies like Canopy and Aurora and Aphria to a lesser degree are being rewarded right now with this momentum, it also means that if there’s any revenue misses from Tilray, which we’ve got coming up in a couple of weeks, HEXO, CannTrust, then we’re, you know, there will be punished significantly on the other side.
And again, it’s not earnings; it’s revenue. People want to see that, in this new commercial market, that there’s something really there to support the revenue. And you know, the other reason that Canopy, you know, even though it missed again on the profit margins, is, we actually saw a decline in sales in Ontario last month, because the online recreational sales isn’t working to what people would imagine; anyone who uses that system kind of gets a sense of that.
So there’s still another leg up with the retail movement, the rollout of retail, and we see already that Canopy has established a leadership position with, potentially with Couche-Tard. So that’s another leg up. So what does that mean for investors that are looking at either HMMJR, a large ETF, or they’re looking at the individual stocks, is dispersion, and when I say dispersion, we’re now starting to see a little bit of feast and famine, where if anyone misses on the revenues on a go-forward basis, you’re looking at a significant potential leg down relative to the sector. So that is a bit of a risk zone.
James West: Does HMMJF own the Canopy and Aurora?
Mark Noble: They own 50 stocks, so they have all the big ones. They would be capped it at 10 percent weight, and that’s really, you know, not to sound too much like a salesman, but that’s really where the appeal is right now, is that well, what you’re going to see is that you get the big movements up on Aphria and Canopy right now; they get captured in the ETF performance, whereas if you have a concentrated portfolio and you hold any losers right now, you could be looking at a significant dispersion again.
So this right now, the revenue and the growth of the sector is really supporting the sector; from an individual company to company basis, that’s where we gotta be a little bit careful and we’ve got to really watch that revenue numbers.
James West: So the sales of cannabis in Canada essentially met expectations across the whole industry.
Mark Noble: Right.
James West: But only 50 percent of the total sales is divided up amongst the other 98 publicly traded companies that operate in Canada. So does that mean HMMJF would look to lighten up on those companies that are going to be fighting over a smaller piece?
Mark Noble: Well, this is the thing about indexing: indexing is a market cap weighted.
James West: Okay.
Mark Noble: So the weight is established based on the market cap of the company, so it’s float. So the larger the market cap, the larger the weight. So as a stock price goes up, its weight in the index increases, and as the price goes down, its weight would decrease.
So a lot of those other companies you’re mentioned are very small weights; they’re like 1 to 2 percent weights, where, you know, Aurora, Aphria, Canopy, Tilray are more in the sort of 8 to 10 percent range.
So we’re going to get a lot more of the large-cap movement at this point in time. Smaller caps, if they disappoint, they’ll have a much less proportional impact on the performance of the ETF.
James West: Right. So is the expectation then, I mean, just as an observer, that the performance that’s going to be reported by Tilray tomorrow and Aphria eventually is going to be impacted by this reality that 50 percent of the sales went to two companies?
Mark Noble: We’ll have to see, and what they’re going to be looking for to see is, are they meeting revenue expectations? Not necessarily earnings expectations, but revenue expectations. And it’s sometimes hard to determine what the market is, but if they aren’t showing the same type of revenue growth that the other large two did, then I would imagine that there’s a hit to those particular stocks.
And it could be that, you know, the big four or five companies have 75 percent of the market share, right? You could see them, the other three big issuers could take the other 30, 40 percent. And we have companies like Organigram, that, you know, that’s what really was started this rally in my mind, is Organigram came out of the gate with the first Q4 earnings, and they knocked it out of the park. And that’s where people start to say, Oh man, those lofty expectations, those high expectations, pardon the pun, are really coming to fruition. And that’s really what started this.
So again, you know, you could see that. And it’s really, we don’t know, we really don’t know. This is why these earnings are so crucial right now, because they’re giving us a little bit of a road map. Not the complete picture; we’re going to start getting the complete picture when we have Ontario retail stores set up, but it’s giving us a little big of a crystal ball into who has established branding, who has established first market mover positions in the adult use market.
