The NEW Cannabis Rally

It’s here.

In an article from August 23rd, Stockhouse took a close look at the Canadian cannabis sector (Near-Term Outlook for Canadian Cannabis Stocks?). This re-examination of market sentiment was motivated by the major news when Constellation Brands Inc (NYSE: STZ) announced its CAD$5 billion investment in Canopy Growth Corp (TSX: WEED, NYSE: CGC, Forum).

This was STZ’s second investment in WEED. Many observers see Constellation’s first investment in Canopy Growth (October 2017) as the major catalyst for the blow-off rally in the Canadian cannabis sector to close out 2017. This new investment by STZ is twenty times as large as its first bite of WEED stock. If all warrants are exercised, Constellation Brands could hold as much as a 38% interest in Canopy Growth.

Given this data, this was our conclusion.

Will 2018 end with a cannabis rally that compares with the rally that ended 2017? Obviously, no one has a crystal ball and a broader downturn in markets would impact this performance. However, the real fundamentals for this sector are even more bullish today than they were one year ago.

And now it’s here. WEED itself was the first big winner. The strategic investment by Constellation Brands equates to a price of $48.60 per share for Canopy Growth stock. Today, WEED is sitting at $66.31 – after reaching a new all-time high of $74.45. The day this big deal was announced, Canopy Growth opened at $32.16.

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That’s an impressive jump in one month for a company with (now) a market cap of over $14 billion. But Canopy Growth is far from alone when it comes to racking up impressive gains since mid-August. Fellow cannabis heavyweight, Aphria Inc. (TSX: APH, OTCQB: APHQF, Forum) has performed nearly as well, up 96% since the Constellation Brands/Canopy Growth announcement.

Some names familiar to the Stockhouse audience have also performed very well. FSD Pharma Inc. (CSE: HUGE, OTCQB: FSDDG, Forum) is one of the biggest winners, already up 328% (as of this writing).

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Honourable mention also goes out to: Valens GroWorks (CSE: VGW, OTCQB: MYMSF, Forum), up 114%; Hillstreet Beverage Company Inc. (TSX: V.BEER, OTCQB: HSEEF, Forum), also up 114%; Emerald Health Therapeutics Inc. (TSX: V.EMH, OTCQB: EMHTF, Forum), up 96%; HEXO Corp. (TSX: HEXO, OTCQB: HYYDF, Forum), up 78%; and Phivida Holdings Inc. (CSE: VIDA, OTCQB: PHVAF, Forum), up 77%.

One-month gains like that can really boost the overall performance of one’s portfolio, and dozens of other cannabis companies have already benefitted from this sudden shift in market sentiment. Of equal importance, not all of these companies began moving right on August 15th, the date of the Canopy Growth deal. Some of these companies have only really gotten traction in markets since investors got more focused on their portfolios after Labour Day.

To be clear, not all cannabis stocks have started to climb – and maybe not all of them will. Here we asked you what you expected when the Next Cannabis Rally became a reality, in a recent Investor Pulse Poll with results published on September 7th. This was the response of Stockhouse investors.

More than two-thirds of Stockhouse investors expected this rally to materialize. But respondents were evenly split on whether this would be another sector-wide rally, or, whether the sector was going to start to divide into “winners and losers”.

As more and more cannabis companies start to move, a sector-wide rally is still a possibility. It’s still too soon to form any firm conclusions on the breadth of this rally. What about the magnitude of this New Rally?

In the rally to close out 2017, even the most enthusiastic cannabis investor would have to concede that valuations had outpaced fundamentals. But this is the nature of most strong moves in markets. Whether going up or down, momentum tends to carry stocks too far.

Throughout the first half of 2018, Canadian cannabis companies endured a harsh reality-check as valuations retreated significantly. Indeed, some of these stocks (generally those that climbed the most) pulled back by 75% or more.

If the ride up was too fast, the same could be said for the ignominious slide that many cannabis companies have experienced in 2018. These companies haven’t been standing still, resting on their laurels following the big spike to end 2017. They have been adding value for shareholders.

Canadian cannabis companies have continued to aggressively build out their operations. Part of this expansion was/is specifically targeting the legalization of recreational cannabis in Canada, to be effective October 17, 2018. Much of this development is even more forward-looking.

