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Getting High – Cannabis stock picking

Forget Canada – try Germany.  Canadis this year’s story – especially with legalsation on 17th Ocotber. But Germany is next year’s story., even though legal sales were only a few million in the 12 months to July 2018/

Global spending on legal cannabis is expected to grow 230 per cent in just five years, from $9.5bn (£7.3bn) in 2017 to $32bn in 2022 says a recent report from BDS Analytics. According to figures from Euromonitor, the legal marijuana market will be worth US$7.5bn in Canada next year, and $10.2 billion in the US, where it’s ony legal in nine states.

Broker Canaccord – which recently appointed a head of cannabis investing – expects European medical cannabis demand to grow by 80 per cent in 2018 compared with 2017, which itself was up 80 per cent on the prior year. By 2028 the European cannabis market is slated to be worth €58bn.

Which stocks are likely to offer the best returns? The answer for the moment is Canadian stocks.  In Canada, recreational cannabis will become legal Octobenr 17th, but the regulatory landscape varies state by state. Ontario will offer weed in under 100 shops, while in Alberta over 200 private retailers will be able to sell marijuana products. In Newfoundland and Labrador, supermarket chain Loblaws will offer marijuana.

As a guide for stock-pickers, marijuanaindex.com is a good starting point. It offers an overview of the largest stocks, share price performance and a comprehensive news feed for cannabis stocks. The North American Marijuana Index – probably the best overall guide to the sector – rose sharply through 2017 but has since retraced some of that move as the euphoria makes way for more hard-headed investment decisions.

Smoking out the winners

Canopy Growth Corporation (Can:WEED), which through its Tweed brand and association with the rapper Snoop Dog is probably the best-known pot stock, was the first publicly traded and federally regulated cannabis company in North America. It’s listed on both the Toronto and New York stock exchanges – respectively under the tickers WEED and CGC. The latter listing in particular has helped to keep it in the limelight. With many pot stocks trading in over-the-counter markets, those that are publicly listed are subject to tougher reporting and corporate governance criteria, making them able to attract interest from funds.

Higher admin costs and marketing expenses saw the company’s net loss last year rise to $0.40 per share from $0.06 a share the year before. It has the capacity to ramp volumes easily as demand picks up, but expect a production glut before too long.

In the most recent quarter it reported $2.3m in sales in Germany, thought to be the largest market in Europe, which is about a tenth of the group’s total revenues. International markets will be a key growth lever, with research suggesting that while North America will see by far the biggest spending over the next 10 years, the most rapid rate of growth will happen elsewhere, in places such as Australia and Europe.

Another well-known stock is Aphria (Can:APH), a medical-focused company that is looking to tap the nascent Canadian market for recreational use and expand internationally. After a spate of acquisitions, the valuation has suffered, profits remain elusive and its international division reported an adjusted net loss of C$2.8m, leaving it with a group net loss of nearly C$5m, nearly twice that registered a year before. Cash on hand is dwindling, sliding from around C$173m at the end of the third quarter to C$105m in the fourth. Bmportant markets such as Italy and Germany. The challenge will be in driving expansion internationally while managing costs. The key question  – and indeed for most other cannabis stocks – is whether international sales can rise quickly enough to offset the capacity ramp up among Canadian producers.

Another company boosting production is Cronos (US:CRON). And like Aphria it’s seeing revenues rise substantially while the investments are hitting profits. In May the firm’s first-quarter report showed a 473 per cent increase in revenues but the net loss increased to about C$1m as production costs soared sevenfold from the prior year. Like Canopy it’s also investing heavily in marketing and admin to prepare for the Canadian legalisation date, which we assume to be a positive even if it hits earnings in the short term.

Aurora Cannabis (Can:ACB). It ticks all the boxes – it is ramping production from an already high level, has made a number of key strategic investments and acquisitions – its C$3.2bn all-stock acquisition of MedReleaf remains the biggest marijuana deal so far – and is building up its international footprint and distribution channels.

 

Finally Cann Trust (TSE:TRST) – it san unstellar stock – already up 3-fold from its one year low.  but its sales a re doubling year on year. Its doina

The key question hanging over the investment case here is whether international sales can rise quickly enough to offset the capacity ramp-up among Canadian producers

