High hopes for budding pot industry

Opinion

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This article was published 20/01/2017 (2667 days ago), so information in it may no longer be current.

Many investors have high hopes for the currently high-flying marijuana industry in North America. It’s to the point where you might even know someone who has bragged over drinks about how they’ve doubled or tripled their money investing in pot stocks in a matter of weeks.

For those who can remember the dot-com bubble of the early 2000s, history rhymes in this regard: stocks soaring in value based on potential, with few real dollars to back it up.

And seemingly everyone’s partaking in these joint ventures.

Yet those similarities aren’t entirely a bad thing. While it might seem like investors have been smoking too much of what the pot industry is selling, there’s more to the industry than smoke and munchies.

“You see a lot of commentary about how this is the tech bubble all over again,” says Bruce Campbell, a portfolio manager with StoneCastle Investment Management in Kelowna, B.C.

Among the few analysts who follow this fast-growing industry, Campbell has spent plenty of time separating the seeds and stem to find the potentially budding flowers of the sector, particularly in Canada.

“The difference is we know there is a market there already,” he says.

Like the tech bubble, many companies involved in the industry have stock prices often supported by no profits — just potential future profits. Consider the pioneer: Canopy Growth Corporation. It’s Canadian, and it’s the largest legitimate marijuana producer in the world. Its stock price has gained about 250 per cent in the last year, and it has a market valuation exceeding $1 billion. Yet it has not turned a profit. What is intoxicating to some investors, however, is its potential. Its share price trades on its future earnings potential with the expectation it will be one of major players in the industry when Canada legalizes marijuana for recreational use in the next two to three years.

“You can certainly be critical that the valuation has got ahead of itself,” Campbell says.

But the business model — one with growing sales — is already there thanks to a fast-expanding medical market. By some estimates, Campbell says, the number of medical users is growing faster than producers can grow product.

“Right now, the medical demand is basically sopping up all of the supply, and with the medical market growing at estimates of around 10 per cent a month, they need to continue to grow to meet that need let alone the recreational side,” he says, adding there are now 100,000 legal medical users in Canada.

With demand growing like a weed in Canada, U.S. investors are also taking note.

“What I’ve seen over the last six or eight months is U.S. investors have really started to migrate toward Canada,” says Alan J. Brochstein, a financial analyst who follows the industry and produces a sector newsletter called the 420 Investor.

“They can’t find the easy trade — that being investing in real cannabis companies — in the U.S. so they go to Canada.”

The recent spate of states legalizing cannabis, including California and Nevada, has driven interest in U.S. companies, but the more astute investors there look here for future profits.

“In many cases in the U.S, it’s really only speculation, but in Canada while there is a lot of speculation, the market is also backed by fundamentals,” he says.

The Canadian market is primarily made up of licensed producers for the legal medical market. They produce marijuana that’s being purchased. But that’s not the case in the U.S, even though tens of millions of Americans can now consume cannabis legally.

Most U.S. publicly traded pot companies are ancillary players in the industry. They offer services or make products for cannabis production and consumption. But because marijuana is still illegal on a federal level, no enterprise involved in production can actually list on a stock exchange (or even access banking services).

Consequently, investing in pot stocks in the U.S. is largely a fool’s game.

“Most of the U.S. companies — it’s not that they’re ancillary that’s the problem,” he says. “It’s that they’re share-selling schemes.”

So while the Canadian market is arguably overvalued, by comparison, it’s much more substantial — even more than many investors might assume.

And that’s because Canada’s cannabis potential extends beyond the promise of a domestic legal recreational marketplace.

The fact is we’re a world leader in legitimate pot production, says the CEO of Canopy Growth.

“Right now, Canada is the leading place on the globe for policy on how to manage medical and recreational marijuana,” says Bruce Linton, who founded the Smith Falls, Ont., firm.

“And if the rest of the world has the same objective, which is to manage the two markets, or least beginning with medical, they are almost going to exclusively look to Canada for policies, which they are most likely to adopt.”

Already, he says, governments from other countries have met with Canopy to get a handle on legitimate production. And Canopy is forging business opportunities in Brazil and Germany as they move toward medical legalization. Through the lens of a global industry — even excluding the U.S. — the market looks less inflated, he says.

“I think that it’s being undervalued in terms of the context of what could happen here and how a five-year head start in Canada could be advantageous if you were trying to create a compliant infrastructure in another country that has adopted a similar policy as we have here.”

Moreover, those who follow the sector argue the promise of pot isn’t in legalized recreational use — though that’s potentially a $22-billion marketplace in Canada alone, a recent study reported. The medical side may hold even more promise as research slowly builds a case for its value as a whole new class of drugs. Hard evidence already points to its value for treating chronic pain, Campbell says.

“With all the concern about opioids, this is a huge area that could be replaced with cannabis.”

And as Canadian companies garner more investment dollars, there will be an increase in research and development for cannabinoid biotech solutions for treating cancer, Parkinson’s and other serious illnesses.

While the possibilities offer remarkable long-term upside, there’s also tremendous risk.

But don’t throw out the bud with the bong water just yet. While the days of rapid stock-price growth may have gone up in smoke, industry observers say the grass remains green for those able to tolerate the dizzying ride over the next few years.