Pot Shots: The legal cannabis market hasn’t lived up to investors’ high hopes. Will that change?

Some pot equities may deserve a second chance.

Credit: Suharu Ogawa

Some pot equities may deserve a second chance

This article was originally published in our March issue, before the COVID-19 pandemic came to Canada.

For the national costume segment of the 2019 Miss Universe competition, Alyssa Boston, our very own Miss Universe Canada, came out wearing a smoking ensemble—literally. Dressed head to toe as a marijuana plant, holding a pot leaf sceptre as if she were the Dumbledore of Dope, Ms. Boston deconstructed her look: “It’s something that we’re very proud of in Canada,” she explained, referring to our Great Cannabis Experiment. “It’s a brand-new industry, and there’s a lot of potential.”

Apologies to Ms. Boston, but from an investor’s perspective, that’s a dime bag of ditch weed. Considering the state of the pot sector, you’d be forgiven for thinking that despite the flamboyance of the costume, the emperor—or empress—is wearing very few clothes. Last year showed much early promise. By the spring of 2019, many of Canada’s highest-profile marijuana companies were scaling brave new heights. Canopy Growth Corp. was the world’s most valuable cannabis company; by the end of April, its share price had topped $70. Around the same time, Tilray had climbed down from its ridiculous 2018 highs but was still packing a premium: in March 2109, it cost around US$70 per share to play in the Nanaimo-based producer’s sandbox. Mergers and acquisitions—and the equity gains that tend to accompany these moves—were commonplace. Everyone wanted in. How to describe the sector? “Frothy” comes to mind.

It would not last. By October, the once-glowing evaluations had been clawed way back, and terms like “flameout,” “disaster” and “bloodletting” studded media coverage. After posting huge second-quarter losses, Ontario-headquartered Canopy shed about 40 percent of its value, while Tilray had come back down to Earth—to the tune of around US$18, a precipitous drop of nearly 80 percent. They were hardly alone. Most cannabis companies had fallen by two thirds from their annual highs. One Globe and Mail headline seemed almost gleeful: “How to lose half your money: Buy Canada’s pioneering pot ETF on legalization day.”

What happened? Supply issues. Red tape. Poor retail rollout. Surprisingly resilient black market. But much of it was thanks to over-the-top hype. This was a new business, although one with an existing customer base and what was believed to be enormous upside. In the rush to line pockets, cannabis equities were released from the buzz-kill tyranny of reality as talk of “potential” replaced conventional, passé metrics like P/E ratios and, you know, actual sales. Could it be that the number of people who actually want to use cannabis may not be as high as initially thought? Talk about sobering.

Not everything is doom and gloom, and a few companies have done fairly well, which is all the more impressive when you consider the scale of the slaughter. California-based real estate investment trust Innovative Industrial Properties is one; look for others to concentrate on property plays. Constellation Brands, the giant U.S. booze conglomerate with a significant stake in Canopy, recently installed its CFO, the extremely competent David Klein, to guide the licensed producer through the next phase. And the across-the-board discounts often mean that solid companies with good management and can be bought on the cheap.

Other positives spring from the sector’s failures. Again, so much of the early stratospheric gains were based on promise, not fundamentals. Like with the run-up to the dot-com crash at the turn of the millennium, irrational exuberance figured as a prime driver of the cannabis equities market. After 2019, a new—and far more conservative—baseline for expectations has likely been established. This bodes well, down the road, at least. It’s an old investment adage: what goes up must come down. Its corollary, however, isn’t necessarily true—regardless of how much hot air is involved.