TSI Cannabis Investing Bulletins August 15, 2018

Bulletin 1, Volume 1

The first issue of our free newsletter, TSI Cannabis Investing Bulletins, has reports and recommendations on two featured stocks: one a marijuana grower, the other a well-known stock with a new marijuana venture. You get our insights and advice on the investment outlook for the cannabis industry; five top news stories on cannabis right now; plus, our exclusive Cannabis Quality Ratings System for marijuana stocks, and more.

Table of content


Marijuana Producer

Big U.S. investment puts even more pressure on Canadian grower

A top producer of medical marijuana since 2014, this grower is expanding its operations as it prepares to launch sales of recreational cannabis in Canada.

The stock took a big jump today, as the company just received a huge $5.1 billion investment from a U.S. giant. It will use the money to accelerate that expansion, as well as grow internationally.


SPECIAL MESSAGE

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CANOPY GROWTH CORP., $43.31, symbol WEED on Toronto (Shares outstanding: 220.5 million; Market cap: $9.5 billion; TSI Cannabis Quality Rating (CQR): ; www.canopygrowth.com), began trading on TSX Venture Exchange under the name Tweed Marijuana on April 3, 2014. The shares graduated to the regular TSX Exchange on July 26, 2016.

On May 24, 2018, the company became the first cannabis producer to be listed on the New York Stock Exchange (symbol CGC).

Canopy is a licensed grower for Canada’s medical—and, very soon, recreational—cannabis market. It has 10 facilities with total capacity of more than 2.4 million square feet of licensed production space. The company shipped its first product on May 5, 2014, from its Smiths Falls, Ontario, plant.

Canopy agreed on November 2, 2017, to sell 9.9% of its shares to Constellation Brands (symbol STZ on New York), one of the world’s largest beer, wine and spirits producers. The two companies plan to work jointly on cannabis-infused drinks in the future.

The partners aim to initially sell those drinks in Canada given expectations Ottawa will legalize edible and drinkable cannabis products as early as 2019. They will not sell those edibles (or cannabis itself) in the U.S. until the U.S. federal government changes its marijuana laws.

Canopy and Constellation will now expand their strategic relationship. On August 15, 2018, Constellation agreed to buy an additional 104.5 million Canopy shares at $48.60 a share, for a total of $5.1 billion. As a result, Constellation will then own roughly 38% of Canopy. It will also nominate four directors to Canopy’s seven-member board.

As well, Constellation will receive warrants to purchase additional Canopy shares over the next three years. If it exercises those warrants (worth $4.5 billion in total), it will own over 50% of the cannabis company.

Canopy is also using acquisitions to expand. In January 2017, it bought Mettrum Health Corp. (symbol MT on the TSX Venture Exchange) for $430 million in WEED shares. Mettrum added two brands to Canopy’s offerings and also diversified into hemp products through Mettrum Originals.

On May 14, 2018, the company announced that it would acquire the remaining 33% of BC Tweed that it did not already own. BC Tweed’s greenhouses have up to 3 million square feet of growing capacity, almost double Canopy’s current licensed capacity.

On July 11, 2018, the company agreed to acquire Hiku Brands Company Ltd. (symbol HIKU on the Canadian Securities Exchange). The Canadian Securities Exchange (CSE), formerly the Canadian National Stock Exchange (CNSX), is an alternative stock exchange in Canada.

Hiku owns the Tokyo Smoke chain of coffee shops that sells cannabis accessories and clothing. Canopy will pay roughly $350 million in stock for that firm.

Canopy is also preparing for further expansion in Latin America. That move is a way to capitalize on new medical marijuana laws in Peru, Chile, and Colombia. Uruguay was, in fact, the first country in the world to fully legalize marijuana. In July 2018, the company announced its Canopy LATAM unit acquired Spectrum Cannabis Colombia S.A.S. That firm has prime land suitable for outdoor growing in Colombia, but also a national license to produce and export cannabis products.

Thanks to those new operations and higher cannabis selling prices, Canopy’s revenue in the three months ended June 30, 2018, jumped 63.3%, to $25.9 million from $15.9 million a year earlier. However, new investments in production facilities caused its losses to balloon to $91.0 million, or $0.40 a share from $9.2 million, or $0.06.

Canopy ended the quarter with cash of $657.9 million, or roughly $3.30 a share. Its long-term debt of $617.7 million is a low 7% of its market cap.

The stock is widely followed by momentum traders. That in part explains why it jumped 35% Wednesday on news of the additional Constellation investment. However, Canopy’s $9.5 billion market cap is extremely high in relation to its sales of just $25.9 million in the latest quarter. Canopy will need to see huge revenue growth to even justify its current stock price—let alone move higher.

Canopy Growth has a 3½-Leaf Cannabis Quality Rating (CQR). The stock is a speculative buy for aggressive investors who want exposure to the marijuana industry.

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Investment Outlook

Weeding out the losers could be key to investment success

Pioneers in an industry are not always the winners, and early leaders in the cannabis industry could lose sales if—or when—these competitors enter the field.


