Ted Ohashi's Marijuana Stock Market Review and Outlook
The announcement this week that Constellation Brands (NYSE: STZ) plans to invest an additional CAN $5 billion in Canopy Growth (NYSE: CGC) was stunning. Upon reflection it seems there are many parallels to the 2017 STZ/CGC transaction. We thought it would be worth having a look back.
The chart below shows the market action of the cannabis stocks for the six months before and the six months after the announcement on October 30, 2017 that STZ was buying 9.9% of CGC shares with warrants that will allow it to increase its interest to 20%.
Looking back to that time, the cannabis stocks had been dull. As the chart above shows, in the six months prior to the announcement, the LTB Marijuana Composite Index had declined -14.9% and, in fact, had been falling for even longer than that. Our headline that week was “We remain confident the cannabis stocks are headed higher” and we were able to squeeze in the few details that came to light over the weekend about the first cross-industry investment by a Fortune 500 company.
At the same time, the Licensed Producer stocks performed in a comparable fashion with a couple of important differences. Leading up to the announcement, the LPs posted a gain of 6.5% in the six months prior compared with the -14.9% loss for the Composite Index. The ensuing rally at 58.3% was somewhat better than average and the correction that followed was slightly more at -22.1%. It is also worth noting that the rally after the announcement was comparatively modest in the Licensed Producers for the first two or three weeks. The positive response in the Composite Index was more immediate.
The announcement seemed to be a trigger for investors who had been waiting for a reason to buy. In the next two months, the cannabis stocks shot up 55.9% and the Licensed Producers rallied 58.3% as investor caution evolved quickly into over-optimism. Canadian legalization seemed to be only six months away and investor consensus seemed to be the rally in cannabis stocks would last until at least until mid-year. Our few words of warning fell mainly on deaf ears and the cannabis stocks slumped into decline. Investor psychology turned back to the negative side and everyone was standing on the edge of the abyss looking into a black hole.
Now we fast forward to this week. The previous charts ended on April 27, 2108. This date is indicated on the chart to the left by the arrow. Since that time we can see the cannabis stocks continued to drift lower. For several weeks we have been looking for a dull, flat to lower market action for the cannabis stocks until after Labour Day. Despite the highly bullish news, the LTB Marijuana Composite posted a small decline of 0.4% last week. We believe this news is important enough to trigger a rally moving ahead but we think it will be more subdued than the one last year. (see also Marijuana Matters below for our detailed assessment of the transaction).
The LTB Marijuana Momentum Index continued to improve last week actually rising in the face of the decline in the price index. There are definite signs that momentum is trying to change direction from the steep decline it has been in since early 2018. A glance at the LTB Composite and the Marijuana Stock Momentum Index indicates that a base is being formed to support an upturn in prices.
The LTB Licensed Producer Composite Index recorded a gain of 1.0% last week. Of course, the Constellation/Canopy Growth deal sparked a rally to end the week. The table summarizes the biggest winners and losers on the week.
The Canadian Cannabis Composite Index, published by Davis and Associates Capital Corp., posted a gain of 5.3% last week. The index gives a good summary of the daily trading pattern as things progressed over the past five days:
Monday - 4.8%
Friday + 4.2%
The week started looking like a lost cause until the STZ/WEED news broke Wednesday. Nothing we see results in major a change in our outlook. We believe the cannabis stocks will remain quiet until after Labour Day but now there might be a bias to the upside.
As might be expected, the events of last week did not have a major impact on the lower priced cannabis stocks. The LTB Low-Priced Composite 2.0% on the week. We stand firm in our belief that this index will lead the way before this cycle has come to an end but we must be mindful of Canopy CEO Bruce Linton’s statement that there are more companies than businesses in the Canadian cannabis industry right now and consolidation won’t solve the problem as much as disintegration. So as always, in the later stages of a cycle when we’re playing musical chairs with the higher risk companies, we have to make sure we have a seat when the music stops.
Conclusion: we explain the implications of the Constellation/Canopy deal in more detail in Marijuana Matters. However, we think it’s clear that Canopy establishes itself as the industry leader and that Constellation believes Canopy’s value is in the range of double or triple what the market thinks it’s worth. In addition, we think it also means the big pharma, big alcohol and big tobacco are not years from taking the leap and we may expect to see more of the same sooner than we thought. All of that is good for cannabis investors.
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