Get 40% Off
🤯 This Tech Portfolio is up 29% YTD! Join Now to Get April’s Top PicksGet The Picks – Just 99 USD

3 Reasons Why Now Is the Best Time to Get Into the Cannabis Sector

Published 2018-12-15, 09:00 a/m
Updated 2018-12-15, 09:15 a/m
3 Reasons Why Now Is the Best Time to Get Into the Cannabis Sector

3 Reasons Why Now Is the Best Time to Get Into the Cannabis Sector

The past two months have been trying, to say the least, for marijuana investors. Owing to bloated valuations, regulations surrounding advertising and distribution, tax-loss selling, and accusations of fraud from short sellers, the overall sector has faced a pullback unlike any we’ve seen yet; as of writing, the North American Marijuana Index is well off its highs, down over 20% for 2018.

However, for those who have been waiting on the sidelines for a pullback in Canada’s biggest growth sector, the recent buying opportunity could be your best bet for double-digit gains going into 2019. Here are three reasons why now is the best time to buy the marijuana names.

Reason one The valuation picture has changed. Before the sell-off, Canada’s major cannabis names were trading north of 30 times their forward 2020 EBITDA. Post-sell-off, the multiples have contracted by 15% or more — or in the case of Aphra (TSX:APHA)(NYSE:APHA), by over 50% from its September peaks. While this is not exactly cheap, say compared to an oil producer, let’s face it: there is no other sector in Canada whose growth prospects look as rosy as cannabis.

Furthermore, a lot of this multiple contraction occurred on the back of the latest quarterly filings, which showed sector-wide top-line growth, coming in below analyst expectations. However, I would argue that this has been a market overreaction, since we knew well ahead of time that recreational sales would have little to no impact on revenues this early in the game.

At the same time, this quarter will prove to be transitional, as medicinal sales continue slowing down going forward in lieu of recreational sales, since there is no hard classification from the end user’s perspective, between what constitutes a medical product versus a recreational one.

Reason two Cannabis stocks are largely insulated from macroeconomic noise. As we are aware, a lot of the fear that is currently present in the equity markets can be attributed to a global economic downturn, stemming from rising interest rates and trade wars between major super powers. However, these fears should have little to no impact on cannabis earnings going forward, since the industry in Canada is isolated from international channels and future capex is now more or less fully funded on the back of equity as opposed to debt.

Even in the event of an outright recession, cannabis demand should remain resilient, mirroring the alcohol and tobacco industries. For those of who are mathematically inclined, correlations since inception of the Marijuana Index versus the TSX and the S&P 500 are 0.42 and 0.30, respectively.

Reason three The smart money will rotate into the sector. There really has been no greater source of returns on the TSX during the past two years, than the marijuana space. With the recent blockbuster investments from legacy alcohol and tobacco names, there should be no further questions on the cannabis industry’s legitimacy.

At the same time, we are seeing financial institutions begin to soften their tone towards investments in the sector, with many of the major banks launching research coverage on the sector leaders. This should also have the added benefit of a decrease in the pace of equity raises from the major LPs, as Canadian banks will now be more inclined to underwrite debt offerings, which will provide a much-needed tax shield once earnings ramp up. With so little opportunities in Canada, the recent sell-off should prove to be a source of alpha for value-oriented institutional money managers.

Bottom line Based on these three factors, the question now becomes, what name should you use to gain sector exposure? I would recommend that investors stick to the majors such as Canopy Growth (TSX:WEED)(NYSE:CGC) or even an ETF such as HMMJ (TSX:HMMJ); the former name is the clear industry leader.

Fool contributor Victoria Matsepudra has no position in any of the stocks mentioned.

This Article Was First Published on The Motley Fool

Latest comments

Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2024 - Fusion Media Limited. All Rights Reserved.