After having watched cannabis stocks for almost four years, it is clear that the sector has made considerable progress, although it has been a long and drawn out process. The investment aspect of cannabis has been a “Wild West,” with the few publicly traded stocks at the beginning of 2013 all trading on the over-the-counter exchanges with insane valuations, terrible corporate governance, stressed balance sheets and no fundamentals. There has been a lot of hype. None of the companies then were in the cannabis cultivation or retailing industry at all, and the ones that were serving the industry as ancillary goods or services providers were not leading companies.
While there has been progress to date, most of the sector remains unappealing to anyone but penny stock traders. The overall universe of publicly traded cannabis stocks consists of almost 400 companies, most of which trade on the OTC exchanges and include a considerable number that don’t even file with the Securities and Exchange Commission (SEC). A handful of OTC companies have made progress and truly represent the industry (generating substantial sales) but the valuations remain pretty steep after a recent rally. GW Pharma (GWPH) has been a great story for the sector. Finally, the Canadian market has been a fantastic opportunity during the past year and should be of interest to investors going forward.
Before discussing the most appealing parts of the cannabis market for publicly traded stocks, it’s important to understand the history and some background. The first cannabis stocks began trading in 2009, and a review of these and those that followed during the next few years, reveals that there was no early-mover advantage as they have all been serial dilution stories with limited fundamental progress. By the end of 2012, which was when the game really changed for the cannabis industry following the successful legalization ballot initiatives in Colorado and Washington, there were just a few companies trading publicly. These stocks doubled in early 2013 in a delayed reaction to the ballot wins, but then drifted lower until August of that year when two transformational events occurred.
First, Sanjay Gupta issued his famous reversal on medical cannabis, saying that he was wrong to have been skeptical as he introduced cannabidiol (CBD) to the American public on CNN’s “Weed.” Second, the Obama Administration issued the Cole Memorandum listing eight points that would allow Colorado and Washington to move forward without federal interference. Stocks recovered into the end of the year in advance of Colorado’s Jan. 1, 2014 retail stores opening date. Extreme media attention in early 2014 set off an unprecedented rally in cannabis stocks, with the 420 Investor Cannabis Stock Index increasing by more than 500% in the first 75 days of the year, with many names posting dramatically higher gains (see “Pot bubble,” below).
Pot’s first bubble
With so few stocks and so many relatively naive traders flooding into the market, valuations were pushed to unsustainable levels, with several companies exceeding $1 billion market caps despite having no substantive business. The next two years saw a steady decline as the number of companies purporting to be in the cannabis industry exploded as traders exited the market. The market finally bottomed in early 2016 but was sitting near the lows as August ended.
A big rally from this past fall from September into November more than doubled the index price as speculators pushed the stocks higher into the elections that featured nine states with cannabis-related ballot measures: five over recreational use (Arizona, California, Maine, Massachusetts and Nevada) and four states contemplating medical cannabis programs (Arkansas, Florida, Montana and North Dakota). While the outlook for cannabis reform at the federal level didn’t improve with the elections as the Senate and House majorities remained Republican and the Presidency creates uncertainty, the Florida medical cannabis blowout and other new medical programs point to likely progress ahead with respect to medical cannabis. The wins in all of the states except Arizona doubled the number of legal states, adding the largest state as well as the first East Coast state.
While the proliferation of state-by-state legalization is a boon for the industry, most of the stocks are not likely to benefit. Among the OTC names that file with the SEC only a few companies have been able to approach sales of $10 million per year. Four worth following are CV Sciences (CVSI), Kush Bottles (KSHB), Surna Inc. (SRNA) and Terra Tech (TRTC); each of which has reasonable trading liquidity (see “Picks to click,” below). CVSI’s main business is selling products with CBD extracted from industrial hemp, though it recently began developing a chewing gum with synthetic CBD and nicotine for which it intends to seek FDA approval. The company is not yet profitable.
