Some younger folk might not know the Cheech and Chong movie, Up in Smoke. It was a 1978 stoner comedy that received mixed to negative reviews at the time. Nevertheless it was a success and is now considered a classic. As I remember it was about a couple of bumbling stoners that could not do much right and only a little more so when they were stoned.
It now reminds me of Canada's version of marijuana legalization. Perhaps the legislators should have been stoned when they made this policy change, because they sure screwed it up. There are excessive rules and legislation around growing marijuana. However the biggest mistake, at least so far, is a very poor retail market for recreational use. Ontario is the largest province in Canada, with about 40% of the population, and is now putting plans in place to open the first 25 marijuana stores. It was a lottery and many of the winners have no or very little retail or business experience.
The biggest joke is the low number. I can drive about 20 minutes down the highway from where I live to the First Nations reserve, where there are over 50 outlets operating and they are all busy. Since legalization, users are not concerned with transporting marijuana they buy on the reserve. Many are driving one to two hours to get it. The product, for the most part, comes from the black market. Just one outlet, Legacy 420, claims it has revenue of about $20 million per year, and that was before legalization.
Many have compared the size of the marijuana market to the beer and wine or alcohol market. According to the Liquor Control Board of Ontario's (LCBO's) latest report, there are 2,332 retail outlets in Ontario, compared to 25 future marijuana outlets. Are you laughing yet? I hope that when CBD-infused beverages are legalized later this year, they simply put them on the shelves of the LCBO, but that would be too simple and cost-effective.
With inflated prices, bans on edibles, heavy regulation of cultivators and limits on private retailing, consumers continue dialing up their friendly neighborhood dealer to avoid all that. The Canadian and Ontario legal marijuana market is going to take many years to gain substantial ground on the black market. I believe it is important for investors to focus on companies who are expanding or focused outside of Canada, are establishing brands and are not affected by the restrictions in the Canadian retail market. This is also a follow up on my Oct. 4 report on the sector, where I warned that overinflated stocks were due for a correction.
Both the Canadian and U.S. marijuana indexes had a very significant plunge after my Oct. 4 report and have now bounced up. The Canadian index peaked in January 2018 and had a bear market rally to the October 2018 high. It then plunged to new bear market lows in December 2018. The current rally looks like another bear rally.
By contrast the U.S. marijuana index made a new bull market high in October 2018. The jury is still out on whether the index can make new highs. As long as the index holds above the 105–110 area all is good, but a drop below that level could signal a more substantial correction. The moves in both indexes are often volatile, moving over 20% in either direction.
Let's look at some previous stocks I commented on and a couple new ones.
Canopy Growth Corp. (WEED:TSX; TWMJF:OTC.MKTS); market cap US$15.5 billion
Canopy has done a lot of diversification outside Canada. In mid-January it made a $150 million investment to develop large-scale hemp production in New York state.
On Feb. 7, Canopy announced it is increasing its interest in Canopy Rivers from 26.5% to 27.3%. Canopy Rivers works collaboratively with Canopy Growth to identify strategic counterparties seeking financial and/or operating support and affiliation with the Canopy Growth group of companies. This helps to build the Canopy brand and also provides diversification outside Canada.
According to the company, Canopy Rivers has recently expanded its portfolio by making several innovative investments in the cannabis market worldwide, including:
- An equity interest in Headset, a real-time data and analytics company;
- Financing of Greenhouse Juice Company, a health and wellness beverage company;
- Increasing its ownership in Canapar, an Italy-based hemp production and processing platform capitalizing on the rapidly expanding European CBD (cannabidiol) market.
On Jan. 21, Canopy updated its operations in Poland and the U.K. According to the company release, in the United Kingdom, Canopy formed Spectrum Biomedical U.K., a new company focused on providing access to cannabis-based medicinal products to United Kingdom patients with severe unmet clinical need. In addition to expanding its medicinal cannabis operations in the United Kingdom, Canopy Growth's Torun-based team, Spectrum Cannabis Polska in Poland, successfully completed its first import of medical cannabis after completing a rigorous regulatory approval process to have the product assessed and approved for sale.