James West: Okay, then, so where do you think this market’s going for the rest of the year? I mean, it’s been on fire since the beginning of the year, and, you know, we’re looking at a chart right now of the HMMJF which has, you know, no matter how you slice it, has very well, you know, outperformed, and so the question is, is it better to own a ETF like HMMJF in this kind of an environment where it’s so frothy and there’s so much friction in the actual sales marketplace? Or is it better to have a balance of ETF versus more speculative individual stocks?
Mark Noble: Yeah, I think you could, you know, I’m obviously in favour of the sector, because what we see with any sector, whether it’s technology or marijuana, is high tides rises all ships. So because the level of dispersion among the stocks could be significant, and you could see some big losers, I’d rather own the full sector.
Of course, you can have both. If you like Canopy and Aurora, you like what they’re doing, you could have an allocation to them, and then have what your sector beta is on the ETF. Also, the ETF you’re going to generate a yield as well, which you’re not going to generate with the other products. So, one of the things that we’re able to do is, as the valuations get frothy, the borrow costs on the stock get enormous. So you know, back in the height of August, the borrow rate on Tilray was like 700 percent.
James West: Yeah.
Mark Noble: Well, the ETF, actually, we take half the stock and we actually lend it out; up to half the stock. And so that generates a yield right now of about 7 to 8 percent, so you’re also getting that, and that kind of works as a little bit of a hedge again, if valuations get frothy.
But we could see momentum now continuing, because you’ve got, now, real sales numbers coming out of Ontario to support the market, and you’ve now got an increased liberalization happening on the US. You know, people are going to start tracking hemp sales, for example, see what kind of market that is, and so there’s going to be a second wave, potentially, particularly from the US investors, as more of these Canadian stocks get cross-listed, to try to capture this and try to see who’s in play now to get involved on the US market.
So I think that, you know, right now, we’re seeing the benefit of good surprises on the revenue side from the marijuana producers in Canada, and then the next leg up, and what’s going to continue to support it, is if we start to see more sense that these companies that are making money have the war chest now to take advantage of a further liberalization on the US and the global market, which I know I’ve mentioned here before, you know, on Couche-Tard; certainly Canopy would suggest looking at a retail distribution globally.
James West: Mm-hmm. Do you think there’s going to be much of a contribution from the international market, ex of the United States?
Mark Noble: Yes, absolutely. Because of the margins. So, markets like Germany, for example, you’re just getting a higher per-gram cost, and it’s a much larger market, right? You’ve got 50 million people in Germany. So the German medical market could be bigger than the entire Canadian market, just that market alone.
You add in Denmark, Israel, Australia – these are real markets that have, and again it’s just medical, but again, the margins are good on medical. So that’s a real growth opportunity for these providers, even ex the US.
Now, when you add in the US, if you add in the US and then you add in the global medical market, if you end up with an adult use market in the US, then you’re looking at potentially globally a $200 billion market. But even ex out the US, you’re probably looking at a $70 billion to $100 billion market with the inclusion of, you know, adult use market in Canada and a global medical market.
So increasingly, and Canopy again, this is where people like what they’re seeing, is you’re seeing a lot more international revenue coming into Aurora and Canopy, and the analysts are cueing into that. They really want to see that diversification coming outside of Canada.
James West: Yeah, you bet. Okay, so what about Latin America? 540 million customers strong, the only company I know of that’s really making headway there so far is Khiron. Does Latin American figure prominently into the global mix?
Mark Noble: Well, I mean, it would, just given the sheer size. Again, though, the question remains is, what’s the margin per product on that? I think if I looked at Canopy’s earnings, the average, and I could be, correct me if I’m wrong, but I believe the average price they were sort of selling in the adult use market was around $8.00. The question I would have about Latin America is, if you end up in the adult use market in somewhere like Uruguay, for example, which is where ICC was before they got bought by Aurora – how much are they actually making? How attractive are the margins in those? So sure, you have a sheer number of people, but from a per-gram unit, how attractive is that going to be relative to selling, I would say, to developed markets, particularly Europe?
James West: Right. Okay, well, Mark, that’s great insight as per usual. I really appreciate it.
Mark Noble: Oh, it’s always a pleasure.
James West: Thanks for coming, and we’ll have you back again soon.
Mark Noble: Oh, great. Take care.
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