Recently, I wrote an article analyzing shares in Aphria Inc. (TSX:APH). At the time they were trading at $11.30, and down about 43% year-to-date. In the article, I said it would be best for investors to wait for the fall before investing in Aphria shares. My reasoning was that since legalization would have a huge effect on the company, it would be best to wait and see what that effect would be.
Since then, there has been a major sector-wide rally in cannabis stocks. Aphria is up about 50% while Aurora Cannabis Inc. (TSX:ACB) is up some 9.3%. Kicked off by the huge 80% one-month gain in Canopy Growth Corp. (TSX:WEED)(NYSE:CGC) shares, the positive sentiment eventually spread to the other big cannabis stocks and drove them up as well.
It’s worth noting that both Aphria and Aurora are down year-to-date. Of the “big three,” only Canopy is pushing into all-time highs. However, if you’d invested in either of the other two in mid-August, you’d be sitting on major gains today.
Reasons for the rally
The main reason for the rally in cannabis stocks was Constellation Brands’ acquisition of 38% of Canopy Growth Corp. News of the purchase sent Canopy flying immediately, and the rallies in Aphria and Aurora followed about a week later.
The timing was probably not an accident. Stocks have a mild tendency to move in concert with one another–especially stocks in the same sector. Since Canopy is by far Canada’s largest cannabis stock, it’s likely that the good news for that company generated positive sentiment for cannabis stocks as a whole. Also, as the Canopy rally started before Aphria and Aurora took off, it’s possible that some investors may have felt they missed out on the former and bet on the others hoping they would become the next big thing.
It’s also possible that investors were hoping Aphria or Aurora would become acquisition targets themselves. It’s not an accident that Canopy was partially bought-out by a beer maker. Beer sales are stagnating worldwide, while (legal) cannabis sales are on the rise. One of the main reasons Constellation invested in Canopy was to form a partnership. Talks of cannabis infused beverages were part of the discussion. It seems as though Constellation partnered with Canopy to hitch its fortunes to a newer, up-and-coming product category — one that could revitalize its sales.
Constellation can’t be the only alcohol manufacturer thinking this way. But with warrants that let it purchase up to 50% of Canopy shares and appoint four of Canopy’s directors, this deal is more or less done. It’s therefore possible that other beer makers may set their sights on Aphria or Aurora as cannabis partner of choice. If that happens, a buyout at a premium valuation is not out of the question.
For now, though, I repeat my original advice:
Wait to see what effect–if any–legalization has on Canada’s cannabis makers before investing in these stocks.
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Fool contributor Andrew Button has no position in any of the stocks mentioned.