Why are cannabis stocks rising? Sector bounces following ugly 2022
I wrote a piece last October asking the simple question: whatever happened to the cannabis stock bubble?
Biden’s election was billed as a massive boost for the cannabis industry. The industry has long fought for legal status, and Biden is generally seen as pro legalising the drug.
Even within the US, never mind internationally, the legal status is nebulous with a divergence between federal and state legality. The below chart shows the current landscape.
So a relatively pro-legalisation President presented as a slice of positivity in the cannabis news cycle. Of course, this was also late 2020, a time when interest rates were still near zero, the money printer was powered on and hysteria was surging through markets, with every risk asset going spectacularly north.
Cannabis stocks didn’t turn down the invitation, printing dizzying gains. And then, it stopped. A transition to higher interest rates in response to the inflation crisis pulled the rug out from under the market. Cannabis stocks, being far out on the risk spectrum, fell further than most.
Cannabis stocks rally in 2023
But while 2022 presented as a brutal beatdown, the first couple of weeks of 2023 have provided a respite for investors.
Inflation data has appeared to soften, with the market betting that this may cause the Federal Reserve to pivot off its high-interest rate policy sooner than otherwise anticipated.
A plot of the price history throughout 2022 against the Federal Reserve’s interest rate policy tells you all you need to know.
But with optimism that tight monetary policy may end earlier than the market had previously priced in, there has finally been some green in the cannabis markets (I couldn’t resist).
The Canadian Cannabis Index is up 20% in two weeks, while the two big boys, Tilray and Canopy Growth Corp, are both up over 15%.
Alan Brochstein, an analyst at New Cannabis Ventures, cautioned that despite the gains to kick off the new year, he does not see a lot of value in the duo.
Canopy Growth has a lot of debt, and it may not be able to move forward on its plans to acquire three American cannabis companies and still maintain its NASDAQ listing. If it can’t close, investors will likely be disappointed, and if it can close, then investors can expect other American cannabis companies to also uplist. The stock currently trades at 1.3X tangible book value, but it is burning cash and enduring large operating losses
Tilray, which reported its fiscal Q2 this past week, is shrinking and too diversified in my view. My target for the end of May, based on the falling outlook for FY24, is now $3.03, a price that is 4% lower than where it closed Friday. The stock currently trades at 3.2X tangible book value.
Alan Brochstein, New Cannabis Ventures
Outlook for cannabis market
What makes the cannabis sector so challenging to predict is the confluence of factors which influence it. Obviously the macro climate is key and has been covered in this piece above, but there are also legal and regulatory variables which influence pricing significantly.
It would not be remiss to say that many of these factors were thrown out the window during COVID, however. The sector almost traded like a meme, with multiples skyrocketing as the Robinhood frenzy coursed through every vein of the stock market.
There was a temptation for lazy analysis during COVID, a naive assumption of “legality is on its way, prices are already rising, they will rise more once it s inevitably fully legal”. Combined with the perfect storm of low interest rates, stimulus cheques and stay-at-home life, price charts went bananas.
Brochstein gives some food for thought which contrasts nicely with the simple assumption that legality brings easy gains:
We don’t see the Canadian market as improving. In fact, the growth is the lowest since it was legalized for adult-use. In October, the market expanded by just 9.5%, and Hifyre projects that the November growth, which will be released on January 20th, will be just 9.3%. We see a lot of opportunity in other sub-sectors, but we find a few Canadian LPs worthy of being considered currently”
Nonetheless, 2023 has been kind to investors following the nightmare of 2022. The market is still down significantly from highs, but at least the light at the end of the tunnel is a little more visible today than it was a couple of months ago.
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