Since October 17, when recreational marijuana was legalized in Canada, high-flying pot stocks have had a hard landing. Losses for the top cannabis equities, such as Canopy Growth (NYSE:CGC) and Tilray (NASDAQ:TLRY), range from 30-50%.
The recent price action clearly indicates the sector was a bubble on the verge of bursting, just as soon as the pre-legalization excitement faded. The biggest reason for the abrupt decline in share prices: the majority of investors built up false expectations of sales growth for companies that still have unproven business models.
As well, the expected, after-legalization pot party hasn’t been as merry as expected. Canada has been experiencing widespread marijuana shortages, forcing analysts to trim their sales forecasts for producers. In a recent note, GMP Securities analyst Martin Landry cut his sales and profit estimates for Canopy, the biggest cannabis producer.
“The first 12 days of the recreational marijuana market have been disappointing from a distribution standpoint. … We now expect that Canadian recreational sales will be more muted than expected in the near-term.”
There is no doubt that marijuana stocks reside in a highly speculative segment of the market, where it’s tough to come up with credible valuation models based on company fundamentals in this early stage of the market’s development. However, if pot stocks are appealing for your investing portfolio, it’s prudent to stick with the biggest names. They have both production capacity and the financial muscles to survive.
For this reason, we like Canopy and Tilray. After the recent sell-off we see each as a buy for long-term positioning.
Tilray: Positioning For Future US Growth
Tilray 300 Minute Chart
The British Columbia-based medical marijuana company is uniquely positioned to benefit from any possible federal legalization of marijuana for recreational use in the US. In fact, Tilray recently gained approval from the US Drug Enforcement Administration to import medical cannabis into the US for testing purposes.
Investors have been pushing Tilray’s price higher on hopes that the company will get a share of the potentially massive American market. Recreational marijuana is currently legal in 10 states and many now see federal US legalization as inevitable within the next five years.
Tilray’s $500 million in cash holdings, its NASDAQ listing and its global reach would allow it to very quickly scale its business in the US if Congress passes the STATES act, which would legalize non-intoxicating cannabidiol (CBD) derived from hemp, said Brendan Kennedy, the company’s CEO during the company’s third quarter earnings call last week. He said he was also closely watching the legislation, which would give individual states the power to legalize marijuana without the threat of federal interference.
Since its IPO in July, Tilray shares have surged more than 400%. The stock has been on a roller coaster ride, with shares ranging from $20.10 to $300; Tilray closed yesterday at $109.31. If you’re investing for the long haul, Tilray could be worth considering.
Canopy Growth: Diverse Offerings, Global Reach
CGC 300 Minute Chart
The world’s largest cannabis company, Canopy Growth is another potential play for long-term investors due to its dominant position in Canada and its fast-growing global operations.
Constellation Brands (NYSE:STZ), the maker of Corona beer and other alcoholic wines and spirits, boosted its stake in the company to 38% in August via a $3.8 billion investment.
What makes Canopy different from other producers is its market size, capacity to ramp up production and diversity of product offerings, alongside its international reach. Canopy currently operates weed-growing facilities with over 2.4 million square feet of space.
But the producer has been expanding its operations quickly, which will deliver the potential to manage more than five million square feet of production space by next year. The stock is currently trading at $34.74, about midway within its price range, which has seesawed between $12.60 and $59.25 over the past 52-weeks.
Pot stocks have been a favorite trade for speculative investors over the past few years. But after Canada’s legalization move, there are now less speculative options for investors who want to focus on fundamentals and long-term potential. We believe both Canopy and Tilray fit that bill.