On Feb. 28 Canopy and Sequential Brands Group (SQBG) announced "Martha Stewart has joined the company in an advisory role to assist with developing and positioning a broad new line of product offerings across multiple categories. With decades of success in publishing, broadcasting, online and merchandising, Martha Stewart has firmly cemented herself as one of the most well-respected businesswomen in the United States."
Canopy reported excellent Q3 results on Feb. 14 in Canadian dollars. It was the first full quarter of recreational sales in Canada and revenue increased to $83 million, up 256% from the previous quarter. The company sold 10,102 kilograms of cannabis and oil equivalent. The company is still losing money and my first concern was that the great quarter was due to inventory drawdown in anticipation of legalization. However, inventory at Dec. 31 was $184,961,000, up from $150,406,000 reported Sept. 30, so that was good to see.
I have no doubt Canopy will be a leader and one of the best brands in the cannabis space, but investors are already paying the price for it. At the current annual revenue run rate and subtracting $4 billion cash from the market cap, the stock is trading around 50 times revenue. This is very expensive, but is often the case with high growth stocks where investors are pricing the stock on much higher future revenues and earnings. Once there is a whiff of slower growth, the stock will sell off hard. That is the risk before and on the next quarterly report, as I believe it will be very difficult for Canopy to report triple-digit growth over the last quarter.
This chart is in US$ price and I see heavy resistance in the $50 to $55 area, which the stock has already tested in this rally. I see some support around $42 and strong support around $30. I see too much risk to be long now, and if you are, I would look to exit on a rally to $49 and a stop/loss at $42.
Tilray Inc. (TLRY:NASDAQ); market cap $6.5 billion
The stock has dropped over 50% since my warning that it was way too expensive in early October 2018, and I still can't find a good reason to own it. There is simply too much hype on this stock and even on the company's website it is hard to wade through and find the real news. It is making some good moves though, taking advantage of its high share valuation and cash.
On Feb. 28 the company closed the acquisition of Manitoba Harvest. "Founded in 1998, Manitoba Harvest is the world's largest hemp food manufacturer and a leader in the natural foods industry. It produces, manufactures, markets and distributes a broad-based portfolio of hemp-based consumer products, which are sold in over 16,000 stores at major retailers across the U.S. and Canada."
On March 3 Tilray announced its wholly owned subsidiary, "Tilray Portugal Unipessoal Lda (Tilray Portugal) has completed a successful harvest of medical cannabis at the Company's European Union (EU) Campus in Portugal."
To help build its brand, on Jan. 15 Tilray announced it has signed a long-term revenue sharing agreement to market and distribute a portfolio of consumer cannabis products within Authentic Brands Group's (ABG's) brand portfolio in jurisdictions where regulations permit.
In the release, Tilray states, "As the owner of more than 50 brands, ABG builds value by partnering with an expansive network of best-in-class manufacturers, operators and retailers. With a global retail footprint of over 100,000 points of sale and more than 4,500 branded freestanding stores and shop-in-shops, ABG's portfolio generates approximately US$9 billion in retail sales annually."
Tilray is licensed to produce medial cannabis in Chile and through its Tilray Latin America subsidiary can import and distribute products in Chile and Brazil. Tilray currently has medical cannabis products in 12 countries through subsidiaries in Australia and New Zealand, Canada Germany and Portugal, along with Latin America. Given the direction Tilray is heading, with global ambitions, it should be compared to the likes of Canopy and Aurora Cannabis Inc. (ACB), but it falls far short.
Tilray will report Q4 and year-end earnings on March 18. Its Q3 results, reported on Nov. 13, 2018, came in at US$10.0 million in revenue and it had cash of $104 million. Tilray completed $475 million in convertible senior notes in October 2018 to bolster its cash position. At a $40 million revenue annual run rate, the stock is trading at 150 times annual revenue, which is about three times the price of Canopy using this comparable.
The stock is still too expensive and the chart shows it could be on the verge of a technical break down. The stock price is just above a good support level at $65. A close at $64 or lower would be a bad sign, without much support until it drops to around the $25 area. That is where I expect the stock is headed and the March 18 earnings report could be the catalyst to get it started.
Valens Groworks Corp. (VGW:CSE; MYMSF:OTC ): 93.2 million (93.2M) shares out; market cap CA$280M; cash on hand $41M
A company that has something in common with both Canopy and Tilray is Valens Groworks. Valens' expertise is in extraction to produce oils and resins, with a current annual capacity to process 240,000 kilograms of dried cannabis. They are recognized as a leader in this regard and have agreements with many large cannabis producers.
