Canada dominates the legal cannabis industry; it has liberally allowed the sale of medical marijuana since 2001, and in October 2018, extended this legality to the sale of cannabis for recreational use. So it’s little surprise that all but two of the world’s cannabis-producing unicorns (companies worth over $1bn) call the country home.

Each of these unicorns has seen incredible growth in recent years. The combined market cap of the eight-biggest Canadian companies has swelled from less than $2bn at the start of 2016 to well over $30bn in 2018.

Arguably, this crop should be the lowest risk cannabis stocks out there. They only operate in countries that, like Canada (and unlike the US), have legal frameworks that allow for operating fully within local laws. This gives them the advantage of being able to list on the NYSE, NASDAQ or TSX.

However, 2018 has been an incredibly volatile year for these stocks. Shares in Tilray, one of Canada’s leading legal cannabis producers which went public in July, surged more than 95% before losing 110% of the gains across just seven days of trading in September. The movement added $10bn, before wiping this from its market cap.

 

$10bn - Amount Tilray gained, then lost from its market cap across seven days of trading

 

The sector has been defined by aggressive gains and losses such as this since its inception, and double-digit falls are not uncommon. A pattern of bubble-like volatility seems to be emerging, where stock prices are highly sensitive to any slight announcement or development.

Other recent surges hit the industry when Corona owner Constellation Brands took a 10% stake in Canopy Growth in October 2017, and again when it upped its stake in September 2018 to 38% – it retains the option of expanding its share beyond 50%. Constellation’s stock price has remained consistent after Wednesday’s legalisation.

Cronos shares were up around 50% for the year on the day before legalisation, though that figure has since dropped. Much like Cronos, Aurora Cannabis, a Canadian-licensed producer of medical marijuana, saw shares spike sharply in the run up to legalisation, but has since lost nearly all those gains.

 

Overpriced?

Despite the numbers and legalisation in Canada, many stocks are not sold on the continued growth potential of these firms. With all of them currently loss-making and the sales levels of some questionable, many analysts say they are overpriced.

Alan Brochstein, founder of New Cannabis Ventures and 420 Investor, is an investor and leading commentator on the legal cannabis industry. Citing Cronos Group and The Green Organic Dutchman, he told Opto in August: “A lot of these companies are better at growing their cash balance through capital raising than through growing cannabis.”

He adds: “No company has proven it can grow at massive scale. Even companies that are growing are burning cash operationally. You’d expect in an industry like this, where companies are generating quarterly sales of up to $20m, they’d be closer to profitability. I predict a massive fail somewhere down the line.”

 

$30bn+ - Combined market cap of Canada’s cannabis unicorns

 

Canopy Growth CEO Bruce Linton is forthright in his assertion that the company will be profitable once recreational sales impact earnings, pointing out that in the second quarter of 2018, Canopy produced more cannabis in those three months than any competitor had in its entire history.

“We had no plans to be profitable before the party started,” he told Opto in August. “We could have been, but that would be like celebrating victory having won the warm up. Now our intent is to dominate and annihilate everyone else.”

 

Going global 

International (but non-US) medical use is where growth potential is seen to be, and is arguably why companies like Canopy have such large valuations.

Canopy has recently launched a Latin American business, acquiring a Colombian medical marijuana producer that adds to forays already made into the Chilean and Brazilian markets.

Canopy is also looking carefully at Europe, having found that the regulatory and health systems are similar to those in Canada. It means established ways of working can carry over to countries like Germany, where it has been active since 2016.

 

“Our intent is to dominate and annihilate everyone else.” – Bruce Linton, Canopy Growth CEO

 

But there’s a glitch to figure out: the opportunity outside the US and Canada is a slow burning one. According to a BDS Arcview report, the $32bn sales that are projected by 2022 will still come mostly from the US (73%), with just 10% coming from outside North America.

That’s why legalisation in the US is the major play many are waiting for. There is an argument that although the Canadian unicorns are preparing for US federal legalisation, they could miss out on building recognisable brands by not launching in states that have already legalised.

 

Back in the US

This is why insights firm Arcview is recommending investors target companies with US activities that are listed on the Canadian Securities Exchange (CSE) – the only recognised stock exchange in North America that accepts those that do business in the US. Arcview director of business development, John Downs, points out Ottawa-based CannaRoyalty [CRZ] as one to watch.

“It has a $500m market cap and is buying significant assets in the US right now – both brands and distribution companies. That’s one way of leveraging anticipated federal legalisation,” he adds.

As well as Canadian companies that are investing in the US, the CSE is also the stock market of choice for US-based companies to list. The biggest to do so has been MedMen [MMEN]. With a market cap of $2.45bn, operations in four states and shops that look like Apple stores, it’s the biggest publicly traded US company.

The back listing (made through purchasing a Canadian company) didn’t go so well though. Investors were turned off by the high price and the fact that the company initially planned to hand up to $50m of the $100m that would be raised from the float to the co-founders. The price immediately fell 25% after.

 

“We think cultivation is over invested and there will be price compression.” – John Downs, Arcview

 

But it didn’t entirely turn investors off of US companies floating in Canada. Green Thumb Industries [GTII], for example, jumped by 70% in the two weeks after listing in June. “That really is one of the best companies” says Brochstein. “And there’s a lot more to come.”

MedMen have since acquired PharmaCann for $682m, the biggest ever deal for a US-based marijuana company.

 

Border control

As one might expect, Linton counters the notion that US activity is the best option for investors and the companies. He believes Europe provides more opportunity than the US, where laws and production are fragmented on a state-by-state basis. Europe allows the opportunity for intellectual property to be developed, something that the US does not allow due to federal prohibition. 

Linton also highlights an issue for international investors putting money into US-based cannabis companies: border guards might not look on federally illegal activities kindly. This was certainly the case for Canadian venture capitalist Sam Znaimer who, in May, was interviewed at the border for four hours about his US cannabis investments, then handed a lifetime ban from entering the US.

However, investing directly in ‘plant touching’ companies in the US market isn’t the only way to invest in the industry. “We’re definitely looking at ancillary companies,” says Downs. “We think cultivation is over invested and there will be price compression.”