Pot Stock Investors Meet the Kitchen Sink
When the capital landlords of Canopy Growth (TSE: WEED, NYSE: CGC), Constellation (NYSE: STZ) showed Mr. Bruce Linton the door in July it was clear as day that write-downs were on deck. Grizzle outlined exactly how it would play out the moment it happened — the stock is down nearly 70% since our note.
We now have full confirmation with Canopy’s latest earnings release that the company is in full write-down/kitchen sink mode. We outline the ugly downside in our review of the earnings.
For a normal established sector, seeing a bellwether go down isn’t a mortal wound for the industry, however, for an emerging sector like cannabis built on a lot of hype and promises it makes things very difficult for the rest of the pot stocks complex.
Cannabis ETF (HMMJ) & MediPharm Performance Since Canopy Growth Share Price Peak (Jan 31/19)
Source: YCharts
Where’s the Bottom?
As I highlighted in my note yesterday there simply isn’t anything fundamental you can hang your hat on in this sector. Cannabis is a commodity and commodity stocks can’t begin to rally until the supply/demand imbalance gets sorted out…. and it’s a big issue — we’re sitting on 250 days of cannabis oil inventory.
Source: Health Canada
Additionally, operational results have been abysmal for big players, heck one of them even grew pot illegally — CannTrust (ha!). Trailing Price-to-Sales is as good of a measure as any to use for a sector continually disappointing investors. We simply don’t see a scenario where Canopy or Aurora (TSE: ACB; NYSE: ACB) should continue to trade at a multiple 3-4x higher than Aphria (TSE: APHA; NYSE: APHA).
Trailing 12-Month Price/Sales
Source: Y-Charts
Also, let’s not forgot that Aurora has a wee little problem of obscene share count. At last tally they were well over 1 Billion (yes capital B) shares outstanding.
Average Diluted Shares Outstanding
Source: YCharts
Trading Pot Stonks
Obviously the easiest tactical move here is to stand back and watch ugly stocks that couldn’t really ever grow pot swirl down the drain.
There’s still a lot of valuation multiple premium to short in Aurora and Scott’s analysis of Canopy suggests we could easily see the stock sell off another 50% without looking ‘cheap’.
The cannabis extraction stocks (MediPharm, Valens) in our view are very exposed to the downside. MediPharm (TSE: LABS) is up over 120% YTD vs the sector (TSE: HMMJ ETF) down -55%. Peak operating margins are never a good look for commodities and the stocks have significantly outperformed the cannabis peer group.
The view that cannabis extraction stocks can magically ‘decouple’ from a sector-wide oversupply is naive at best.
M&A Wildcard
It’s been nearly a year since we’ve heard any hype about mega-cap consumer product companies (CPG) looking to get splashy with an investment in the cannabis sector. And frankly why would they? Constellation and Altria have literally taken a capital bath in their investments of Canopy and Cronos, respectively.
Our view is that either Canopy or Cronos are far better off acquiring a producer that can actually grow good pot versus continuing to grow their own ditch weed or chasing unfruitful celebrity joint ventures.
Every #potstocks rally continues to get FADED, harsh reality of oversupply (of ditch weed)
Companies with a semblance of a balance sheet ( $CRON, $WEED) should/will at some point have a critical look at companies that CAN grow chronic at scale ( $WMD, $FIRE, Tantalus… ) https://t.co/hdCUNkLtGX
— Thomas George (@thomasg_grizzle) November 12, 2019
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