Despite cheap valuations, pot stock outlook cloudy for 2022

After a disappointing 2021, investors may be wondering whether this is the year cannabis stocks spark back up.

With valuations at multi-year lows for many U.S. and Canadian pot stocks, 2022 could be a buying opportunity for savvy investors willing to take a bet on a potential market that is expected to surpass the US$50 billion mark in 2025, according to industry consultancy New Frontier Data.

Cannabis still carries a significant amount of risk for investors. Rising demand during the COVID-19 pandemic and a boom in the number of licensed stores pushed sales in Canada to about $4.2 billion last year, while Americans snapped up US$25 billion worth of marijuana. Nevertheless, valuations for the companies that produce the stuff took a dramatic tumble.

"Things are looking very, very cheap right now," said Nawan Butt, portfolio manager at Purpose Investments and the manager of the firm's cannabis fund. "The overall risk-off sentiment in the market is causing some of the downside in cannabis right now."

Closer to home, Canopy Growth Corp., backed by U.S. alcohol giant Constellation Brands Inc., saw its stock fall by two-thirds in 2021. Tilray, which leads the Canadian market with a 12 per cent share of sales, trimmed its valuation by nearly one-quarter. Auxly Cannabis Group Inc., another major player that rapidly increased its market share in 2021, lost half its value last year.

Those declines came amid a broad struggle among industry players to become profitable while operating in a hyper-competitive market with nearly 300 producers selling into the recreational space across the country, coupled with a fickle consumer base and an ongoing price war with a still-relevant illicit market.

Craig Wiggins, managing director of The Cannalysts Inc., an independent cannabis research firm, maintains a bearish view of the sector.

"It's uninvestible," he said in an interview. "Until someone shows progress, which I define as an increase in sales greater than how the market is growing, and your gross margin is positive in a sustainable way, and you can cover your [selling, general and administrative expenses], there's no company right now that can meet that very low bar."

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THIS WEEK'S TOP STORIES

CannTrust on the brink of winding down amid liquidity shortfall

CannTrust's final chapter may see the beleaguered cannabis producer wound down as a result of liquidity challenges it faces after dispersing $50 million to settle several class-action lawsuits. On Thursday, the company said it is in default of a minimum covenant tied to its EBITDA under terms of the debtor-in-possession loan it obtained after it was granted creditor protection. It stated in a release that it is in discussions with potential investors and strategic partners to determine if the company can continue, be wound down or its assets sold. CannTrust has less than $3 million in cash left on its balance sheet, according to court filings. The developments come years after federal regulators suspended CannTrust's licences after it was found to be growing thousands of kilograms of cannabis in unauthorized rooms at its Fenwick, Ont. facility.

Ontario pot shops warned to stop selling unregulated hemp 

Ontario's cannabis retail watchdog has warned the province's legal pot shop operators to avoid selling unregulated hemp products, according to a report by The Canadian Press. The Alcohol and Gaming Commission of Ontario issued cannabis retailers a warning that selling those products could violate their license terms. The warning was prompted after compliance officials found two Ontario cannabis stores selling the unregulated products in their shops. Ontario's licensed cannabis stores are only allowed to sell pot and hemp products purchased from the OCS, and must keep the items in their original packaging.

U.S. SEC charges three with insider trading over deals including Aphria bid

The U.S. SEC announced charges against three Florida residents on Thursday for their alleged involvement in an insider trading ring that is believed to have netted millions of dollars in illicit gains, including from tips tied to an ill-fated attempted takeover of Canadian pot producer Aphria. The regulator claims the three individuals received inside non-public information and traded ahead of an announcement about Green Growth Brands' takeover offer for Aphria in Dec. 2018, as well as two other separate announcements. According to a complaint filed by the SEC, one of the accused was tipped off by a cousin who served on the board of directors of Green Growth Brands, and tipped off two friends about the deal. Green Growth Brands initially announced its plan to make a $2.8-billion offer to buy Aphria in Dec. 2018 but ended its plans for a hostile takeover in April 2019. 

MedMen, Ascend squabble over fate of New York assets

U.S. cannabis retailer MedMen has backed out of a deal to see its New York assets sold to Ascend Wellness, the company announced earlier this week. MedMen, which operates in six states and initially planned to divest its New York holdings to Ascend in Feb. 2021 for US$73 million, has announced it is terminating the deal, without providing specifics. Ascend issued a press release shortly afterward stating that MedMen's refusal to close the deal is invalid despite obtaining regulatory approval. "[Ascend] again calls on MedMen to honor its commitments made in the investment agreement and to close the transactions contemplated and provide continuity to the medical patients of New York," the company said in a statement. 


ANALYST NOTE OF THE WEEK

Previewing Tilray's fiscal second quarter

Canadian cannabis giant Tilray reports its fiscal second quarter results before markets open on Monday. Analysts expect the company to report US$164 million in revenue - an annual jump of 191 per cent - and US$11.3 million in adjusted EBITDA. However, Tilray's sales gains don't reflect the market share declines that the company has experienced, which may now hover at around nine per cent in Canada's largest provinces, according to BMO Capital Markets Analyst Tamy Chen. She believes Tilray lost share to other players due to a combination of smaller producers supplying more premium flower to the market and deep discounting in the bulk segment. Alliance Global Partners also highlights how the resurgence of COVID and return of lockdowns in Ontario will likely see Tilray's market share fall even lower beyond its fiscal second quarter, according to Hifyre sales data. 

Cantor Fitzgerald's Pablo Zuanic points out that less than half of Tilray's revenue (42 per cent) is derived from its cannabis operations, and sees industry data showing the company's recreational pot sales down 16 per cent from its first quarter. Despite that, he expects Tilray's gross margins to remain stable or even up slightly in its second quarter.  


CANNABIS SPOT PRICE

$5.02 per gram 

- This week's price is down 0.6 per cent from the prior week, according to the Cannabis Benchmark’s Canada Cannabis Spot Index. This equates to US$1,791 per pound at current exchange rates.


WEEKLY BUZZ 

54.2%

- The number of sales made through Ontario's legal cannabis channels between July and September, overtaking the illicit market for the first time ever.