Infused cannabis products will not become legal in Canada on October 17th. However, language is already on the books to legalize these infused products one year from the initial launch of recreational cannabis in Canada at the national level. This is one of the reasons why we are already seeing these large strategic investments and joint ventures between Canadian cannabis companies and some of the alcohol beverage giants.

Even as Canadian cannabis companies position themselves for the introduction of recreational cannabis next month, these same companies are already jockeying for position as new/additional cannabis markets and niches are about to open up in Canada.

This provides new opportunities across the cannabis space. Companies with a cultivation focus already have several markets for their crops: wholesale supply deals with provincial governments, B2B sales to other cannabis companies (for the production of cannabis oil/extracts), and direct retailing.

Many of these cannabis cultivators were still planning their initial crops one year ago. Today, these same companies are now harvesting crops – and reaping revenues.

Similarly, one year ago many Canadian cannabis companies were still developing their value-added activities such as the production of cannabis oils. Today, these companies are selling these products.

As cannabis-infused products come to Canada next year, we will see a similar evolution in these additional markets. Today, Canadian companies are rolling out their plans to produce cannabis-infused products, or to commercialize different forms of “infusion technology”. A year from now, these companies expect to be marketing their cannabis-infused products – or netting revenues from licensing fees as this infusion technology is commercialized.

Then there is the United States. While the repealing of (misguided) cannabis Prohibition is a much more uneven process South of the Border, there is a dramatically larger total population base in the U.S. that now has legal access to cannabis – at least for medicinal use. Even with respect to adult-use “recreational” cannabis, the nine U.S. states that have legally authorized recreational use comprise a larger population than all of Canada.

The 2017 end-of-year cannabis rally was not a “Canadian” cannabis rally, it was a North American rally. Companies with operations based on both sides of the border saw spectacular gains to close out the year. There is no reason to expect the New Rally to be any different.

Some of the highest-flying cannabis stocks were ten-baggers in 2017, in just the final two months of the year. While these companies start the 2018 rally with (generally) significantly larger market caps, there is also a lot more money on the table.

Many cannabis investors have already locked in sizable gains from their previous investing in this sector. Vast numbers of retail investors are still educating themselves to this new opportunity and have not yet entered this space in any meaningful way.

On the business side, “cannabis plans” have turned into cannabis markets. With substantial revenue flows beginning to materialize in this sector, future projections will soon become corporate earnings. This is not some “dot-com bubble” where fly-by-night companies hype markets that don’t exist.

Cannabis is a real commodity. The marijuana sub-species is already proven to be potent, safe medicine. As a recreational drug, being both non-toxic and non-addictive, marijuana is arguably a much more civilized option than toxic/addictive alcohol or nicotine.

Then there is hemp. In addition to being (at least) equally valuable for medicinal applications, hemp has literally thousands of other industrial applications. In many of these applications, hemp is a superior input as a raw material. As part of the evolution of the cannabis industry, we’re seeing cannabis companies diversifying into more and more hemp-based applications. This makes “the cannabis sector” even bigger as a commercial opportunity.

“Calling” a rally is always at least somewhat an exercise in hindsight. In order to build a convincing case for the thesis, it’s necessary to produce evidence – a number of different charts, or else sector-wide data which supports the premise that a move is underway in that sector.

Such evidence is now clearly evident. That said, the cannabis market does not exist in a vacuum. A correction in the broader markets and/or some sort of significant slow-down in the form of economic data could still blunt this New Rally. Absent such exogenous factors, it’s “full speed ahead” for at least some of the companies in this sector, with still a significant possibility of an industry-wide rally should a flood of new investor dollars enter the sector.

Investors who identified the cannabis market as a major opportunity early on have generally already been well-rewarded for their foresight. For newer investors, the message is very definitely that “you’re not too late to the party”.

After nearly a century of Prohibition, the cannabis sector represents a multi-decade growth opportunity, as it becomes fully integrated into our economies – claiming significant market share from numerous sectors. Investors who choose not to add cannabis exposure to their portfolios are missing out on a superb, long-term growth opportunity.