Cannabis Stocks: Revisiting Their Valuations in November

This month, prominent cannabis companies Cronos Group (CRON), Canopy Growth (WEED) (CGC), and Aurora Cannabis (ACB) reported their earnings. All three companies posted lower-than-expected revenues. Also, the sector is witnessing near-term challenges, such as pricing pressure and excess inventory levels. All these factors have dragged the cannabis sector down.

Month-to-date, the ETFMG Alternative Harvest ETF (MJ) and the Horizons Marijuana Life Sciences Index ETF (HMMJ) have fallen by 14.2% and 15.5%, respectively. Meanwhile, the S&P 500 Index has increased by 2.7% during the same period.

What could drive cannabis stocks?

Although near-term weakness exists in the cannabis stocks, we expect Cannabis 2.0 products or cannabis-derived products could act as a catalyst. After Canada legalized the -infused products on October 17, several cannabis players have submitted their products to Health Canada for approvals. The approval period is 60 days. So, we can expect these companies to introduce Cannabis 2.0 products by the end of this year.

Through Cannabis 2.0, companies can differentiate their products. Also, companies can charge higher prices, which could improve their margins. The legalization of cannabis at the federal level can also boost the sector. Today, the US House Judiciary Committee recently marked up legislation that federally decriminalizes marijuana. For more, please read Congress Announces Vote on Marijuana Legalization Bill.

Cannabis Stocks: Revisiting Their Valuations in November

Cannabis companies’ valuations

Cannabis companies are still in the growth phase. During this period, these companies could have higher operating expenses, and the majority of the companies are not profitable yet. So, we have selected the forward-EV-to-sales multiple instead of more widely used PE multiple.

The blue line in the above graph represents the median EV-to-sales multiple of 12 cannabis companies. The median valuation multiple has seen downward momentum since July. However, the fall this month has been steeper. As of November 19, the median forward-EV-to-sales multiple stood at 2.8x compared to 3.23x at the end of October. It is also trading at a discount from its historical average of 7.92x since the beginning of 2017.

In this article, we’ll look at the valuation multiple of six cannabis companies, and compare their forward-EV-to-sales multiples with their historical average and that of their peers. For our analysis, we have considered Aurora Cannabis, Canopy Growth, Cronos Group, Organigram Holdings (OGI), Innovative Industrial Properties (IIPR), and Curaleaf Holdings (CURA) (CURLF).

Cannabis Stocks: Revisiting Their Valuations in November

ACB, WEED, and CRON

As of November 19, Aurora Cannabis was trading at a forward-EV-to-sales multiple of 4.88x compared to 5.83x on October 31. The company’s valuation multiple is significantly lower than its historical average of  10.48x. The weak sales in its first quarter and its management’s decision to scale down its expansion plans appear to have caused the company’s stock to fall. Following its first-quarter earnings, several analysts have cut their price targets, which also pushed the company’s stock price down.

Canopy Growth reported its second-quarter earnings on November 14. For the quarter, the company missed both revenue and adjusted EBITDA estimates. The weak second-quarter performance and analysts’ price cut appear to have dragged the company’s stock price and its valuation multiple down.

As of yesterday, Canopy Growth was trading at a forward-EV-to-sales multiple of 6.16x compared to 7.0x at the end of last month. Also, the company traded at a significant discount compared to its historical average EV-to-sales multiple of 14.87x.

As of November 19, Cronos Group’s valuation multiple stood at 6.51x compared to 7.23x on October 31. The company is also trading at a significantly lower valuation multiple compared to its historical average of 22.28x. The company had reported its third-quarter earnings on November 12.

For the quarter, the company reported lower-than-expected sales and adjusted EBITDA. The company’s management had pointed to pricing pressure for its lower revenue.  The weak performance in the third quarter had dragged the company’s stock price and its valuation multiple down.

OGI, IIPR, and CURLF

As of yesterday, Organigram was trading at a forward-EV-to-sales multiple of 2.8x compared to 3.23x on October 31. It is also trading lower than its historical average forward-EV-to-sales multiple of 5.77x.

On November 11, Organigram provided revenue guidance of 16.3 million Canadian dollars for its fourth quarter of fiscal 2019. This guidance was lower than analysts’ expectations and represented a decline of 34.2% from its previous quarter. The lower-than-expected fourth-quarter guidance and weakness in the cannabis sector appear to have dragged the company’s stock and its valuation multiple down.

From the above graph, we can see that only IIPR is trading above its historical average forward-EV-to-sales multiple. On November 19, the company was trading at a forward-EV-to-sales multiple of 11.43x compared to its historical average of 9.2x. However, it is trading below its valuation multiple of 13.03 on October 31.

IIPR reported a strong third-quarter performance on November 6. Its revenue and EPS beat analysts’ expectations, which led to a rise in the company’s stock price. However, the company’s valuation multiple declined due to analysts raising their revenue expectations for the next four quarters.

Since the beginning of this month, Curaleaf’s stock has increased by 15.3%, driving its valuation multiple up. On November 19, Curaleaf was trading at a forward-EV-to-sales multiple of 2.01x compared to 1.7x on October 31. However, the company is trading below its historical average of 5.5x.

This month, the company opened its first recreational or adult-use dispensary in Massachusetts in Oxford. Also, the company received a “buy” rating from GMP Securities at the end of last month. All these factors appear to have raised the company’s stock price, driving its valuation multiple.

Conclusion

The valuation multiples of cannabis companies have fallen from their highs as investors’ euphoria has been replaced by caution. It appears that investors are concerned about increasing operating losses in the majority of the cannabis companies. They also seem concerned about the thriving black market even after the completion of one year of cannabis legalization in Canada.