You’re reading a copy of this week’s edition of the New Cannabis Ventures weekly newsletter, which we have been publishing since October 2015. The newsletter includes unique insight to help our readers stay ahead of the curve as well as links to the week’s most important news.
2020 is ending with a strong rebound in cannabis stocks. With three weeks to go, the New Cannabis Ventures Global Cannabis Stock Index has rallied 151% off the March lows and is up 1% in 2020. The index has been led by American companies, as evidenced by the year-to-date performance of the New Cannabis Ventures American Cannabis Operator Index compared to the New Cannabis Ventures Canadian Cannabis LP Index.
The New Cannabis Ventures Canadian Cannabis LP Index has rallied a modest 40% off of its lows and is still down over 30% year-to-date. In sharp contrast to the weakness among Canadian LPs, three of the largest ones have posted strong gains, with Aphria increasing 74% year-to-date, Canopy Growth by 57% and Cronos Group by 43%. We have commented recently that the largest LPs appear to be rallying due to hope that the U.S. market may open to them, though we think this is an erroneous assessment of what lies ahead, as we discussed four weeks ago when we said that investors betting on legalization are buying the wrong stocks.
There may be more factors driving these large LPs than the optimism that the U.S. could open up. For one, international markets do appear to be finally gaining traction, and these LPs are poised to benefit. Also, the Canadian market is improving, with sales doubling year-over-year, according to Statistics Canada, as more stores open and new product formats launch.
The challenging roll out of adult-use cannabis in Canada left many of the LPs with too much production capacity and too much inventory, and the Canopy Growth announcement this week continues a trend of necessary asset impairments that will help bring supply and demand more into balance. Still, with such high market caps for these largest LPs, especially Canopy Growth at US$11 billion, we don’t expect a better Canadian market to necessarily drive their stocks higher.
As we look at the balance of the Canadian LP sector, we see much better values. Part of this is due technical pressure on some of the stocks, as we have seen some operators address weak balance sheets by selling stock or converting debt to equity, a process that has likely depressed their stocks while leaving them fundamentally stronger. Additionally, after two years of declining prices, many investors have written off the smaller LPs, leaving many to trade at relatively low ratios to their tangible book value or to their future expected sales and earnings. The large ETFs that hold Canadian LPs have narrowed their holdings and no longer own many of the names held previously.
For those who believe that the Canadian adult-use market is likely to continue its growth, we expect the best way to capitalize on it won’t be by buying the very largest LPs, which have already rallied substantially. Instead, select smaller LPs as well as retailers are likely better positioned to benefit from the expansion of retail stores in Ontario and BC and the roll out of more derivative products. With these smaller LPs, it’s important to assess their financial strength, management capability and growth strategy, as not all companies are well positioned.
Trichome Financial, which has already begun to prove its thesis with the purchase of JWC out of bankruptcy, is in a unique position as a platform to further consolidate and rationalize Canadian LP assets. It believes it has the opportunity to acquire additional operating assets with meaningful revenue and cash flow generation capability at a fraction of previously invested capital.
Get up to speed by visiting the Trichome Financial Investor Dashboard that we maintain on their behalf as a client of New Cannabis Ventures. Click the blue Follow Company button in order to stay up to date with their progress.
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Alan & Joel