Although pot stocks experienced double the average trading volume on October 17, most major cannabis stocks fell. Tilray (NASDAQ: TLRY) experienced a 6 percent decrease to close at around $148 per share. Likewise, Canopy Growth (NYSE: CGC) fell 4 percent to close at around $50 per share.
Why did cannabis stocks fall on Canada’s most important day? Over the last year, investors have hyped cannabis stocks to extreme heights in anticipation of the all-important October 17 legalization day. Prices for cannabis stocks kept soaring as investors placed a hope and a prayer that Canadian recreational sales would greatly surpass Canada’s previous medical cannabis sales revenue.
In general, most marijuana stocks began falling on Tuesday, a day before Canada’s legalization date. Wednesday’s selloff affected the entire sector; both large and small businesses were affected, as were cannabis companies beyond Canada, including companies that sell to American states that have legalized cannabis in some form.
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Tilray, for example, could only sell to medical prescription holders before Wednesday. Already in a bubble, Tilray was priced for perfection by some analysts, who issued a buy rating and a $200 per share target price, yet the stock closed below $150. Why the stark difference?
The answer lies in the expectation that Canadian recreational sales could exceed C$4 billion in 2019 and be as much as C$10 billion over the next five years. The speculation has been all upside, albeit inflated, particularly since Tilray has never exceeded $10 million in sales in the medical cannabis market.
Many cannabis stocks were already in a bubble leading up to October 17. The stocks then experienced a strong rally leading up to that point. Tilray, although down from its all-time high earlier in 2018, is still priced at a bubbly valuation. Now that legalization is over, Tilray still has plenty of downsides.
However, the hype about the cannabis industry is not just hype; it’s real. Therefore Tilray can also experience tremendous upside in the months and years ahead. In other words, one day does not a stock price make. Market reports like Deloitte’s “Recreational Marijuana Insights and Opportunities Report” from 2016 shows consumers’ primary motivation for recreational use is for medically-related reasons like better sleep or reduced stress, so medical uses drive the recreational market.
Tilray agrees. The company believes that the recreational legalization of cannabis in Canada will lead to a greater acceptance of its medical use, and they released a press statement to that effect a few hours before Canada’s legalization went into effect: “Our focus at Tilray will continue to be developing and manufacturing medical cannabis products in our GMP-certified facility and supplying medical cannabis to tens of thousands of patients in Canada and across the globe.”
Tilray has entered the recreational adult-use cannabis market through its wholly-owned subsidiary High Park Company, which is separate and distinct from the parent company’s medical cannabis operations. Tilray has positioned High Park to be a market leader once retail sales begin. The company has been aggressive at signing supply agreements with the provinces.
Parent company Tilray was one of the first licensed medical cannabis producers in Canada, and it will remain focused on its core, which is advancing scientific knowledge and clinical applications of medical cannabis. For example, Tilray has an ongoing study at Toronto’s Hospital for Sick Children to study the effects of their high-CBD formulations on children with epilepsy. They also have research efforts in PTSD, glioblastoma, COPD, and essential tremor, among others.
Tilray is expected to have around US$40 million in revenue this year, but many analysts still think the valuation is over-inflated. The company has about 17 million Class 1 shares owned by Privateer Holdings and over 75 million remaining outstanding shares. This calculates to a $15 billion market cap, which is extremely optimistic. To reach earnings levels that would even get Tilray to this market cap, the company would have to more than double its capacity from its current 76,000 kilograms to over 160,000 kilograms.
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Some analysts say the cannabis bubble is even more pronounced with companies like Canopy Growth (CGC). The company has weathered analysts who say that dried cannabis is just a commodity and that “farmers” like Canopy Growth have overvalued stock. The shares have experienced tremendous growth, climbing nearly 300 percent in the last year; the company is valued at over $4 billion. The Canadian company became listed on the NYSE this summer.
When measured by market cap, Canopy is the world’s largest pot stock and the world’s largest cannabis producer, on target to produce 300,000 kilograms of dried cannabis by the end of 2018.
As the world’s largest cannabis growing company, Canopy Growth’s value is based on far more than just October 17. Canopy is a major player—the biggest player—in the $200 billion potential cannabis market.
One reason Canopy Growth’s value is not just set on October 17 is because only flower and oils are available on the recreational market now. Edibles and other consumable products won’t be legal until next year, and Canopy’s value is derived from its bevy of future cannabis products and not just those that launched on October 17.
Canopy is more than just “farmers.” The company is a very diversified cannabis and hemp company that provides services over the entire operation from production to market execution. Canopy Growth has facilities in seven countries on four continents. The company currently operates cannabis production sites totaling over 2.4 million square feet of production capacity, and are adding 3.7 million square feet of space, and they’re the most recognized brand in Canada.
Canopy has been masterful in achieving strategic partnerships, such as the big-brand backing of Constellation Brands, maker of Corona beer, which invested nearly $200 million in Canopy earlier this year. They’re partnered with DNA Genetics, Green House Seeds, and Snoop Dogg’s cannabis enterprise. Just this week, Canopy announced its acquisition of Ebbu, a hemp research company based in Colorado that will add to its R&D capabilities for genetic breeding and cannabinoid production.
The company just achieved another milestone, by being the first to ship cannabis from Canada to the United States for medical research, by gaining U.S. Drug Enforcement Administration approval to do so.
Canopy CEO Bruce Linton traveled to Newfoundland on Tuesday evening to participate in the first sale of cannabis after legalization in Canada. While Linton is thrilled that the recreational market in Canada is now open, he says Canopy is focused on the longer-term global opportunity. In an interview with Mad Money’s Jim Cramer, Linton emphatically stated that cannabis could disrupt some $500 billion worth of global markets, calling that a more "accurate" estimate than "conservative, cautious" predictions of a $200 billion disruption:
"We disrupt alcohol potentially, cigarettes potentially, in terms of smoking cessation. We really disrupt pharmaceutical, because whether or not you're geriatric care, you're dealing with arthritic conditions, you're someone who can't sleep, you're going through an oncology treatment, I think you're going to find cannabinoid therapies really hit there. And so you add all that together, plus the existing $200 billion illicit market, that pretty quickly gets you up around $500 billion” Linton said. “ “It sounds like a 'How could it be?' but just do a bit of the back-of-the-envelope math. It's not crazy,” he continued.
Linton said that Canada's legalization will prompt other countries to move out on cannabis. They’ll quit ignoring it and figure out how to regulate and govern it. Linton’s view is that if Canopy does it right, the big bump won’t just be Canada. Rather, the Canadian milestone better positions Canopy for the global market.
Today, the valuation of CGC still looks high, but so does the rest of the industry. Because of Linton’s outlook, many industry analysts view CGC as a big opportunity over the long term. After all, the company has more than enough capital, a well-poised global position and excellent expertise in the space.