When Canada legalised recreational cannabis a year ago, investors went potty about the potential for profits from the legislative milestone. At its peak in September 2018, the first cannabis-focused ETF listed in Canada, the Horizons Marijuana Life Sciences Index, had more than C$1bn ($758mn) in assets and reached C$26.66.
Furthermore, the value of the global legal cannabis market is expected to more than triple from this year to reach $40.6bn by 2024, according to Arcview Market Research and BDS Analytics.
But several headwinds, including supply issues, delayed dispensary licence approvals, slow capacity expansions and overpriced tie-ups, have led to a slew of disappointing earnings releases. As a result, prominent cannabis stocks like Aurora Cannabis [ACB], Canopy Growth [CGC], Cronos Group [CRON] and Tilray [TLRY] are down by 25%, 23%, 21% and 68% so far this year, respectively.
A bleak horizon?
The Horizons ETF, which has holdings in all of the above companies, has seen its value fall by more than half over the past 12 months. So far this year, the ETF is down by 53% from its year-to-date high of C$23.87 on 19 March.
Canadian marijuana ETFs are currently worth around C$700m, according to a report in The Financial Times. But since the US Securities and Exchange Commission approved cannabis ETFs to be listed on US exchanges, six funds have already outpaced them with $1bn in value, despite the North American Marijuana index being down almost 50% since March.
George McBride, CEO of Hanway Associates, in remarks to CNN, noted that despite the “early movers” being able to raise money “astronomically fast”, their sales were unable to match investor expectations. He thinks this year’s sell-off is part of a wider trend of investors moving away from either over-hyped unicorns or companies that have likely been oversold.
Battered stocks signal disappointing earnings
Investors’ expectations remain bleak after Hexo [HEXO] lowered its revenue guidance alongside several lower estimates from other companies, due to significant operating losses.
Hexo’s stock fell by 22% – its biggest one-day loss – on 10 October citing “lower-than-expected product sell-through” and “regulatory uncertainty”. This led it to withdraw its 2020 outlook and lower revenue guidance for the upcoming quarter to C$14.5mn to C$16.5mn. Following the announcement, the Horizons ETF dropped to lows not seen since 2017.
Amount that Hexo stock fell in 1 day
For Jefferies analyst Ryan Tomkins, expectations may still be too optimistic.
“Into the next quarter, we continue to think consensus may be expecting too much sequentially from names in a market where growth is not significant (yet), some capacity is being earmarked for extraction, and costs are increasing as preparation for derivatives ramps up,” Tomkins said in a note.
Even Cronos, the world’s largest cannabis company with a market value of $2.6bn, is expecting operating losses to increase in H2, despite reporting a surprise Q2 profit after revenue tripled.
Tomkins suggested that there should be a better sense of how the Canadian market is shaping up when Aurora announces its earnings results on 11 November, followed by Cronos and Tilray a day later and Canopy on 14 November.
For W Andrew Carter, a Stifel Nicolaus analyst, Canopy and Cronos could weather the sector’s weaknesses. Both companies have strong cash positions of roughly C$3bn and C$2bn, respectively, he wrote in a note to clients. This allows each of them to invest “aggressively behind their businesses and to capitalise on any opportunities”.
|Canopy Growth||Cronos Group|
|Return on equity (TTM)||-52.27%||90.90%|
|Quarterly Revenue Growth (YoY)||249.10%||201.60%|
Canopy & Cronos share price vitals, Yahoo Finance, 23 October 2019
While any loosening of regulation would likely prompt a rally across the sector, investors shouldn’t count on that happening.
“As we look at the charts of leading companies in the sector, it’s not clear that the downturn ended last week as the market reversed,” said Alan Brochstein, a principal at New Cannabis Ventures, in a note on 6 October. “Our best guess is that we are within 10% of a low that we expect in the next few weeks should these prices not hold.”
Meanwhile, health concerns and profit issues are headwinds for cannabis companies too. As such, they should pay close attention to their environmental, social and governance risks as well as take steps to mitigate them early, according to Morningstar.
“Doing so could result in operational and reputational benefits accruing to early adopters and improve public perceptions of the industry as a whole. Better for legal cannabis to be seen as sustainable than as just another sin stock,” Jon Hale said in the report.
With cannabis stocks low, they could be attractive to investors looking for more reasonable valuations. “The large, public cannabis companies were overvalued. This is a come-back-to-Earth rationalisation,” Matt Hawkins, co-founder and managing principal of Entourage Effect Capital, told CNN.
“The large, public cannabis companies were overvalued. This is a come-back-to-Earth rationalisation” - Entourage Effect Capital co-founder Matt Hawkins