Canada weed stocks come off high as challenges loom before legalization

East Side Games

20/11/2017 12:00

By Nichola Saminather and Nivedita Bhattacharjee 
    TORONTO/BENGALURU, Nov 20 (Reuters) - Canada's marijuana 
stocks, which have surrendered some of the potent gains that 
pushed them to record highs this month, face a bumpy ride in 
2018 that could purge smaller players, as the country moves to 
allow recreational use of cannabis in July. 
    Canada is set to become only the second country in the 
world, after Uruguay, to legalize the production, sale and 
consumption of recreational marijuana, and the country's nascent 
weed sector has been on a tear in anticipation. 
    But uncertainty over the scale of expected demand, selling 
prices that may be less attractive than the black market, 
initial supply hiccups, and even the chance legalization may be 
postponed, will weigh on the industry into 2018, analysts say. 
    "I think a bubble is being created here and the fundamentals 
really don't justify the valuations," said Chris Damas, editor 
of the BCMI Cannabis Report. 
    U.S. alcohol producer Constellation Brands'  STZ.N  C$245 
million ($192 million) investment in Canopy Growth Corp 
 WEED.TO , Canada's biggest marijuana producer, last month gave 
fresh momentum to a sector that had been chugging higher at a 
more moderate pace, but the stocks have pulled back recently as 
investors took profits.  urn:newsml:reuters.com:*:nL4N1N5484 
    The four biggest stocks by market capitalization - Canopy, 
Aurora Cannabis  ACB.TO , MedReleaf Corp  LEAF.TO  and Aphria 
 APH.TO  - soared between 40 percent and 143 percent since the 
Constellation deal to highs earlier this month. MJIC Inc's 
Canada Marijuana Index is up over 30 percent this year, versus 
the Toronto Stock Exchange benchmark's  .GSPTSE  4.7 percent 
gain. 
    BCMI's Damas said the big four pot companies are trading at 
an average price-to-sales ratio of 55, based on last quarter's 
annualized sales of C$167 million. 
    Canopy, the only marijuana producer included in the S&P/TSX 
Composite Index, is trading at 57 times sales, the 
second-highest on the benchmark. 
     
    SKY-HIGH VALUATIONS 
    But investors are betting the jump in sales after 
legalization will justify the astronomical valuations, although 
sales projections range from under C$5 billion to C$10 billion a 
year. 
    The Canadian cannabis black market is estimated to be worth 
between C$7 billion and C$10 billion a year.  
    Bruce Campbell, portfolio manager at Stonecastle Investment 
Management, expects C$9 billion in sales in 2020-21 from both 
recreational and medical use, versus the industry's C$11 billion 
market capitalization.  
    The market value in a growing industry can be as much as 
five times sales, Campbell said. "Even if they trade at two 
times sales, they could have another C$7 billion of market gain 
over the next few years," he said. Stonecastle owns shares in 
Canopy and MedReleaf along with some smaller pot companies. 
    Alan Brochstein, founder of cannabis-sector information 
provider 420 Investor, said supply concerns and possible delays 
loom, particularly with Quebec this week asking for legalization 
to be postponed.   
    "There probably won't be as much sales in Canada as people 
are expecting at first," he said. "The size of Canada is 
extremely finite. There are a lot of companies competing, and 
they aren't going to make it by just focusing on Canada."  
    Bigger companies are more likely to attract capital from 
global investors and expand overseas, he said.  
    Brochstein expects intermittent pullbacks but expects the 
sector to trade in a higher range than in 2017 before 
legalization.  
    The inevitable consolidation will underpin the survivors' 
stocks, analysts said. This month, Aurora launched a bid for 
smaller rival CanniMed Therapeutics  CMED.TO , which in turn is 
set to buy Newstrike Resources  HIP.V .  urn:newsml:reuters.com:*:nCNWCylXna  urn:newsml:reuters.com:*:nASB0BUOM 
    Most analysts are bullish on the industry's long-term 
prospects, given Canada's early mover advantage.  
    "We expect a pullback in the sector as is typical after any 
significant runup in stock prices," said Jason Zandberg, special 
situations analyst at PI Financial Corp. "We believe there is 
still long-term growth in the sector but many of the smaller pot 
companies may not survive when competition heats up."     
    ($1 = 1.2818 Canadian dollars) 
 
 (Reporting By Nichola Saminather; Editing by Denny Thomas and 
Chris Reese) 
 ((Nichola.Saminather@thomsonreuters.com; +1-416-687-7604;)) 
 
Keywords: CANADA MARIJUANA/STOCKS