Why Canadian Stocks are on Sale

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This year has been a rough start for Canadian marijuana producers who, in the previous two years, were favored in the stock market. Though early January brought a surge to record highs, the year-to-date Canadian Cannabis LP Index is since down 12.7%. Analysts and marijuana stocks investors who have taken a longer-term perspective on the decline view this as a necessary correction to the rapid growth since the middle of 2016.

Weed stocks in Canada have one thing in common among their performances in 2018: decline.

The index, which peaked at 1438.87 on January 9th, has since fallen 39% to 877.46. However, prices have still risen 83% in spite of the correction since the end of October brought about largely by the announcement of Constellation Brands’ investment in Canopy Growth. Investors recognized the profound ramifications this transaction might have industry-wide. Then in March, the announcement of tobacco giant Alliance One International’s acquisition of a 75% stake in Canada’s Island Garden marked another investment cross-industry.

Canada’s number of publicly traded marijuana producers continues to grow; 29 to date, with more private licensed producers (LPs) making their way to public markets. Per sales numbers, Canada’s top cannabis companies are Canopy Growth Corp.(NASDAQOTH:TWMJF), Aurora Cannabis (NASDAQOTH:ACBFF), Aphria (NASDAQOTH:APHQF), and MedReleaf (NASDAQOTH:MEDFF). Though performance has varied significantly among the group this year, what they all have in common is decline.

The recent decline of marijuana stocks in Canada can be attributed to several industry-specific factors. 

To start, Canada’s implementation of legal recreational marijuana, originally set for July, has been pushed back to some time in September. To add to this, the passing of the Cannabis Act was brought into question when it was met with heated deliberations at the Second Reading a few weeks back. The bill has been considered a “done deal” up to this point and, while it passed to committee review, the unexpected opposition caused a ripple of concern. More importantly, though, were the restrictive packing guidelines issued by Health Canada near the end of March. Cannabis companies fear these restrictions will make competition with the black market more difficult for LPs. The industry has been subject to negative commentary from financial media while facing the possibility of supply glut and leading to much higher valuations.

Among the largest growers, Aphria has performed the worst this year with its stock down nearly 46%; concerns over the company’s Nuuvera acquisition appear to have had the largest impact and drawn criticism from market participants. The marijuana stock did experience a boost in December following the announcement of a potential, exclusive supply agreement struck with Shoppers Drug Mart. Aphria’s Q3 report for 2018 comes out in mid-April via conference call.

However, marijuana-specific factors aside, overall markets have also experienced recent lows. Using the S&P/TSX Composite Index as a measurement, Canadian stocks have all fallen 5.6% in 2018. It is also possible investors are paying off last year’s gains by selling shares.

Investors looking for marijuana stocks to buy can access longer-term investment opportunities by exercising due diligence as the Canadian market opens to adult-use.

Marijuana stock valuations are still a concern for many investors; however, as prices are lowering and the date for Canada’s final vote draws near in June, the timing for those looking to enter the market and those searching for longer-term investment opportunities seems to be improving.

Some analysts believe the market is shifting to neutral, or somewhat bearish, from a period of a more bullish period. As far as potential oversupply is concerned, others believe a shortage will happen earlier on, akin to the shortages U.S. markets have experienced after a state goes legal.

At this point in time, the majority of LPs lack substantial inventory with the exception of Canopy Growth. The amount of supply expected once the recreational market launches is not likely to be available in its entirety on day one. With this in mind, dried cannabis is Canada’s primary market and, thus, edibles and extracts will either be significantly limited or excluded from the initial legal offering. In short, LPs won’t initially have access to the true market demand which should help mitigate supply.

The longer term picture is likely to include a market oversupply, though, perhaps not to the degree many would forecast. Analysts and investors taking a company’s guidance at face value should note a number of companies’ projects won’t result in producing the anticipated scale.

While LPs traded on public markets have historically moved in unison, investors may see companies deliver substantially different returns in the new stage of Canada’s market. Investors should prioritize assessment of management capability and execution risk in their exercising of due diligence. It is important to note success in the medical marijuana market is not a guarantee of success in the new legal recreational market; the new market will have a distribution model which, unlike the medical market, will look different in each province.

Investors looking for weed stocks to invest in now are encouraged to adopt a longer-term view when it comes to assessing marijuana stocks valuation.

Canadian producers will not only sell a commodity. As time passes and rules permit, products such as vape pens, edibles and extracts will become increasingly differentiated. Also, numerous international opportunities should open for licensed cannabis producers. The companies with the ability to create products for the pharmaceutical market will, perhaps, have the greatest advantage, granting them access to a market even larger than the current recreational and medical markets combined.

While Canada’s LPs have gone through the ringer, they have maintained high valuations. Investors and traders can take advantage of the current price decline to buy in, paying attention to specific companies over the sector at large.

(For related news, read Here’s Why Marijuana Stock Investors Shouldn’t Be Worried.)

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