Investors in marijuana companies such as Canopy Growth Corp. (TSX:WEED) are betting big on the creation of a legal recreational market in Canada.
Let’s take a look the current situation to see if this is a good time to own these stocks.
Scary valuations
Valuations for marijuana companies are far beyond reason, given the current state of the market.
For example, medical marijuana market leader Canopy Growth reported revenue of about $10 million for the quarter ended December 31, 2016. The company continues to expand at a healthy rate, but that simply isn’t enough to justify a market capitalization of $1.6 billion.
So, what’s the attraction?
Investors are betting that Canada will open a legal recreational market in the summer of 2018. There’s no doubt the opportunity is huge, as estimates for the size of the market start at about $5 billion per year.
The Federal Government recently said it plans to table legislation in the coming months and have its ducks lined up to support an open market by July next year.
That sounds good, but the devil is in the details.
Ottawa has decided to let the provinces and territories shoulder the burden of deciding on distribution, sales, and pricing of cannabis products in their respective jurisdictions. This is no easy task to accomplish in a little more than a year. Committees have to be set up, studies conducted, public discussions held, and then the politicians actually have to start making some difficult decisions.
The most important might be tax.
If the provinces get too greedy, they will simply drive buyers to the black market. If they don’t collect enough tax, the costs of setting up, monitoring, and regulating the industry could outweigh the revenue. From a taxpayer’s perspective, if the province can’t make money on the sale of marijuana, there isn’t much sense in going through the process.
Deciding who gets to sell the products, where they sell them, and how they will be sold is also going to require careful consideration. If the rollout goes bad, it could cost many politicians their jobs at the next election.
All of this should be of concern to cannabis investors, but there is one small detail in the government’s plan that might be the biggest market killer.
DIY pot
In the task force report delivered to Ottawa last fall, the committee recommended allowing Canadians to grow a limited amount of marijuana at home for personal use. According to a recent report by the CBC, it appears Ottawa plans to allow four plants per household.
This is a potential risk for investors.
If Ottawa says you can legally grow your own supply, who is going to go around knocking on every Canadian door to ensure there are actually only four plants per household?
Think about it!
What should investors do?
The opportunities in this new market are certainly attractive, but investors might be getting ahead of themselves by buying marijuana stocks at the current valuations.
As such, I would keep any speculative position small, and if you managed to get in at the start of the game, it might be wise to book some profits.
