Canopy Growth Corp (TSE:WEED) (NYSE:CGC), Aurora Cannabis Inc. (TSE:ACB) (NYSE:ACBFF), Aphria Corp (TSE:APHA) (NYSE:APHA), Cronos Group (TSE:CRON) (NASDAQ:CRON) and Organigram Holdings Corp (TSE:OGI) (NASDAQ:OGI) all have one thing in common: share price performance was horribly negative.
But that’s not going to last. Chicken Little is going to get the boot.
And smart investors are already building positions in stocks that are poised for a rebound in 2020.
Let’s look at the factors that got us here first:
- 2019 was the year that cannabis companies went from trading on speculative future valuations to financial performance valuations. They did this because the leading companies began reporting revenue. The revenue relative to the valuations made investors re-think their positions, and the exodus began.
- Coincident with this new valuation mindset, cannabis companies started reporting large, low-cost harvests from outdoor grow operations. That hadn’t been factored into the valuation equation at all. Now there was a new mindset, and tonnes of cheap weed. The fear factor ratcheted up accordingly, and the sell-off intensified.
- Throughout 2019, founders and early stage investor share positions that have been subject to escrow began to see those escrows come to an end. There was also an increasing number of employees in the cannabis industry able to exercise options. Investors who had been easing out of positions were now beginning to panic, and so large warrant positions were exercised and dumped. Selling begat more selling, and the herd migration toward the exits became a stampede.
- In Q4 2019, most companies started reporting lower revenues and “earnings” than they had reported in Q3, thanks to all the cheap outdoor weed now competing for buyers. The stampede morphed into all-out hysteria.
- The unlicensed supply of cannabis, through all of this, has not suffered any appreciable decrease in availability. Statscan reported that somewhere in the neighbourhood of 80% of Canadian weed sales were actually sourced from the black market. Investors became suicidal.
With rational disinclination to buy cannabis stocks turning to panic selling, the selloff took on the contours of a bursting bubble, and indiscriminate selling saw valuations of all companies sink to intra-year lows.
But now that tax-loss selling and all of these cheap shares have been dumped, the average buying price has plateaued, and a differentiation based on quality has reshaped the market again. Now, large US companies with investor-friendly share structures (not super-voting structures) who have been notching increasingly higher prices and margins in select markets are starting to appreciate again.
Trulieve has emerged as the US Multi-State Operator benchmark, with CBD market leader Charlotte’s Web reporting solid growth, and Cresco Labs and Green Thumb Industries are all starting look even a little cheap at current prices.
This is what I call the Great Bifurcation that has been widely anticipated by astute investors.
With the US market growing in addressable size state by state, and the Canadian market looking uglier and uglier, with none of the international markets reporting anything worthy of more than “meh”, US Multi-state Operators are going to start performing in stark contrast to their Canadian peers.
But 2020 is where the next leg up is going make the 2019 sell-off look like a mere paper cut.
Because 2020 is the year that Federal de-prohibition of cannabis becomes an election issue for both parties. This will make investors suddenly revalue the whole sector again, as it beoe clear that, no matter what, the US will legalize cannabis federally if not by the end of 2020, then most definitely the following year.
This will be the great 3rd wave of investment that will see major institutions and global hedge funds barging into the space, and the indiscriminate selling will once again turn into indiscriminate buying. This rising tide will even cause the Canadian cannabis boats to rise, as investors are reminded that most major Canadian companies have a built-in, instant US-ification strategy.
Canopy has Acreage Holdings, Aurora has Australis, and there are many more not-yet-visible US integration strategies afoot.
The sun will shine brightly again on the whole industry, and the same mistakes made by a new crop of investors will be repeated, and valuations will again become too grand too soon, and the stage will be set for….yes. You guessed it. Another downturn. Get long now, then get ready to go short. Do not make the mistake of thinking the music is not going to stop. Have a plan. Stick to the plan, man.
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