Tilray, Canopy Growth, Aurora: which share price to back as bubble fears intensify?

Cannabis stocks have produced some remarkable growth in recent years. Tilray [TLRY] shares, for example, climbed from $24 to around $148 between late July and October 2018. According to Forbes, it hit a valuation of $20bn, roughly equal to that of American Airlines [AAL]. Since then, though, Tilray shares have plunged to around $26. But its fundamentals, as well as those of other major cannabis stocks, remain strong.

Positive vibes

A dozen US states have legalised marijuana. Canada has recently legalised adult-only use of the drug, and there is growing demand from the global medical market for cannabis-based products, particularly in Europe.

There are also potentially large markets for products such as cannabis-based drinks, oils, food and skin creams. As such, large investors in these sectors have been attracted to cannabis stocks and will likely keep investing to ensure they succeed.

Tilray has a partnership with brewer AB InBev, and Canopy Growth has sold a 40% stake to Corona owner Constellation Brands [STZ]. Canopy [CGC], which recently bought UK skin cream group This Works, is also investing in production, brands and intellectual property with its recent purchase of Colorado-based Ebbu. Cronos Group [CRON] is focusing on new cannabis vape products, while Aurora [ACB] on cannabis oils.

Although profits in the cannabis sector are hard to find, the stocks keep growing the top line. Part of that is down to reinvestment, as they spend cash to diversify and expand quickly to take advantage of demand.

Tilray’s second-quarter revenues beat expectations, with investment in cultivation centres in Canada and Portugal eating into its margins. “It’s early days, and we’re continuing to invest to build long-term value for our shareholders,” Tilray CEO Brendan Kennedy said.

Tilray’s international exports could grow, thanks to the Portugal facility, according to Cowen analyst Vivien Azer. This will also help economies of scale, and Kennedy says Tilray will be profitable in Canada and Europe in the next couple of quarters.

Canopy has the powerful backing of Constellation behind it. Aurora Cannabis is expected to be the leading producer of cannabis with projections of 625,000 kilos annually from June 2020. Aurora is also the leader in supplying the European medical cannabis markets, particularly Germany.

Cronus is also growing internationally, after recently buying four operating subsidiaries of Redwood Holding, which makes premium cannabis oil consumer products.

These stocks may never reach previous highs, but they will continue to prosper as the market matures and patients and consumers become more comfortable with the use of their products.

Negative vibes

The cannabis industry used to be associated with crime, rebellion, secrecy and health fears. It will clearly take time for such a young market to mature. But analysts are increasingly asking for evidence of near-term profit growth.

Cannabis stocks have already had their moment in the sun and the hype must make way for reality, according to Stephen McBride, editor of RiskHedge Report. “Most marijuana companies stand little chance of ever making significant profits. Now, it’s becoming legal there’s nothing special about marijuana. Like corn or wheat, its’s a crop,” he said. “Farmers are lucky to squeeze out a penny or two of profit for their broccoli and carrots, and this price compression is marijuana’s future. Oregon was one of the first states to legalise marijuana in 2015 and the handful of growers could charge exorbitant prices. But prices have been cut in half since as new companies flooded the market.”

“Most marijuana companies stand little chance of ever making significant profits. Now, it’s becoming legal there’s nothing special about marijuana. Like corn or wheat, its’s a crop” - RiskHedge Report editor Stephen McBride

McBride thinks some cannabis stocks will go on to achieve big gains, but overall the industry is “dead in the water”.

Indeed, the stocks are losing money as the companies invest in new facilities and international expansions. And they are also being hit, certainly in Canada, with a backlog and slowdown in licensing applications. That means problems with processing, cultivation, distribution and supply shortages – not just in Canada or the US, but also in any of the countries included in international expansion plans.

Tilray, Canopy Growth & Aurora share price vitals, Yahoo Finance, 4 September 2019

The opening rates of cannabis retail stores are also failing to pick up. Cronos has its growth eyes on vaping, but it is uncertain if the Canadian government will allow the launch of vaporising products.

High tax rates on marijuana production in the US are another drag on cannabis stocks.

Looking at Tilray’s and Canopy Growth’s earnings per share ratings, they sit at a lowly 1 because it is unlikely that they will be turning over meaningful profits any time soon.