The Canadian cannabis sector has officially taken off, and despite significant declines since the beginning of this year (some drops have been 50% or more in just a few months), investors looking for a good spot to back up the truck on any of Canada’s largest producers are likely to continue to be disappointed for a few reasons over the long term.
This article is intended to speak to investors considering buying cannabis stocks and holding on for a decade or more. Traders can do their own thing, but for those interested in an alternative perspective on the hype, which has infused a level of euphoria into a group of stocks I have seen only once in my lifetime previously, listen up.
The domestic growth argument
Canadian cannabis consumers are likely to buy Canadian cannabis. With legalization on the horizon, hype surrounding how many new Canadian consumers may choose to light up has many investors bullish on the Canadian market as a whole, leading to growth rates that have been ascribed to this sector that are out of this world. I have reported on just how much growth has been factored into the domestic Canadian market in the past, and readers should reference the numbers listed in these articles for historical perspective of just how crazy things were (and largely still are).
The international growth argument
The Canadian market for cannabis, like financial markets, represents a tiny sliver of global consumption. Where most companies are staking their claims appear to be on export markets, with companies like Aphria Inc. (TSX:APH) buying smaller companies (Nuuvera Inc.) in an explicit attempt to gain access to export markets and buy into global supply chains (or — dare I say it? — vie for global domination!)
The problem here, as Aphria investors may remember, is that export markets around the world are not really as open as we would like to think. With Aphria being forced to divest most of its U.S. assets to maintain a listing on the TSX and potentially join the ranks of Canadian cannabis companies listed on the NASDAQ, thinking about how “rosy” the international picture really is should be a priority for long-term investors in Canadian cannabis.
The competition argument
Some have said that since many Canadian cannabis companies have been at it for some time now, operational excellence and lower costs of production as a result of a learning curve advantage may allow for a more competitive product worldwide, and therefore a “first-mover advantage” which deserves some sort of premium.
I’m not saying the Canadian cannabis industry is destined to become the BlackBerry Ltd. (TSX:BB)(NYSE:BB) of the global market for smartphones, but the reality is that other large global players are getting larger, and Canada will need to compete on an even bigger scale. Population size is always an issue, so somehow Canadian companies will need to get significant footholds internationally to be able to have a shot — something I see to be problematic over the long term.
I just don’t understand the argument of why an Australian or German company would be able to pick up 20% market share in Canada. On the flip side, why would a country which recently legalized marijuana allow for the majority (or even a significant percentage) of its supply to come from Canada, when jobs and taxation could be created in a booming cannabis market in a country looking to legalize the commodity?
The quality argument
Another commonly referenced argument in favour of Canadian cannabis companies is that Canadian cannabis is better than stuff grown around the world.
I’m sorry, but a plant that comes from a seed that can be grown in a warehouse anywhere around the world using some of the best soils, which can also be bought and imported, doesn’t do much for me in terms of the ability of Canadian producers to really say they have the “best” stuff out there. While patenting and branding have certainly been attempted, the reality remains that the Canadian government’s restrictions on packaging is likely to provide a huge headwind for investors long term.
Like many other attractive, shiny investment opportunities out there, by digging a bit deeper, it becomes clear that the valuation multiples for these firms today are simply too high for any rational long-term investor to consider.
Just don’t do it.
Stay Foolish, my friends.
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Fool contributor Chris MacDonald has no position in any stocks mentioned in this article. The Motley Fool owns shares of BlackBerry. BlackBerry is a recommendation of Stock Advisor Canada.