Getting Into The Weeds

My latest article, Getting Into the Weeds, hit #1 on Seeking Alpha! It’s an extension of The Intelligent Investing Podcast I did with Eric Schleien (GSCM). Eric’s podcast is doing very well and about to break the top #100 in the investment space.  In the article I take the time to dig deeper into specific sector of the marijuana industry.  With the legalization in Canada coming tomorrow (October 17) it’s good to have a sense of the buzz surrounding the space.

Just to be clear, I’m not an investor in the space. I’m also not recommending investing in the space. While on the sidelines, I know a lot of people making plenty of easy money on cannabis stock. We have seen Canopy Growth (WEED) go from $2 to $75 in a very short-time. Tilray, a company with just $20 million in first-half revenue, was briefly worth $30 billion. That’s more than Twitter, CBS, Harley-Davidson, Fitbit and American Airlines. At its height Tilray’s enterprise value surpassed 85x bullish estimates for its 2020-year sales and 340x that year’s estimated cash flows. Fast easy money is tempting and contagious. I’m happy for them but I believe the party is not going to last. We have seen this story repeat itself in the past.

To me the investor’s high on the marijuana sector is a red flag, and signaled that a sobering up may be imminent. The speculative craze is fueling a future crisis. This is the same story that repeats itself over and over. The tech bubble that ended in 2000, the pre-crisis U.S. housing craze, and the cryptocurrency bubble are some of the most recent examples of speculative manias. In each case, a defensible investment thesis – that technology will eventually dominate the economy, American housing prices could only move in one direction, and the blockchain was going to revolutionize everything – was extrapolated to a form of ridiculousness where no price was too much to pay for related investments.

There are some serious questions about just how profitable these companies can become under legalization. I think most investors do not understand what the space looks like, how competitive it is, what the margins look like. Distribution costs, advertising and sales taxes will further erode profit margins and cause price compression, possibly squeezing companies whose production costs are too high out of the market. Some of the companies that have gone public suffer from weak management, and investors need to be ready for a fall in marijuana prices because too many suppliers have entered the market. I see the valuations being attributed to places that have virtually no production, virtually no off-take agreements, which don’t operate in multiple countries and have a very limited R&D.

I’m not a market timer, I don’t have a crystal ball, and I don’t what’s going to happen. But I know that a company without profits can’t survive in the long-run. Right now these stocks are being valued like junior mining companies. They are valued in the “promised” of future riches. Eventually, once they start producing (legal sales in our case) they are valued based on their fundamentals (cost, margins, distributions, market, profits etc.). This is similar to a junior mining company transitioning from exploring to producing.

It’s a space that I suggest proper judgement.

Article: Getting Into The Weeds

Podcast: #36: Getting into the weeds on marijuana stocks (we aren’t so high on them) + Update on BAM & TSLA ItunesGoogle. First 23 minutes is a recap on Brookfield Asset Management and Tesla. Weed talk at the 23 minute mark.

Enjoy!

Brian


Getting Into The Weeds

By Brian Langis

  • Canada is legalizing marijuana for recreational use on October 17, 2018.
  • The changes that are underway closely mirror the process that alcohol went through after prohibition ended in the 1920s: liquor regained social acceptance and the product proliferated.
  • Investors need to figure out what something is worth and try to buy it for less. Investing in the marijuana industry is not different in that regard.
  • Most investors do not understand what the space looks like, how competitive it is, what the margins look like. There are questions about just how profitable these companies can become.
  • The long-term prospects for marijuana are very positive. The question is how much are you willing to pay for it?

The cannabis sector has been on a two-year high. Cannabis related stocks are trading at sky-high valuation. “The sky is the limit” as the saying goes. Since August, the segment has surged to a new level of hysteria on a wave of announcements. The sector got a boost when Constellation Brands (STZ), the brewer of Corona and Modelo, agreed to add $4 billion to its investment in Canada’s lead weed company Canopy Growth (CGCWEED). The hysteria got a new boost when Coca-Cola (KOconfirmed an interest in spiking sports drinks with cannabidiol (NYSE:CBD), the non-psychoactive ingredient of marijuana. And thanks to the DEA approving Tilray’s (TLRY) plan to import pot from Canada, a company with just $20 million in first-half revenue was briefly worth $30 billion.

I’m in Canada, and I have a first row seat to the mania. It’s easy to see why investors got interested in marijuana. Marijuana has a hand in two worlds, fun and health (or consumer discretionary and medical to be more proper). At Tim Horton’s coffee, I overheard a conversation of older men talking about marijuana stocks, and that was a couple months ago. With the income they made they probably upgraded their chat to Starbucks. People that have never bought stocks in their life are now making money on pot. I was reading that interest in self-directed investing is rapidly growing. A lot of these new accounts are young millennials picking marijuana stocks for the first time.

Marijuana is in the middle of re-branding their image. Once a batch of small, highly risky stocks that traded on obscure exchanges, cannabis shares are reaching a new level of maturity. And with the U.S.’ federal drug laws mostly dissuading companies to list on country’s stock exchanges, they’ve found a home on the Toronto Stock Exchange (TSX) and other Canadian markets.

As Canada prepares to legalize weed nationally, a multi-billion-dollar investment boom is underway in North America. Canada’s legal marijuana industry is poised to transform from a multimillion-dollar market serving thousands to a multibillion-dollar market serving millions – and investors are hoping to profit from that sea of change. Entrepreneurs and investors are rushing headlong into the nascent legal marijuana industry, fueling a stock craze reminiscent of the late 1990s dot-com bubble and the recent bitcoin mania. Investment opportunities to create new businesses have never been more compelling.

Full article here

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