Part of cannabis and investing
There are many things that probably won’t end well. Donald Trump’s presidency, Brexit and the Montreal Canadiens’ upcoming NHL season, to name a few.
Add to that list the mania gripping Canada’s publicly traded cannabis industry.
This is not an investment story. It is a mad gold rush – and it will not end well for many investors.
Last week’s wild swings in the stock price of Tilray Inc. were a warning sign about where this may be headed. At one point on Wednesday, shares of the Nanaimo, B.C., cannabis producer doubled, swelling its stock market value to $36-billion. That briefly made Nasdaq-listed Tilray more valuable than such venerable Canadian companies as Rogers Communications Inc., Sun Life Financial Inc., Telus Corp. and Loblaw Cos. Ltd.
That’s impressive, but also absurd when you consider the potential size of Canada’s legal cannabis market. Economists estimate that legalization will add about $7-billion to $8-billion to Canada’s annual GDP next year – a speck in a $2-trillion economy.
It’s hard to imagine there will ever be a market large enough to justify the tens of billions of dollars that investors have already sunk into this dream.
Like a gold rush, investors are chasing something that is partly real. Canada will become the first major developed country to legalize recreational cannabis next month. That’s a big deal because it creates a whole new industry, elevating cannabis from a niche medical product to a mainstream consumer item.
But far too many companies and investors are pursuing a limited prize.
Last week, Tilray was worth four times the cannabis market’s projected contribution to annual GDP in Canada. And that’s just one company. There are now nearly 100 publicly listed Canadian cannabis companies. The largest two dozen combined are worth nearly $100-billion.
Many of these stocks doubled in value in just the past few weeks.
Canopy Growth Corp., the largest Canadian-listed stock, is now worth about $15.5-billion, making it more valuable than Canadian Tire Corp., Power Corp. of Canada, Bombardier Inc. and many other companies with billions in sales and global reach. Aurora Cannabis Inc. has a market capitalization of $12-billion.
To believe that all these companies – or even a clutch of them – will one day justify today’s lofty valuations hinges on several unproven assumptions.
For starters, economists must be vastly underestimating how much legal cannabis Canadians will consume. Or perhaps investors believe that Canada will be home to several global champions, selling vast quantities of recreational cannabis to the world as other developed countries legalize.
Consider Tilray, which has captured the imagination of U.S. retail investors. There is nothing tangible to suggest this is a company destined for global domination. In the six months ended in June, the company had revenue of just US$17.5-million. Of that, a mere US$540,000 was generated outside Canada through medicinal product sales.
It’s a similar story at Canopy Growth, which had $78-million in revenue for the year ended in March. Less than $4-million of that came from foreign sales.
Maybe there will be a massive consolidation of the industry, leaving just a clutch of large, thriving survivors. Or perhaps the best of Canada’s cannabis producers will get swallowed up by global consumer product giants. That narrative got a lift in mid-August, when U.S.-based Constellation Brands Inc., maker of Corona beer and Kim Crawford wine, announced it would invest an additional US$4-billion in Canopy Growth.
Maybe. Maybe not. That’s the dilemma, and the danger, facing investors.
Of course, there is a sunnier way to look at all this.
Mr. Trump may one day get his face etched in the side of Mount Rushmore, alongside U.S. presidential greats George Washington, Thomas Jefferson, Theodore Roosevelt and Abraham Lincoln. Britain could still quit the European Union with all the benefits of membership and none of the hassles. And 18-year-old Jesperi Kotkaniemi may be the next Guy Lafleur, leading the Habs to the Stanley Cup.
But don’t bet your retirement or children’s college fund on any of that happening. Look at what’s happened to Tilray since touching that $36-billion high last week. By Monday afternoon, the company’s market cap had dwindled to about a third of that.
Starting next month, there will be a real market for cannabis in Canada, enabling investors to eventually compare the hype and the reality. And it will be become much more difficult to justify today’s lofty valuations.
Until then, investors are chasing a fanciful cannabis dream.