Is Canada’s pot sector all dried up?

Canadian marijuana stocks have taken a tumble of late, but as we move closer to next year’s legalization of recreational cannabis, investors are wondering where the sector is headed. Is there another major run in the works? With so many unknowns about the pot industry, anything’s possible.

Canadian cannabis stocks have certainly seen healthy growth, stretching back to the fall of 2015 when the Liberal government first came to power on the promise of turning over a century’s worth of prohibition on recreational use. Even leading up to this April’s introduction of a legal framework, stocks bounced upwards. Only to fall into the doldrums ever since.

Some, like Canopy Growth Corp., Canada’s first billion-dollar pot company, have seen shares drop 21 per cent over the past three months. Markham, Ontario’s MedReleaf Corp. lost a whopping 28 per cent after its IPO, and across the continent, the North American Medical Marijuana Index has fallen 21 per cent in three months.

Is this a correction? Are cannabis stocks overvalued? There’s going to be a long build-up between now and next summer, so what can we expect from the industry?

“I don’t think the stocks are overvalued,” says Bruce Linton, Chief Executive Officer of Canopy Growth Corp., to Cantech Letter. “Why have they gone a little quieter? Over the last two years, we’ve had a good news cycle for cannabis. Right now, there are no new major federal events, other than say next June when they cut the ribbons on the first points of sale. Currently, it’s all of us companies just working away.”

Darren Karasiuk, VP Strategy at MedReleaf, agrees. “Clearly, we see a lot of growth for the cannabis sector,” says Karasiuk to Cantech. “The medical market continues to outpace Health Canada estimates and new global markets continue to open and are looking to Canada, a global leader, for insight and direction.”

Right now, countries like Germany, Australia and Brazil are making moves towards legalization, meaning that the few years’ head start owned by Canadian companies may be the difference in the end. In fact, that could be the cannabis sector’s saving grace.

  Canopy CEO Linton: “Right now, there are no new major federal events, other than say next June when they cut the ribbons on the first points of sale. Currently, it’s all of us companies just working away.”

Speculation has it that once the recreational industry gets up and running, the big players in the rec industry (think alcohol and tobacco) will want to swoop into the newly-developed territory, meaning that only the strongest of Canada’s marijuana companies will have a fighting chance.

“We believe that there will be M&A activity in the future, most likely from global tobacco, alcohol or pharmaceutical companies, even agricultural tech companies,” says Noel Atkinson, an analyst who covers the sector for Clarus Securities, to Cantech. “But we don’t expect any of that until it’s crystal clear that the recreational market is rolling out to expectations. Likely, it’ll take six months to a year after legalization to see how it all shakes out.”

Although there are a few examples to draw upon —states like Colorado and Washington in the US, for example— legal recreational pot still carries a frightening number of unknowns. How much of the current black market production will shift over to legitimate businesses? Who among us curious Canadians or casual pot smokers will start indulging on a regular basis? When will pharmacies get involved and inevitably start squeezing profit margins for producers?

All that makes the market too unstable for many investors, but Atkinson contends that once legal pot gets going, the field will whittle down to a more manageable set of legitimate, investable companies.

“Today, we see a small handful of the current licensed producers that we call advanced producers, with a meaningful history of producing to Health Canada requirements and trying to continually innovate their processes, setting up international connections,” says Atkinson. “Of all the public companies out there, it’s these advanced producers that are going to dominate once this sector evolves.”

It’s still not easy to know how to pick ‘em, though, as right now, public marijuana companies seem to be travelling in pack formation.

“From a valuation standpoint, the most difficult thing is that you’re trying to project on what we know today to 2020, ’21,” says Bruce Campbell, portfolio manager at StoneCastle Investment Management, to Cantech. “But I think right now, the valuations are probably pretty decent, if anything they’re more attractive now than they were going back to April.”

“It’ll take a while, but you’ll eventually see the sector sort itself out as individual companies instead of trading up and down as a whole sector,” says Campbell. “Then, it’ll come down to who’s executing, who’s producing at a level that they said they’d produce, that’ll drive the individual stock prices.”