FREE REPORT

The straight dope on cannabis investing: the one report that tells investors what they need to know to succeed

Cannabis growers continue to ramp up production ahead of the legalization of recreational marijuana use on October 17, 2018. At the same time, investor interest in cannabis stocks continues to build. However, even for aggressive investors, it’s important to understand the risks associated with these stocks.

The share price of many Canadian cannabis stocks has soared since mid-2016—although most have now given back some of those gains.

The speculative appeal of Canadian marijuana stocks continues to attract investors looking for a “ground-floor opportunity.” However, the pioneers in an industry are not always the ones who survive. That’s especially true for this and other industries where barriers to entry for new competitors are low.

Longer term, following full legalization, major agricultural and tobacco firms are likely to enter the field. They would take sales away from existing growers.

Shares of many marijuana stocks may move higher as momentum traders buy the widely followed stocks on the latest upswing. However, considering their current sales and earnings, many Canadian producers have very high “market caps” (the value of all shares outstanding). That means they need huge revenue and earnings growth to justify even their current stock prices.

All in all, we suspect that few of today’s cannabis producers will turn into profitable companies. Some may wind up worth much less than they are today.

We think a better way to profit from this industry is with firms like Molson Coors. It already has a solid base of other business and sound prospects. It also has the added appeal of a sustainable dividend.

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Cannabis-Connected

Industry leader ready to capitalize on cannabis with non-alcoholic beverage

We think one of the best ways to profit from the growing cannabis industry will be with firms that already have a solid business base and strong prospects outside of marijuana.

One of the world’s largest breweries, Molson Coors recently formed a joint venture with a Canadian producer to develop cannabis-infused non-alcoholic beverages. It also gained the right to buy a roughly 5% stake in the producer. Meanwhile, the company continues to see its earnings rise on its main business, beer.


YOUR MARIJUANA I.Q.

When are edible recreational cannabis products likely to become legal in Canada?
Do you know the answer to this question? Take our Marijuana Investment Quiz and be ready for October 17.

MOLSON COORS CANADA INC., (Toronto symbols TPX.A $95.99 and TPX.B $95.98; Shares outstanding: 215.7 million; Market cap: $20.7 billion; www.molsoncoors.com) is one of the world’s brewers. Its main brands include Molson Canadian (Canada), Coors Light (the U.S.) and Carling (the U.K.).

Molson recently announced a new deal with Canadian cannabis producer The Hydropothecary Corp. (Toronto symbol HEXO).

Under the terms of that agreement, Molson will own 57.5% of a new joint venture focused on developing cannabis-infused non-alcoholic beverages. Molson will also receive warrants to buy shares in Hydropothecary.

Ottawa will legalize recreational marijuana use effective October 17, 2018. However, it will prohibit the sale of foods and drinks containing cannabis until at least mid-2019. Ultimately, cannabis-infused beverages should help Molson offset slowing beer sales. The company’s marketing expertise and extensive distribution networks should also give it an advantage over makers of other cannabis drinks.

The company’s sales fell 15.2%, from $4.2 billion in 2013 to $3.6 billion in 2015 (all amounts except share prices and market cap in U.S. dollars).

In October 2016, Molson Coors acquired the remaining 58% of the MillerCoors brewing joint venture from SABMiller for $12 billion. It now owns 100% of this business. MillerCoors was formed in 2008, when Molson and SABMiller entered an agreement to combine their U.S. brewing operations.

Thanks to that purchase, Molson’s sales improved to $4.9 billion in 2016, and soared to $11.0 billion in 2017.

Earnings fell from $3.16 a share (or a total of $581.3 million) in 2013 to $2.10 a share (or $391.3 million) in 2015. Earnings then jumped to $9.35 a share (or $2.0 billion) in 2016, but declined to $6.52 a share (or $1.4 billion) in 2017.

If you disregard restructuring costs and other unusual items, overall earnings for Molson Coors rose 1.5%, to $968.6 million in 2017 from $954.6 million in 2016. Due to more shares outstanding, earnings per share rose 1.1%, to $4.47 from $4.42.

In the second quarter of 2018, Molson’s sales fell 0.2%, to $3.085 billion from $3.091 billion a year earlier. That missed the consensus forecast of $3.095 billion. If you exclude the impact of current exchange rates, sales declined 1.9%. Lower beer volumes in the U.S. and Canada offset gains in Europe and other international markets.

However, the company continues to cut costs in the wake of the MillerCoors acquisition. It expects the elimination of overlapping operations and job cuts to save a total of $600 million: $210 million in 2018 and $135 million in 2019. That focus on efficiency cut $255 million in 2017.

If you exclude all unusual items, earnings in the quarter rose 10.6%, to $1.88 a share (or a total of $406.1 million) from $1.70 a share (or $367.1 million). That beat the consensus estimate of $1.83.

The Ontario government recently cut the minimum price allowed for beer in the province, from $1.25 a bottle (or can) to $1.00. However, it’s unlikely that Molson would lower its selling prices.

