‘We’ve seen this before’: How investors can play the legalization of cannabis edibles
The new wave of cannabis legalization in Canada was met with optimism from investors on Thursday, but analysts warn it’s still too early to bet on the market’s rejuvenation.
Trapped in a bear market for months, cannabis stocks flashed some of their old potential as market leaders such as Canopy Growth Corp., OrganiGram Holdings Inc., MediPharm Labs Corp., Cronos Group Inc. and Aurora Cannabis Inc. each closed between five and eight per cent up. Hexo Corp., which was battered last week after significantly lowering guidance, gained nearly 20 per cent to close at $3.81.
It’s never clean from the beginning. There’s going to be a lot of starts and stops for the next two to three quarters
Roth Capital Partners analyst Scott Fortune
While cannabis derivative products such as edibles, vapes and beverages have been legalized, they can only begin appearing on shelves after a 60-day moratorium ends on Dec. 16. Instead of jumping into the market now, Roth Capital Partners analyst Scott Fortune recommends that investors — especially those with a long-term scope — wait a few quarters until the market settles.
“We’ve seen this before in California,” Fortune said. “Every time you have a new legalization, it’s messy. It’s never clean from the beginning. There’s going to be a lot of starts and stops for the next two to three quarters.”
In the two months leading up to the legalization of cannabis in 2018, the North American Marijuana Index jumped more than 40 per cent. But after sales began on Oct.17, the benchmark index entered a downward spiral that would see it bottom out in late December. A cannabis 2.0 market won’t follow the same example, Fortune said, as he doesn’t expect stocks to once again run up in advance of sales.
Investors have switched their mindsets to focus on profitability, he said, something that very few cannabis companies have proven capable of producing. Even with the introduction of new products into the market, he doesn’t suspect that will change over the next three quarters.
Evolve ETFs portfolio manager Elliot Johnson thinks too much emphasis has been put on chasing profitability in the cannabis space. Most licensed producers are still focused on spending to expand their production ability, he said, and that’s likely to continue due to the new influx of product for which they’ll be responsible.
From the start, Johnson is focused on which companies will be able to establish brands, especially on beverages and edibles. He’s looking to the market leaders — Aurora, Canopy and Cronos — to be the ones who do so first — and is moving his portfolio toward them.
Hexo, in particular, stands out to AltaCorp Capital analyst David Kideckel. The Gatineau, Que.-based company has launched a joint venture with Molson Coors Brewing Co. called Truss Beverage Co that should make it in a front-runner in the drink category. Truss announced on Thursday that it will be ready to launch six cannabis-infused beverages in December.
Kideckel reduced his target price for Hexo after the company pulled its guidance and offered a profit warning last week but says his “bull thesis hasn’t changed at all.” His new target is $7.25 and he values Truss at $1.21 of that — or 17 per cent.
“We think Hexo is well-positioned to capture a good chink of the market, not only for beverages but other derivative products as well,” he said.
Fortune may be cautious on the space short-term, but does see opportunity in MediPharm as a play on the lack of infrastructure in place needed to extract product for the consumer demand related to cannabis 2.0.
Stocks may have bottomed, but “nothing’s changed fundamentally about the size and the opportunity” in the space — especially after 2.0 products hit shelves, Fortune insists.