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Canopy Growth Corp. and other weed stocks could be wildly overvalued, this PM says

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Brian Madden, portfolio manager at Goodreid Investment Counsel

Weed stocks such as sector leader Canopy Growth Corp. (Canopy Growth Stock Quote, Chart, News: TSX:WEED) may be drifting towards prices not seen since mid-December, but tantalizing as they may be their multiples are still too crazy, says Brian Madden, senior vice president and portfolio manager at Goodreid Investment Counsel.

Madden thinks stocks like Canopy Growth Corp. face a future in which they may end up the poster boys for a low-margin space where returns are similar to those of agricultural crops like corn or soybeans.

The portfolio manager says he avoids stocks like Canopy and others because of this top-down assessment.

2018’s Q1 has been a pretty turbulent time for Canada’s marijuana stocks, as shares of companies like Canopy and Aurora Cannabis (TSX:ACB) reached all-time highs at the start of January, only to fall back down to Earth and stay flat for the rest of the quarter.

Canopy hit a high of $44.00 by January 9 but closed on Wednesday at $27.64, while Aurora’s peak of $15.20 came a bit later on January 24. It, too, is now trending lower, closing Wednesday at $7.62. Horizons Marijuana Life Sciences ETF (TSX:HMMJ), a marker for the sector in general, lost ten per cent of its value over the quarter.

But down or not, a real industry will by most accounts be up and running in a half-year’s time, one which experts say will be bigger than beer or tobacco. In January, Statistics Canada came out with a report estimating that Canadian adults spent $5.7 billion on marijuana last year, of either the medical, legal variety or the illegal recreational kind.

In itself, that number is smaller than that spent on alcohol (over $22 billion last year) or tobacco ($16 billion), but only a small fraction of Canada’s alcohol and tobacco consumption is domestically produced, whereas the vast majority of the cannabis will be, come legalization. And if the legal market ends up drawing in even more Canadians than the black market has, that means a big industry is about to take off.

But what kind of industry is the question.

Madden, for one, says that it’s likely going to be closer to an agricultural crop than a high-margin product like beer or cigarettes, which would cut significantly into valuations for Canada’s pot stocks, he says.

“There are two possible ends to that continuum,” said Madden in conversation with BNN. “[The marijuana sector] could evolve into being something akin to an agricultural commodity grower like soybeans or corn or wheat or barley where that margin is something like two, three or four per cent and the return on invested capital is similarly skinny, in the single digits —in which case, these companies don’t warrant much of a multiple on their earnings or their book value or their sales, at all.”

Madden says that at the other end of the spectrum is the scenario where the cannabis market emerges as closer to the branded production seen in either liquor or tobacco, where the margins are up around 45 or 50 per cent. Which is unlikely.

“We don’t think that’s going to happen. And that’s why we’d be wary of these stocks even at these lower prices,” he says.

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About The Author /

Jayson is a writer, researcher and educator with a PhD in political philosophy from the University of Ottawa. His interests range from bioethics and innovations in the health sciences to governance, social justice and the history of ideas.

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