Canopy Growth Corp (TSE:WEED) (OTCMKTS:TWMJF) (FRA:11L1) was cast in a negative light recently by one of the more venerable media properties in the United States.

Already laboring under crumbling sentiment and legalization timeline uncertainty, Barron’s delivered an unfortunately-timed gut punch to the cannabis sector on March 30th. In a piece titled Marijuana Stocks Could Be A Buzzkill (alternate link), the 97-year old financial publishing icon questioned the valuation of Canadian marijuana stocks, deeply inferring multiples were much too high. Many investors regard that article as the spark which lit the recent dumpster fire in the space. But was the piece an accurate portrayal of the Canadian cannabis market, or hit piece in disguise? We examine.

My first observation upon reading the piece was that it was reasonably well researched from a top line perspective. It’s hard to dispute many of the actual facts strewn throughout. Yes, valuations are currently monumental in many cases; yes, operating cash flow remains deeply negative industry-wide; and yes, investors already expect cannabis prices to drop (best case: remain steady) post-legalization. There’s very few people I’ve encountered who believe cannabis is magically “different” from other cash agricultural crops.

While the article’s tenor is undoubtedly bearish, author Bill Alpert does pay more than cursory homage to the bullish perspective. This manifests itself in several instances, most notably by a quote from bullish Eight Capital analyst Daniel Pearlstein, who claims “This is a market that is simply way bigger than a lot of people believe.” (quote bolded by the author). Alpert further notes “Canada’s recreational cannabis use is among the highest in the world”, implying domestic sales targets can be met. This wasn’t a true ‘hit piece’ in an unequivocally totalitarian sense; some modicum of balance was presented.

With that said, I have questions regarding several aspects of the piece—including timing. By focusing almost exclusively on current earnings/cash flow and domestic market potential, the author seemingly paints an inaccurate portrait of aggregate market potential. Widen the scope a little bit, and some of the valuation numbers don’t appear so daunting.

It’s the same reason why so many tech stocks, for example, can toil at ridiculous price/sales numbers with more daunting odds of achieving commercial success. Heck, even Amazon.com was hemorrhaging hundreds of millions of dollars over two decades before it became marginally profitable over the past few quarters. Yet, the price has gone parabolic (twice) well before that profitability point, and continues to trade at 233 price/earnings.

It’s all about forward earnings projections, which this article (mostly) seems to miss by focusing almost exclusively on domestic sales.

As such, I posit five questions to the author which, if covered, could have completely changed the tenor of the article:

Question #1

The article states: “These companies trade for more than 100 times their 2017 sales, and several hundred times that year’s cash flows.”

Q: Why would investors care how the market was valued based on last year’s earnings when legalization hasn’t taken place yet? Does the author believe investors invest based or trailing revenue and cash flow models?

We get that 2017 earnings are the only comps available, but they’re certainly not the numbers being used in today’s investing-based decision making.

Question #2

The article states: “If Canada’s retail market can reach $9 billion in annual sales in a few years—as one bull estimates it will—that would yield only a couple of billion dollars in cash flow to wholesale producers like Canopy. So today’s investors are effectively paying 15 times the industry’s cash flow five years from now.”

Q: Why doesn’t the author take into account significant cash flow expectations generated from international markets where cannabis is being introduced? Does the author believe the conglomerate cannabis survivors—like Canopy Growth—will only generate profits in Canada? If not, why doesn’t the author includes revenue models for markets in Europe (Scandinavia, Spain, Germany, Switzerland, U.K.) South America and Australia?

Suddenly, that “15 times the industry’s cash flow five years from now” statement gets much less myopic.

Question #3

The article states: “Traveling in Canada, cabbies, bankers, and even border guards will tell you their favorites in a bubble that has floated Canadian cannabis stocks to a collective stock-market value above $30 billion. That’s already about half the market capitalization of Canada’s gold mining industry.”

Q: According to the Canadian Marijuana Index, the Top-25 cannabis companies were collectively trading at approximately $23.8 billion at publishing time. If we include valuations of companies outside the Top-25, like Harvest One Cannabis, Delta 9 Cannabis and Cannex Capital Holdings, we can perhaps tack on another $2 billion more. Why did the author use outdated statistics to inflate the true worth of cannabis valuations if not to prove a point?

Remember, many of the junior players are already operating in legalized states south of the border, yet no mention of U.S. revenue integrations were elucidated.

[fvplayer src=”https://www.youtube.com/watch?v=FJwHJO0db-8″]

Cannex Capital Holdings Inc (CSE:CNNX) Director and CEO Anthony Dutton talks to James about their recent listing in the public markets. Cannex acquired a major cannabis player in Washington State which did over 3 million in sales for the month of January 2018 alone.

Question #4

The article states: “Most predictions fail to consider the dizzying price drops registered in states like Colorado and Washington after they legalized marijuana.”

Q: Can the author ensure this statement is accurate, given that Canopy Growth CEO Bruce Linton communicated this very fact last month at the Economic Club of Canada? Other CEOs—like Vic Neufeld of Aphria Inc.—have discussed and revolved their business models around this very scenario. Watch (beginning around 7:40).

Question #5

Timing: Why was the article disseminated now, with pot stocks 30-50% removed from peak valuations? While the thesis still has merit, the bearish case is undoubtedly less powerful than it was three months prior. Echoing the sentiments of Midas Letter CEO James West:

It is curious that the piece would decide to jump all over the sector, rather than take aim during the really frothy spell that occurred in mid-January, and saw Canopy Growth touch its all time high of $44 a share.

Peculiarly, the article is disseminated on a Friday (closed session) of a long weekend, giving investors extra time to stew on the thesis.

While we don’t expect to receive a reply, we hope these questions provide additional prospective lacking from the original piece. With so many moving parts and international jurisdictions coming online, context is everything.

Technical Take