The cannabis industry is fighting against several odds in 2019. The ongoing US-China trade war and recessionary worries have hurt valuations across the global market. Also, the still-growing cannabis industry hasn’t escaped these problems. In such tough environments, investors put their money in safe havens.
On the other hand, the cannabis industry doesn’t have the history or credibility of withstanding difficult economic cycles. Hence, the ongoing political and macroeconomic concerns have made it difficult for cannabis companies to get capital. Ironically, cannabis stocks may prove to be one of the better investments in recessionary times.
Trade war worries continue to haunt cannabis investors
The overall market started rallying from October 8 in hopes of some solution for the ongoing US-China trade war. On October 11, President Trump came up with the first phase for a deal with China. He even stopped a proposed tariff hike. Both parties reached a preliminary deal to ease tensions between these superpowers.
Despite this, on October 14, CNN reported that the negotiators would require up to five weeks to draft the text of the trade agreement. In the meantime, investors in both countries are worrying again about the details of this deal. Also, China’s state-run newspaper China Daily claimed the possibility of Washington stopping this deal.
The cannabis industry hit by industry-specific concerns
While these problems are far from over, new problems have come up for cannabis investors in the last few weeks. Hexo Corp.’s (HEXO) dismal pre-earnings announcement had a huge impact on share prices of almost all cannabis players. The company highlighted problems like pricing and competitive pressures and regulatory uncertainty for cannabis-derived products in Canada.
Also, the company restated the much talked about problem of a slower-than-anticipated retail rollout in Canada. This is limiting access to cannabis. This news was followed by a sharp share price decline and a series of downgrades for many cannabis players.
Additionally, the vaping crises continues to rear its ugly head. On October 17, the CDC (Centers for Disease Control and Prevention) said that there were more afflicted patients associated with vaping-related lung injuries. As of October 15, CDC reported 33 deaths and 1,479 lung injury cases associated with vaping.
The depressed environment has hit the valuations of a majority of cannabis stocks. In the first week of October, we looked at the valuations of six cannabis companies and compared their historic levels. Here, we will repeat the same exercise for six more companies. Also, we will track the median valuation of the cannabis sector for the past two years.
Here, we see that the sector’s forward EV-to-sales multiple has been moving sideways in October 2019. On October 21, the median forward EV-to-sales multiple was 3.43x. This is close to its value of 3.31x on October 1. Since October 1, the median forward EV-to-sales shrunk and reached 2.60x on October 10. However, it has picked up the pace. Now, it is trending upwards in line with the overall market.
How do these cannabis stocks compare with each other?
We will also compare the EV-to-sales multiple of six cannabis stocks with the sector median. This will help us highlight the stocks that are trading cheap or expensive relative to the sector. The EV-to-sales multiple helps us compare companies without considering their capital structure. It is also well-suited for the majority of cannabis companies, who have yet to report positive net incomes.
Here, we’ll be comparing the relative valuations of Aphria Inc. (APHA), OrganiGram Holdings (OGI), CannTrust Holdings (CTST), Cronos Group Inc. (CRON), Hexo Corp. (HEXO), and Supreme Cannabis Company Inc. (SPRWF). All these stocks are currently trading at discounts to their historical averages.
Aphria’s valuation is low
On October 21, Aphria traded at a forward EV-to-sales multiple of 1.95x. This is a lot less than the company’s historical average multiple of 7.96x. On October 15, the company saw a strong financial performance for the first quarter. While the stock rose on that day, Aphria failed to maintain its gains.
According to MarketWatch analyst, Max A. Cherney, the company’s first-quarter profits were not from its core business of selling cannabis and cannabis-derived products. Instead, these were from paper gains. This came from a change in accounting methods used to value its convertible debt and investment in Althea Group Holdings (AGH). Also, the company’s consensus target price fell from $13.00 in September to $9.52 in October.
OGI and CRON valuations
On October 21, Organigram was trading at a forward EV-to-sales multiple of 3.43x. This is a lot less than the company’s historical average multiple of 5.66x. Besides the industry-wide troubles, the company is facing safety concerns associated with its cooling towers. This has been going on since early October. However, it seems investor sentiment may turn around for the stock considering Jefferies’ recent upgrade of the company.
On October 21, the Cronos Group was trading at a forward EV-to-sales multiple of 7.45x. This is also a lot less than the company’s historical average multiple of 21.92x. The stock rose by almost 41% in after-hours trading on October 16. This spike mostly followed the news of the company’s listing on the Australian Securities Exchange. This is scheduled for November 2019.
Since then, the stock has already lost most of the gains. On October 17, Stifel’s W. Andrew Carter upgraded Cronos’ rating from “hold” to “buy.” However, he lowered the company’s consensus target price from $16.50 to $14.00.
HEXO, CTST, and SPRWF valuations
On October 21, Hexo traded at a forward EV-to-sales multiple of 4.07x. This is a lot less than the company’s historical average multiple of 5.57x. This follows the company’s disappointing pre-earnings announcement on October 10.
CannTrust was trading at a forward EV-to-sales multiple of 1.25x on October 21. This is also a lot less than the company’s historical average multiple of 5.26x. However, the company has now agreed to comply with Health Canada. Despite this, there are several other hurdles in CannTrust’s path to recovery.
On October 21, Supreme Cannabis Company traded at a forward EV-to-sales multiple of 1.41x. This is a lot less than the company’s historical average multiple of 5.64x. The company seems to be a victim of industry-wide issues. Also, the stock is suffering as the company has not yet reported profits.
Overall, cannabis sector valuations have come down a lot from their levels in 2018. Investors now prefer cannabis companies with earnings, cash balances, and reasonable valuations.