Are We Discounting Cannabis Stocks too Much?
I used to be a major bear on cannabis stocks. It wasn’t a particularly bold stance (remember Tilray trading at an EV/sales of 420 in 2018?), but I was vehemently on the other side of the pot stock bubble of 2018. If you don’t believe me, here is a poorly written blog post to timestamp my take.
Since the 2018 peak, the North American Marijuana Index, which tracks the largest public companies in the industry, has fallen from 300 to just above 100. That’s is awful relative to any benchmark.
We may have hit peak pessimism, or the “trough of disillusionment,” in Gartner hype cycle terms, for cannabis. Here are two reasons I’m leaning that way:
This “Founders Field Guide” interview with Justin Singer
The Harris/Biden ticket being for federal legalization of cannabis
Singer’s interview was fantastic, and a must-listen for anyone interested in cannabis. My big takeaway was that a few years ago a ton of pretenders started companies or raised money because it was easy to do, not because they had a strong business model. Now that the wash-out has occurred, the entrepreneurs that are passionate about marijuana and CBD have stuck around and are grinding it out.
As for legalization, I have no prediction for how it will happen but am fairly confident it will happen within the next five years. The puck is just moving that way. As Singer said in the interview, federal regulation is way more important than people think. Setting national standards will help companies find their way, and carve a path for businesses to succeed in this wild west environment.
Let’s look at the financials and valuations cannabis companies are currently trading at. This is important because even if these businesses are primed to grow, it doesn’t guarantee the stocks will perform the same.
Canopy Growth Corporation
Enterprise Value: $5.83 billion
TTM gross margin: 22.5%
Projected $900 million in 2023 sales
Innovative Industrial Properties
Enterprise Value: $2.95 billion
TTM gross margin: 100% (this is a real estate company, so the financials look a bit wonky)
$44 million in TTM operating income
2022 revenue estimate of $230 million
Enterprise Value: $647 million
TTM gross margin: a negative number (yikes)
2022 revenue estimate of $190 million
Enterprise Value: $1.61 billion
TTM gross margin: 35.2%
2023 revenue estimate: $896 million
Using these four stocks and their financials as a proxy, it feels like the industry is still in “heavy investment” mode (i.e. the financials look terrible). But now, I guess the stocks are priced like it? I would need to dive in further to actually have a stance, but my thoughts right now are there will be some massive winners but mostly losers out of the few dozen publicly-traded cannabis stocks.
Since we are investors in individual stocks, there may be some opportunity in cannabis at the moment. But as a broad sector, even after the 2018-2020 drawdown, it still smells like a bad bet.
Disclosure: The author is not a financial advisor, and may have an interest in the companies discussed.