The company’s earnings per share will likely rise 9.6% to $4.90 U.S. in 2018. The class A shares trade at 15.0 times that forecast (15.0 times for the class B shares).

Investors holding class B shares have less voting power to elect directors than those with class A shares. But the B shares are more liquid and receive the same dividend. The current annual dividend rate of $1.64 U.S. yields 2.2% for class A shares, and 2.2% for class B shares.

OUR RECOMMENDATION: Molson Coors B is a buy.

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TSI Cannabis Quality Rating System

Our Cannabis Quality Rating (CQR) considers a range of factors to determine the investment-quality rating for a cannabis producer. Individual ratings range from a 1-Leaf CQR—for stocks we believe lack almost all of the fundamental quality markers of even speculative cannabis stocks—to a 5-Leaf CQR for the highest-quality cannabis stock.

All told, we look at 13 factors in determining the quality rating of a marijuana stock:

13 QUALITY FACTORS

  1. Does this cannabis producer have rising revenue?
  2. Is its revenue stream significantly diversified?
  3. Is the company currently in production?
  4. Does the company have a sound balance sheet—cash and low debt?
  5. Does it have international operations?
  6. Industry prominence?
  7. Is the firm free from high dependence on a single customer?
  8. Does the cannabis producer have a prominent client list?
  9. Is its cost structure competitive?
  10. Is the stock’s market cap in line with the company’s sales (not an outsized market cap in relation to sales)?
  11. Is the company focused on organic growth rather than growth through acquisition?
  12. Has the stock’s price risen in line with the market average (not gone up faster than the market average)?
  13. Is the company outside of the broker media limelight?

Marijuana producers with most if not all of those factors earn a 5-Leaf Cannabis Quality Rating (CQR) for their sound investment quality and reasonable valuation compared to their current price and market cap.

Companies with many of these factors, receive a 4-Leaf or 4.5-Leaf CQR. That means they offer reasonable investment quality, but are somewhat overvalued at their current price and market cap.

Companies with a 3-Leaf or 3.5-Leaf CQR have a few of those key factors, which suggests they have reasonable investment quality. Still, they are likely overvalued at the current price and market cap.

Companies with a 2-Leaf or 2.5-Leaf CQR have a number of investment flaws and are very likely overvalued at the current price and market cap.

Companies with a 1-Leaf or 1.5-Leaf CQR have little investment quality and are almost certainly overvalued at the current price and market cap

Note: Even a 5-Leaf CQR is not the same as a BUY recommendation. In a new market where production is just now ramping up and both demand and supply are uncertain, most of these stocks lack fundamental value. Plus, most move up or down on the latest swings in investor interest and momentum regardless of their individual quality rating.  

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Cannabis by the numbers

The HORIZONS MARIJUANA LIFE SCIENCES ETF (Toronto symbol HMMJ) invests in North American firms that are legally involved in the cannabis industry. Canadian companies—including Aurora Cannabis (12.1% of assets) and Canopy Growth (11.0%)—make up 80% of the portfolio. As such the fund’s performance—specifically, its Daily NAV* and trading volume—reflects the ups and downs of this country’s cannabis producers.

*Net asset value (NAV) per unit is the underlying value of the ETF’s stocks and other assets at the end of each trading day divided by the number of outstanding units.

Read more on horizonetfs.com

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Cannabis in the news

Cannabis stories seem to be more prominent in the headlines every day, but we believe these five stories give investors the most important insights into developments in the run-up to full legalization on October 17, 2018.

1. Canadian marijuana stocks fell as much as 9% Tuesday following news the Ontario government will delay the sale of cannabis at bricks-and-mortar stores until next spring.

The declines reflect market disappointment with the government’s decision to limit recreational marijuana sales to its own Ontario Cannabis Store website until April 1, 2019. That’s more than five months after Canadians in other provinces will be able to walk into stores and make similar purchases.

The province’s attorney general calls the delay necessary to ensure public safety as the government comes up with a framework for private sellers.

2. Canada’s federal government will provide the country’s cannabis farmers with some funding, although it will restrict their access to two key crop programs.

Specifically, cannabis producers will get blocked from two federal crop programs that provide subsidies to farmers affected by damaged crops and large market fluctuations.

3. The Alberta Gaming, Liquor & Cannabis Commission has now finalized contract agreements for the distribution and warehousing of recreational marijuana.

The commission selected 13 federally licensed producers from the much broader list of 31 companies that met a February 2018 deadline. Those firms include some of the industry’s largest TSX-listed producers but also lesser-known private and public growers.

4. The B.C. government has now selected more than two dozen licensed cannabis producers to supply what is expected to become one of Canada’s largest markets for the drug.

5. The City of Los Angeles has now begun to accept license applications from marijuana growers, manufacturers and testing companies. The move comes seven months after California legalized recreational cannabis use for adults.

Under state law, local governments can continue to outlaw commercial cannabis activity, which means consumer access to legal marijuana varies from community to community. Before the licensing of local producers, LA retailers say they were forced to buy from producers outside the city. California law restricts licensed retailers to buying their cannabis from licensed growers.

 

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