On Dec. 13, 2018, Valens announced a deal to provide multiyear extraction services for Canopy Growth, and on Feb. 26, 2019, announced a multiyear deal with Tilray for a minimum of 15,000 kilograms (15,000 kg) of dried cannabis per year.
Valens has announced numerous similar deals with Organigram, Sundial Growers, Harvest One and, most recently, on March 11, with Green Organic Dutchman, who will supply Valens with an annual minimum of 30,000 kg in the first year and 50,000 kg in year two.
Valens does not require big grow facilities and will benefit from the much higher margins on cannabis oil. Its proprietary extraction process is boasted as the best and most efficient on the market. Investors are able to attest to this with the ISO 17025 certification, the Thermo Fisher award and supply deals with Canopy Growth, Tilray and many others.
This graphic is a slide from the Valens presentation.
There are many advantages to a focus on oils and resins, such as:
- a longer shelf life compared to the flower;
- aging flower can be bought at a discount;
- numerous uses as shown above;
- higher margins on oils and resins.
An obvious way you can verify the higher margins is looking at any of the LPs recent financials that are selling oils. They all claim increased dollar values per gram sold, and attribute this increase to higher ratios of oil and concentrate sales.
There has been much hype in the market about the Constellation deal with Canopy for beverages, Molson Coors Canada, and speculation about Coca-Cola. Valens is already positioned as well or better than anyone for the beverage market in 2019. Its multiyear deal with Tarukino Holdings gives Valens access to Tarukino's proprietary emulsion technology, which transforms cannabis into a water-soluble form for beverages while masking any cannabis taste. Valens also has the distribution rights in Canada for Tarukino's popular Happy Apple drink, Washington State's #1 selling cannabis infused drink three years in a row, and Pearl20, which can be used to mix drinks and edibles.
Tarulino's SōRSE emulsion technology surrounds oils, transforming the entire solution into water-compatible forms. All of this means you can add cannabis to products, including beverages, without that "weed" taste or smell. The product also:
- is shelf stable for over 180 days (not proven anywhere else);
- has zero cannabis taste, color or odor;
- provides effective, consistent dosing;
- has lower dosage due to an increase in bio-availability when consumed;
- has a faster onset and offset, making it the safer and more trusted edible option.
Oil usage has grown at faster rates than flower usage since soon after recreational legalization. You will find this is the case in Colorado, Washington and other legal states. Also note that Canopy reported oils at 33% of revenue, up from 23% in the same period last year, which further attests to this.
Canopy sold 10,102 kg of cannabis equivalent in the latest quarter, which would be 40,408 kg in a year. Valens is able to process 250,000 kg per year, and just its deal with Green Organic Dutchman, and Tilray is at 45,000 kg in the first year. In essence Valens will be processing and selling more kilograms of cannabis equivalent than a number of the major producers combined.
Valens will not post the large revenues of selling a lot of consumer end product (flower) but will be capturing the margins on flower to oil, which are quite large. Its input costs are much lower and Valens is most likely to be more profitable than the big LPs. In its presentation, Altacorp Capital is shown as initiating coverage with revenue estimate of $43.5 million in 2019 and $118.7 million in 2020.
Subtract $40 million cash from the $280 million market cap and the stock is trading at only five times projected 2019 revenues, very cheap in comparison to most.
It is also worth noting that Valens Labs has a Health Canada Dealers license, is the first ISO 17025 accredited lab in Canada for a cannabis matrix and has been named a "Center of Excellence in Plant Based Science" by Thermo Fischer Scientific.
Valens Farms' B.C. cultivation
This was a great deal for Valens because its a zero cash outlay, with Kosha contributing 100% of land, building and equipment costs. All hard assets will be split 50/50 between Kosha and Valens, thereby providing $37.5 million of net assets to Valens' balance sheet with no cash outlay or liability incurred. Valens and Kosha will split profits on a 50/50 basis following cost recovery by Kosha. Valens Farms is expecting Phase 1 production of up to 56,000 kg per year of premium monocrop cannabis, primarily for extraction purposes. This will be exclusively extracted by Valens and made into Valens branded products.