European cannabis market

 Population   Recreational volume (tonnes)  Recreational volume (g/capita)  Recreational prevalence (%)*  Medical cannabis (kg) 
 Germany      82194                         400                             4.9                           13.4  1100 
 France       65959                         545                             8.3                           21.5  minimal 
 Italy        61325                         471                             7.7                           20.7  600 
 UK           64908                         290                             4.5                           11.6  zero 
 Spain        47586                         314                             6.6                           17    n/a 
 Poland       38200                         145                             3.8                           9.8   20 
 Netherlands  16962                         128                             7.5                           15.6  1020 
 Czechia      10873                         67                              6.2                           19.3  40 
 Austria      8653                          44                              5.1                           14.1  30 
 Ireland      4872                          21                              4.3                           13.8  minimal 
 Romania      21379                         35                              1.6                           5.8   5 
 Sweden       9895                          24                              2.4                           7.4   minimal 
 Croatia      4211                          31                              7.5                           16    1 
 Finland      5511                          19                              3.5                           13.5  30 
 Denmark      5729                          22                              3.8                           15.4  minimal 
 Belgium      11295                         41                              3.6                           10.1  40 
 Switzerland  8483                          25                              2.9                           120 
 Norway       5304                          11                              2.1                           8.7   50 
 Slovakia     5467                          21                              3.8                           9.3   minimal 
 Portugal     10596                         20                              1.9                           8     n/a 
 Bulgaria     6943                          20                              2.9                           10.4  minimal 
 Estonia      1269                          7                               5.2                           13.6  0 
 Greece       11100                         8                               0.7                           4.4   zero 
 Hungary      9845                          13                              1.3                           3.6   zero 
 Latvia       1997                          7                               3.7                           10    zero 
 Lithuania    2964                          5                               1.8                           6     zero 
 Slovenia     2089                          8                               3.6                           10.3  zero 
 Luxembourg   563                           2                               4.2                           9.8   minimal 
 *Percentage of 15-34 using cannabis recreationally in the last 12 months 
 Source: EMSDDA, Seedo, INCB, IDMU, Canaccord Genuity estimates

Key takeaways

These stocks are fully priced. For example, Cronos trades at a trailing 12-month price/earnings ratio of about 1,000. Many stocks will  fall as expectations for growth are so high. On the plus side, cannabis stocks are not nearly as highly valued as they have been with the entire sector down by around a third since the peak in January, potentially offering an in for investors.

A capacity glut is coming. Canadian production is expected to soar as every player positions for the growth opportunity. So, while revenues are going to rise with supply and demand increases, margins and profits are less certain.

Acquisitions and international deals will be needed to drive growth outside of Canada is becoming apparent. Those Canadian producers that can leverage distribution agreements with partners overseas will probably do better than those focused on just the North American market.

Healthy balance sheets are particularly important in the new cannabis sector as companies need to make bold investments to capture growth opportunities. The industry is highly fragmented and as the market matures it’s likely that companies with the healthiest balance sheets will win out as they snap up rivals and develop economies of scale.

The British government’s legal U-turn followed the path set out by many other countries (cannabis is now legal for medical purposes in nine European countries and 39 US states) and has accelerated the pace of growth in the commercial market. According to Melissa Sturgess, founder of cannabis investment vehicle Ananda Developments (Nex:ANA), “one year in cannabis is like seven years in anything else – it’s just extraordinary the pace that it is growing at”.

In the UK, access to that potentially enormous market currently lies in the hands of just three companies. Ananda, Sativa Investments (Nex:SATI) and High Growth Capital (Nex:HASH) are all NEX-listed investment vehicles, set up to benefit from the surging demand for medicinal cannabis. With some of the £1m raised at its IPO, Sativa has taken a stake in two Canadian-based pharmaceutical cannabis companies, Veritas and Rapid Dose Therapeutics. Ananda has backed an Israeli company that is aiming to improve the process of extracting CBDs and THCs from cannabis. The group is looking to make further investments in the whole spectrum of cannabis applications: genetics, growing, lighting, bolt-on devices and services.

Both companies will no doubt hope to replicate the success of the UK’s first medicinal cannabis company, GW Pharmaceuticals (US:GWPH), which cancelled its Aim listed in 2017 in favour of the US Nasdaq market. GW was the first company to gain approval for a pharmaceutical grade medicine which uses both CBDs and THCs. Its two drugs, Sativex and Epidiolex, are used to treat multiple sclerosis and epilepsy, respectively, and are approved in the UK, Canada and much of Europe. The potential success of ongoing US trials could be another catalyst for the share price which is already up a tenth in 2018.

Outside of the UK, there are a number of opportunities for investors to grab a slice of the medicinal cannabis market. Cara Therapeutics (US:CARA) and Axim Biosciences (US:AXIM) both have drugs in the early stages of development that could be used for a range of illnesses, while pharma giant AbbVie (US:ABBV) has a synthetic cannabis-based treatment which is used to treat nausea associated with chemotherapy.

Meanwhile, there is a growing pool of cannabis companies that have expressed an interest in listing on the UK’s main or Aim market. Nick Davis, a lawyer at Memery Crystal, says his firm is currently talking to half a dozen companies which are considering IPO, that compares to zero this time last year: “London is just starting to wake up and catch up”.

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