In Focus: The Fall of The Weed Industry
Updated: Oct 27, 2019
July 2018, Tilray, Inc (TLRY) goes public and closes up 31%. Fresh off of Canada's new legislation to legalize the recreational use of marijuana by adults, Tilray, incorporates in the U.S. to raise money from U.S. investors. One month later, the stock is up 60%. The new train to millionaires row is legal weed, which has replaced Bitcoin. Two months later Tilray touches $300 per share, marking a 1200% increase from its IPO price. Money is rolling in, and weed investors are rolling in cash like Uncle Scrooge in his money bin. All this excitement, hype, and money and Canada's new law hasn't even gone into effect. The country is still a month away from allowing smokers to legally purchase weed.
The champagne days don't last much longer. Tilray never touches $300 per share again, actually the stock starts it's decline back to reality, but it's too late. Men, women, boys, and girls have seen their friends, co-workers, and neighbors make a killing from investing in weed. Weed stocks are in, everything else is out.
The professional investment community fanned the weed investment fire. Research report after research report updated investors on what the weed industry could be worth in 5 years, 10 years, 15 years or more; $10 billion, $20 billion, $40 billion, the marijuana industry has the potential to be big, real big. Young investors pile in to names like Aurora Cannabis (ACB), Canopy Growth(CGC), Cronos Group (CRON), and Hexo Corp (HEXO), waiting and hoping for the second wave of massive weed stock increases.
As of Q4 2019, the second wave of massive weed stock increases hasn't come. Stocks in the weed industry have experienced sharp declines since the end of summer 2019. The trend has been a mini trend within a larger trend of declines. Since the law in Canada has gone into effect, the stocks of the five companies mentioned are all down. Investors are now wondering, what happened to the weed industry?
Pennies Make Pounds and Pounds Make Profits
One reason for the declines in weed stocks are the lack of profits. While many of the companies in the industry have been able to grow revenue at a very impressive clip, the expenses to fuel revenue growth has eaten into profits, leaving the companies in the industry with nothing to show for their efforts.
Investors have had several quarters of earnings reports to review, and instead of losses getting smaller and companies moving closer to profitability, they've instead witnessed expenses swell and net losses get bigger. Not the typical recipe for a successful company. Aside from the growing expenses, analysts of the industry point to another issue preventing profitability.
Analysts who track the industry believe a cause for the lack of profits is due to the small number of retail outlets available to customers. The shortage of retail outlets is blamed on the mounds of red tape created by a slow moving Canadian government. Companies in the marijuana industry that want to market a product must register with Health Canada and provide a 60 day notice. In addition, weed companies in Canada are barred from advertising, adding another barrier between company, potential consumer, and profits.
But the shortage of retail outlets and the absence of advertising isn't affecting everyone in the weed business. The black market in Canada continues to boom because of the hoops that legal companies need to jump through. While legalization allowed many legal weed dealers to spring up, not all the illegal ones faded away or decided to go legal. Statistics Canada points out that only 29% of weed buyers are using legal sources. 7 out of 10 weed consumers are still getting weed the illegal way, which is not a good stat for weed stock investors.
These issues may explain why investors have been fleeing weed stocks since mid July 2019. The growing pains that come with building a new industry aren't for everyone, and in a lot of cases investors under estimated the hurdles the industry still had to face after legalization. But will it always be this way? Are weed stocks headed to pennies?
In Canada, new regulations have been passed allowing the sale of cannabis derivatives like edibles, cannabis infused drinks, and vaping products. The actual products won't be available until December, but investors who are still holding on are hoping the new legislation brings renewed enthusiasm to weed stocks. We'll have to wait and see how it turns out.
The dramatic fall off in weed stocks is the best thing that could've happened for long term investors. If you're holding the bag on one of these stocks it may not feel like a good thing and I can understand that. But this time for weed stocks is what late 2000 to 2001 was to dotcom companies, its the time for the markets to purge the weak.
In 1999 and 2000, any company with a .com at the end of its name was as coveted as weed stocks were in summer 2018. But in 2001, when the shit hit the fan, and dotcom companies couldn't produce profits, shaky companies like eToys.com, Boo.com, Webvan.com, Freeinternet.com, and Pets.com were gone, and companies like Priceline.com (BKNG) and Amazon.com (AMZN) thrived. The weed industry is reliving this. Many companies will fail, some will get acquired, but the strong will survive. But who are the strong?
The strong companies in the weed industry have solid management teams. Teams with people from retail, from agriculture, from healthcare and biotech. The strong companies have people who have run businesses before in the C-suite.The strong companies have balance sheets that stand above their peers in the industry. In a story run by MarketWatch.com, analyst Greg McLeish stated a review of 50 companies in the industry revealed 21 of them have six months or less of cash on hand. These are just a few things investors should look for as the weed industry goes through this cycle.
For investors holding a bag of weed stocks, now is a great time to evaluate the portfolio. Decide which companies are strong and have a chance to be profitable companies in the future. Now may be a great time to shift money from the weak companies to companies that have a better chance of surviving this down cycle.
I'll admit to you that I am not a smoker, I prefer to drink my problems away, but I'm extremely interested in the weed industry. I haven't taken any positions, I've taken a wait and see approach. When it comes to growth industries I'm a believer that you don't have to get in at the bottom or the beginning to see great gains. A wait and see approach can spare investors the pain that early investors in the weed industry are suffering now.
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