The stock trades more volume on the Canadian side under symbol VGW, but this US$ price chart shows a higher close, and trading above US$2.25 in February, so a technical breakout. The recent pullback is a decent entry level and has established some support around $1.80. A close above $2.45 would be very positive.
RISE Life Science Corp. (RLSC:CSE) is quite interesting and a hidden gem
Volumes are light, so it may take some patience to buy below US$0.25. The stock also trades in Canada; its market cap is CA$13 million.
If you speak with any pothead, they will tell you that cannabis can cure anything and is good for everything, including better sex. RISE does not have any cannabis production but has developed its own brand of wellness products, including some for sexual enhancement. They say "sex sells," so this could be a nice advantage for RISE.
RISE just started sales in Southern California in June/July, so its last financials only reflect about one month of sales, which was CA$141,783. The company has just raised CA$5.5 million and have expanded into Mexico. We will need to see at least a couple quarters of sales revenues to get an idea how its products are moving
In the end of January Greg Mills, formerly head of RBC Capital Markets' global equities, joined the RISE board of directors. According to the announcement, "Mills joined RBC in 1998 as head of equity trading, and in 2005 was promoted to head of global equities and served in that position until 2018. Mills' key responsibilities included business planning, risk management, global profit and loss, client relationships employee governance and equity research."
In early February RISE selected Solcanna SA de CV to act as a distributor of its Life Bloom Organics brand of cannabidiol-based health and wellness products in Mexico. According to the announcement, "The initial purchase order executed with Solcanna will see Life Bloom Organics' wellness formulation initially placed in three key Mexican markets: Mexico City, Guadalajara and Monterrey. . .Solcanna and RISE have planned this launch in the Mexican marketplace with an initial order of approximately $350,000 to place product at retailers in Mexico City, Guadalajara and Monterrey. The expectation is for recurring orders to be placed, additional Mexican markets to be launched, and additional products to be added to RISE's Mexican portfolio."
The announcement goes on to state, "Delivery of product to Solcanna is subject to regulatory approval from COFEPRIS, the Mexican Secretariat of Health's agency responsible for the regulation of a variety of food- and health-related products in Mexico, to which application has been made." Mexico is a huge market with a population of over 123 million people and the government is moving toward legalization. The government controls the house, so no major setbacks are expected with the legislation.
Products
Life Bloom Organics' proprietary Nano hemp extract oral sprays can be found at natural health food markets, chiropractic offices, specialty retailers and medical dispensaries in Southern California, as well as online.
The U.S. farm bill is a direct and significant benefit for RISE Life Science
In its statement on the farm bill, the company noted "RISE's lifestyle product brands, Life Bloom Organics and Karezza, feature hemp-extracted cannabidiol oil. Using industrial hemp—the same material legalized by the 2019 Farm Bill—has allowed their products to be available to all U.S. consumers, with shipping offered to all 50 states. Using industrial hemp in their formulations also means that the RISE Life Science brands will benefit from continued and even greater access to quality raw plant materials. The farm bill helps support hemp farmers by providing them with agricultural benefits and support not previously available."
I believe the Karezza product line differentiates RISE from most or all competitors. On July 12, 2018, RISE acquired Cultivate Kind. "This added significant in-market expertise, provides immediate revenue to the company and brings U.S. distribution capabilities in-house. Cultivate Kind was born from the traditional CPG agency world, and brings over 30 years of consumer marketing experience and brand launch strategy to the RISE portfolio. For any start up with products, marketing experience is essential."
I believe RISE is positioned very well in this new cannabis market and the stock prices has not reflected that yet. There is more trading on the Canadian side so I show that chart. There is an uptrend in place and the pullback from recent highs gives a better entry price. It will probably take prices over $0.40 for liquidity to improve.
Ron Struthers founded Struthers' Resource Stock Report 23 years ago. The report covers senior and junior companies with ample trading liquidity. He started his Millennium Index of dividend stocks in 2003 - $1,000 invested then was worth over $4,000 end of 2014 and the index returned 26.8% in 2016. He retired from IBM after 30 years in customer service, systems and business analyst, also developing his own charting software. He has expertise in junior start-ups and was a co-founder of Paramount Gold and Silver.
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