KSHB is a packaging company with operations in California, Colorado and Washington that realized sales of more than $8 million in fiscal year 2016. The company has a clean balance sheet and was the first OTC cannabis company stock to receive institutional research coverage, with Cowen and Company issuing a Buy rating with a $3 price target in September.
SRNA sells equipment to cultivators designed to reduce energy consumption, a major component to the cost of production. The company is addressing a near-term balance sheet challenge. Finally, TRTC is the only large-scale publicly traded cultivation and dispensary operator, with cannabis operations in California and Nevada. While these represent some of the best direct or ancillary cannabis stocks, the valuations are challenging for the entire group.
GW Pharma, which has traded publicly on the Alternative Investment Market (AIM) since 2001 (until giving up its listing recently) and listed on the Nasdaq in 2013, has been a great success story in terms of developing its pipeline and raising capital (see “Cannabis all-star,” below). The UK-based biotech company extracts cannabinoids from cannabis to produce pharmaceutical-grade medicines (see “Cannabis R&D,” above). While it is not a one-trick pony, the main driver of its appreciation over the past several years has been the advancement of Epidiolex, which has completed three successful Phase 3 clinical trials for the treatment of seizures caused by rare forms of childhood epilepsy. The company intends to file a New Drug Application with the Federal Drug Administration in the first half of 2017, which could be on the market by early 2018. The product, which is 99% CBD, has been shown to be both safe and effective, and if the drug is approved, GWPH will have seven years of market exclusivity.
At a recent price of $120, GWPH’s market cap is close to $3 billion.
One of the most exciting parts of the market has been the Canadian sector. Canada already has a federally legal medical cannabis program, with 10 of the approximately 30 licensed producers trading publicly, and serving approximately 100,000 patients in a program that is growing at more than 100% per year. The country is also on the verge of legalizing cannabis for adult use, a process that should play out by mid-2018, if not a bit earlier, creating a potential $10 billion market.
The companies have been very successful raising capital to expand capacity in the coming years (see “Canadian A-list,” below). The market leader, Canopy Growth (CGC), was able to uplist to the Toronto Stock Exchange and plans to change its trading symbol to “WEED.” The market has institutional investors, research coverage, good liquidity and valuations that are high but within reason and supported by strong revenue growth. Additionally, there are opportunities for many of these companies to export their products or their intellectual property to other countries.
The outlook for 2017 is mixed, with the vast majority of the OTC stocks unlikely to sustain recent gains but continued progress for GWPH and Canada as two likely favorable trends. While many of the stocks that have benefited from the speculative trade surrounding the ballot initiatives are unlikely to sustain gains, the advancement of the market could bring in new public companies. One that is of high interest to me is an announced IPO of a REIT, Innovative Industrial Properties, which will list on the NYSE with the ticker “IIPR” and is seeking to raise $175 million.
The company has announced its first sale-leaseback with one of the five licensed cannabis companies in New York, PharmaCann, which operates in Illinois as well. The team behind the REIT has experience as a public REIT, including the founder, Alan Gold, who was a co-founder of Alexandria Realty (ARE) and the founder of Biomed Realty (BMR), which was acquired by Blackstone in early 2016 for $7 billion. The Innovative Industrial Properties IPO, if successful, will allow mainstream investors to participate in the cannabis industry indirectly and will provide much needed capital to the industry.
The publicly traded cannabis market has been slow to develop and is still attracting mainly retail traders. Slowly, though, there have been a few OTC-traded companies that have been able to make progress fundamentally, while GW Pharma and the Canadian licensed producers have opened the market to institutional investors. Looking ahead, in addition to the IIPR IPO, expect to see a Canadian LP dual list on a major U.S. exchange in 2017. We also could see an ancillary company or two pursue a Nasdaq IPO in the next two years. Additionally, Scotts Miracle-Gro (SMG), which has assembled a portfolio of leading ancillary companies, could spin them out into a separate vehicle. The bottom line is that we are getting closer to publicly traded cannabis stocks being worthy of investment consideration.