The Canadian cannabis industry has been on a wild ride heading into legalization in 2018, and in the years following. Companies in this sector saw their valuations surge to multi-billion dollar market capitalizations (in many cases) as expectations of sky-high growth in a fully legalized market created a euphoria around this sector, which isn’t typically seen within the Canadian stock market.
Companies like Canopy Growth (TSX:WEED) and Aurora Cannabis (TSX:ACB) saw absolutely remarkable valuations as investors looked to pinpoint which companies would see the greatest upside from legalization. However, as the stock charts below show, it’s been a rough past five years for these former high-flying growth stocks in particular, and most in the sector.
Now, the question is whether it’s possible the cannabis bubble could re-inflate, and what would drive outsized interest once again in these two stocks, and this sector as a whole.
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Canopy and Aurora
I think Canopy Growth and Aurora Cannabis are two of the best companies to look at when assessing previous hype around the cannabis sector.
These two companies produce both medical and recreational cannabis, under some of the most renowned brands in the market. Additionally, both companies have exported to other markets where medicinal marijuana is legal. They are companies many investors were betting could be beneficiaries of eventual legalization in the U.S. market.
Unfortunately, despite some bullish rhetoric during the Biden administration, the legalization discussion in the U.S. never really took off as many industry experts were hoping. And with another Trump administration set to take hold, odds of legalization materializing appear to be getting lower by the day.
Additionally, underlying fundamentals for both companies have taken a hit, in large part due to the accounting practices that allowed these companies to see their net income and revenue surge in the early days before and immediately following legalization (essentially, revenue was a function of plants grown but not yet sold), so when demand didn’t materialize as many expected, these companies’ valuations took a hit.
In order for there to be a broad-based rebound among cannabis stocks, I think we’d need to see a resurgence of demand for legal weed in Canada. Right now, the black market appears to remain very strong, with too much activity taking place behind the scenes (to avoid very high taxes on legal product sold at retail stores).
Additionally, it’s unclear that the cost-cutting measures Canopy, Aurora, and most companies in this space are putting forward will ultimately be good for growth. From both a supply and demand standpoint, cash flow projections for this sector remain muted, and that’s the underlying story here.
So, a rebound can’t ever happen?
In my view, there are some exogenous events that could re-inflate the hype bubble around the Canadian cannabis sector. For one, if a 180-degree turn is seen in the U.S. market and the incoming tariff war doesn’t happen, and cananbis is legalized or rescheduled on a federal level, maybe there’s something to the narrative that Canadian cannabis producers can benefit. That said, both Biden and Trump have taken an “America first” stance on trade. Trump has been even more antithetical to the idea that trade with Canada will boom anytime soon. So, there’s that.
I think that a recovery in Canadian cannabis stocks will have to come from domestic demand picking up. Right now, I’m not seeing that in the data. So, until things change, this is a sector that could remain cheap on a valuation basis for a long time.
