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Cannabis Stocks: Is the Worst Really Over?

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This year, the cannabis space has underperformed the broader US equity market. The ETFMG Alternative Harvest ETF (MJ) and the Horizons Marijuana Life Sciences Index ETF (HMMJ) have fallen 31.9% and 36.9% YTD (year-to-date), respectively. Meanwhile, the S&P 500 Index has risen 25.3% during the period.

Prominent cannabis players Aurora Cannabis (ACB), Canopy Growth (CGC) (WEED), and Cronos Group (CRON) have fallen 52.7%, 32.6%, and 37.4% YTD, respectively. Industry-wide concerns such as pricing pressure, the expectation of a slowdown in cannabis sales, and vaping-related deaths have dragged the sector down.

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However, the sector got a boost after the House Judiciary Committee cleared legislation to legalize cannabis at the federal level on November 20. Investors’ optimism over the House clearing the bill offset some of the decline. So should you consider buying cannabis stocks now? Let’s see what analysts have to say.

Analysts’ opinions on the cannabis sector

Elliott Fishman of Scotia Wealth isn’t optimistic about the marijuana sector. As reported by Cantech Letter on November 20, he said, “This is a typical ‘Buy on mystery, sell on history’ thing. The mystery is over—they don’t make any money and they aren’t going to make any money for quite some time.” He added, “Everybody is looking at it now because it’s so cheap, but what is the bottom to a stock which is truly two to three years from truly coming into the table?” He also expects the sector to see cannibalism and volatility going forward.

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Owen Bennett of Jefferies believes that the surge in cannabis stocks after the House cleared the bill was just a reaction to positive news, and there was no significant shift in the investor sentiment, as reported by MarketWatch on November 25. He believes the cannabis space hasn’t yet bottomed out and expects more pressure from the liquidity crisis.

Bill Kirk of MKM Partners said, “We are already beginning to see the cracks in Canada: Pricing is down, gaps [between the pricing of sanctioned and illicit product] aren’t closing, and consumption per federal license is contracting. To us, this means the future does not have a near-term path to profitability, and consensus expectations are unrealistic,” as reported by MarketWatch.

Recently, Mad Money host Jim Cramer expressed disappointment in the cannabis sector. Read more in Is Jim Cramer Not a Fan of Cannabis Stocks Anymore?

Bank of America upgrades Canopy Growth

Despite all the pessimism, Bank of America recently upgraded Canopy Growth from “neutral” to “buy.” As reported by CNBC on November 20, the bank stated that Canopy’s valuation looked reasonable after its recent fall. Further, Bank of America believes analysts’ estimates are achievable. For more on the upgrade, read Bank of America Upgrades Canopy Growth to ‘Buy.’

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Our take on the cannabis sector

We expect short-term challenges such as pricing pressures and excess inventory to put pressure on cannabis companies. However, the introduction of Cannabis 2.0 and the legalization of cannabis at the federal level could boost the sector.

We expect cannabis companies to introduce Cannabis 2.0 products by the end of this year, which could boost their sales. With derived products, companies could differentiate their offerings and command higher prices, which could improve their operating margins. Also, most cannabis companies are focusing on improving their efficiencies and lowering their production costs. In the latest quarter, Aurora managed to lower its cost of production to 0.85 Canadian dollars per gram. We expect the cost of production to come down going forward.

The legalization of marijuana at the federal level in the US could act as a catalyst to drive the sector. On May 1, 2019, Barclays stated, “We estimate that the total US cannabis market, if legalized today, could be worth $28 billion, increasing to $41 billion by 2028 on a pre-tax basis,” as reported by CNBC. Also, with the federal government prohibiting marijuana, banks can’t do business with the companies involved with it. So the prohibition has starved cannabis companies of much-needed capital to fund their expansion plans.

Currently, companies can’t transport cannabis across state lines. Therefore, they must produce and sell all their cannabis products within the state, which has raised their operating expenses. Legalization could solve all these problems and aid in restricting black-market sales.

For more marijuana-related news and updates, check out 420 Investor Daily.

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