Part of cannabis and investing
Investors will scrutinize Canada’s high-flying cannabis companies this spring as the fledgling industry delivers its latest quarterly results – and those who fall short of expectations could face a tough reaction.
Analysts say it was likely a hard quarter. Cowen and Co., which is bullish on cannabis, suggested there would be a slow start for the sector this year. Scotiabank declared that expectations are “too optimistic” and predicted stock of companies that deliver weaker-than-forecast numbers will “trade sharply lower on earnings day.”
Cannabis companies are a high-wire act, with lofty market valuations underpinned by predictions of future financial windfall, while the reality is less bright. Half a year into legalization, investors will parse an array of details on whether companies are delivering, everything from the physical challenges of growing cannabis on a large scale to what it costs to produce the product.
“People want to see if the business model is working,” Greg McLeish, an analyst at Mackie Research Capital, said in an interview.
Aphria Inc. and Organigram Holdings Inc. report earnings on Monday. Cannabis companies operate on a variety of fiscal-year calendars so unlike the banks or oil companies, financial results from different companies arrive over a longer period of time.
After Aphria (with third-quarter numbers) and Organigram (second quarter) set the stage, investors will next look closely at some of the sector’s leading names coming in May, including Aurora Cannabis Inc. (third quarter), Cronos Group Inc. (first quarter) and Tilray Inc. (first quarter). Canopy Growth Corp. in mid-June will release its fourth quarter and fiscal 2019 numbers.
One big question investors will focus on is the logistics of growing cannabis. It is not an easy plant to grow and is susceptible to issues such as mould due to excess moisture, infections that take the form of powdery mildew and bud rot. A number of companies are trying to grow vast amounts of cannabis in large greenhouses, often ones converted from previous uses such as growing bell peppers.
“What people are finding is cannabis is a lot harder to grow at scale than they thought,” Mr. McLeish said.
Cowen and Co. analyst Vivien Azer, in an April 8 report, warned that the industry is seeing a “build-up of unsellable inventory,” because the cannabis is of “sub-par quality.”
Consensus expectations for revenue and profit for the coming quarterly results are inflated “both on the ability for producers to bring production to market and the size of the current market,” analyst Oliver Rowe at Scotiabank said in an April 10 report.
The consensus suggests Aphria quarterly net revenue will exceed $80-million, roughly quadruple the $22-million it reported in the last quarter (its September-to-November period, which straddled the Oct. 17 legalization).
Mr. McLeish said smaller companies that fall short of expectations will be more vulnerable to investors dumping their shares. Bigger companies such as Canopy, with stronger balance sheets and the backing of alcohol seller Constellation Brands Inc., are in a better position to weather missteps in the minds of investors.
Stocks of cannabis companies in general peaked in the weeks leading toward legalization and then fell sharply to the end of 2018, as the broader market also swooned.
Cannabis stocks, along with the market, shot higher earlier this year but didn’t recoup previous highs. They have drifted lower more recently. The sector has scored some mainstream recognition: Canopy, whose market capitalization is $19-billion, is the first cannabis company to join the S&P/TSX 60 index. Canopy replaces Goldcorp Inc. as of Thursday.
Ms. Azer of Cowen and Co. has been a strong promoter of cannabis companies. Her price target for Canopy is $82 – close to 50 per cent higher than the company’s $56.31 close in Toronto on Friday. Ms. Azer predicts Tilray could triple to US$150 on the Nasdaq from its Friday close of US$52.91.
Still, Ms. Azer has trimmed near-term expectations. For Canopy, she sees fourth-quarter revenue of $89-million, down from a previous estimate of $107-million.
She said gains from the legal market will be more modest because of the slow emergence of the retail market. Her fiscal 2020 revenue forecast for Canopy is now $701-million, down from $778-million – though the revised figure would still be more than triple estimated fiscal 2019 revenue of $222-million.