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Marijuana stocks weekend investor roundup: Analysis of the week's most important events in the cannabis industry (February 23)

Feb 26, 2019

Finance and Investing

By Scott Willis

PotNetwork is pleased to bring you our Marijuana Stock Weekend from our partner publication Grizzle. Grizzle journalist and Head of Research Scott Willis covers the marijuana stock market in-depth, with over 12 years of institutional investment management experience in analyzing both debt and equity securities. He has held senior investment research roles at Credit Suisse and TD Asset Management. He’s also a Chartered Financial Analyst and has been featured on BNN Bloomberg and CBC. For more of Scott’s writing check out Grizzle - the language of new money.

Initial rules around edibles likely to benefit the black market

Bottom Line: Canada is taking a cautious approach to legalizing cannabis, which is good for public health, but bad for licensed producers' ability to grow revenues. Come Oct. 17, 2019 Canada will legalize edibles and vape pens that are far inferior and more expensive than black market options.

We are most concerned about vape pen rules. Vape pens are the fastest growing and most popular cannabis product in America and if the Canadian government doesn't allow at least 500mg of active ingredient per vape pen, the size of the market and the growth rate will disappoint investor expectations.

Licensed producers finding workarounds to owning Ontario retail stores

Bottom Line: It is clear LPs are having no problems finding workarounds to legally operate cannabis retail stores in Ontario, even though the intent of the government was to give small businesses a chance to compete in this market. If the government doesn't crack down it means Ontario retail will eventually be dominated by LPs in the end.

First quarter of legal sales in Canada off to a slow start

Bottom Line: Recreational and medical sales in Canada are running at a $670 million annual pace and grew only 4 percent in December over November. The government thought sales would be $900 million in the fourth quarter, yet they only came in at $160 million. We estimate the black market still makes up 90 percent of sales in a $7 billion a year market. If legal demand doesn't pick up soon, producers are going to be showing much slower revenue growth than the market expects.

CBD gathering steam as a beauty ingredient

Bottom Line: Research house Piper Jaffray notes that beauty retailer Sephora already has a dedicated CBD section in their stores. Exploding demand for raw CBD oil is likely creating an opportunistic window for first movers to sell CBD oil at a high markup.

We expect farmers to overplant hemp in the next two years eventually leading to a significant fall in wholesale CBD prices until revenue per gram approaches production costs of less than $1 per gram.

Tilray does biggest CBD deal yet

Bottom Line: Tilray's deal to buy Manitoba Harvest signals they really want hemp distribution infrastructure and established sales channels. Manitoba generated only C$6MM of EBITDA LTM and lost money in the last three years, so Tilray is paying 70x EBITDA for the business, Tilray trades for 40x. Focusing on sales channels instead of supply may turn out to be a smart move. At the end of the day the industry needs to find buyers for all the CBD supply to come.

Large study finds teens smoke less after legalization

Bottom Line: Cannabis use among teens dropped 1 percent according to a large survey covering states that legalized medical marijuana. The most interesting finding from the study is below.

other research has suggested that after the enactment of medical marijuana laws, youths' perceptions of the potential harm of marijuana use actually increased

This study directly contradicts the popular conservative argument that legalization will lead to a spike in teen cannabis use.

Twice as many women in California bought cannabis in 2018

Bottom Line: Retail data shows that Baby Boomers and woman are the fastest growing demand demographic. Twice as many women bought cannabis in 2018 vs the year before. This on the ground research echoes what we are seeing from high-level state sales data. Demand for cannabis and hemp-based CBD, in particular, is exploding. Expect an increasing number of first-time users as more research comes out supporting the medical qualities of cannabis.

Weekly marijuana stock performance

Marijuana stocks outperformed the broader market this week up 5 percent compared to the S&P 500 up 1 percent and the TSX up 2 percent. U.S. multi-state operators (MSO) are back to outperforming Canadian names.

Interestingly, so far this year the four largest Canadian LP's have outperformed both the cannabis index as a whole and the U.S. MSOs by 11 percent and 23 percent respectively. We think the U.S. MSO's will start to outperform if the STATEs act allowing cannabis banking is passed, possibly in 2019.

Market Outlook

Stocks are seeing a bounce back in the first quarter after selling off so heavily in November and December. Sentiment is getting more positive with the overall market so it is hard to see stocks going through another 20 percent+ selloff in the first quarter without additional negative earnings news or a global recession. A full buyout of a cannabis company by a consumer packaged good or pharmaceutical company would be a strong positive catalyst for the entire industry.

From a fundamental perspective, be careful owning cannabis stocks into the next two-quarters of earnings. Distribution bottlenecks and a government monopoly do not bode well for licensed producers' ability to meet or exceed lofty earnings estimates, however, so far the market has been happy with strong revenue growth even if profitability is nowhere to be found.

Longer term, with the Canadian market legalized, we expect retail and wholesale price compression from a legal oversupply by the second half of 2019. Falling cannabis prices will pressure producer stocks later in 2019. After a shakeout, the remaining stocks will be better positioned as long-term buying opportunities.