September 25, 2018

Last week, there was a laser-like focus on pot stocks that took investors for one of the biggest roller-coaster rides in recent memory. The trend toward the legalization of weed has created “reefer madness” in the price action of several pot stocks, where volatility became about as extreme as anyone can remember.

Canada has taken the lead on making pot legal throughout the entire country. Marijuana use in Canada will likely be legal as of mid-October after legislation cleared regulatory hurdles in June.

There are several ways to invest in the potential marijuana boom. Many are plays for recreational use of marijuana, which will boom if legalization goes forward as expected. Many other investments are medical plays, which have the potential to be quite successful, even though the upside is smaller.

In the U.S., all marijuana-related products are grouped into the Schedule I classification by default. Drugs in this Schedule are illegal at the federal level, with the U.S. government declaring them to have “no currently-accepted medical use, and a high potential for abuse.” But Shares of GW Pharmaceuticals[GA1]  (NASDAQ: GWPH) rose sharply last week, spurred by Morgan Stanley analyst David Lebowitz’s report that the U.S. Drug Enforcement Administration (DEA) plans to reclassify GW’s cannabidiol (CBD) drug Epidiolex as a Schedule IV controlled substance to treat rare forms of epilepsy.

(Please note: Bryan Perry does not currently hold a position in GWPH and Navellier & Associates does not currently own a position in GWPH for client portfolios).

The last category of marijuana-related investments is made up of those that happen to have a lot to gain from the pot industry but aren’t necessarily reliant upon it for success. This is where the smart money is finding a way into the sector – in a highly cautious, almost indirect manner. These would involve joint-ventures (pardon the pun) by large blue-chip companies partnering with highly speculative small-cap cannabis companies to develop an array of medicinal and recreational products. As ancillary businesses, a failed joint-venture only has a negligible impact, whereas a successful venture will be highly celebrated.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary

The headlines have caused several of these small pot stocks to soar. While there are many micro-cap pot stocks that trade only in Canada, a handful now trade as American Depositary Receipts (ADRs) on Nasdaq or Over-the-Counter (OTC) and are cleared to be owned by most major brokerage firms.

American investors eager to get in on the weed rush have pounced on these recently-listed securities in what resembles a bubble-like buying panic that has sent their stock valuations sky high. There is even an exchange traded fund, the ETFMG Alternative Harvest ETF (MJ) that has become wildly popular of late, trading at a sky-high premium to its NAV.

As a result, the hottest names in the sector have soared and crashed in recent weeks. As with any stock mania, the shorts got crushed and the panic buyers that paid top dollar are seeing their investment capital go up in smoke. The current pullback is going to define which pot stocks offer legitimate opportunity. Of the names most coveted, Canopy Growth (CGC) shares have doubled this year, while Tilray Inc. (TLRY), which made its debut in July, rallied 500% since Labor Day, hitting $300 before getting knifed back down to $123 as of last Friday. But it still trades at 400 times forward sales!

(Please note: Bryan Perry does not currently hold a position in CGC or TLRY and Navellier & Associates does not currently own a position in CGC or TLRY for client portfolios).

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Catching A High-Quality Profit Buzz in the Pot Sector

A major catalyst fueling the pot stock rally and bringing credibility to the whole investment theme is the interest and entry by Fortune 500 companies into the space. This is what I deem the “smart money” trade in what is a highly speculative sector, where there will be a few big winners and many more, and bigger, losers.

For instance, marijuana stocks spiked higher after a report that Coca-Cola (KO) is looking to get into the industry. Aurora Cannabis (ACBFF), a Canada-based cannabis producer, rallied more than 20% in trading after Bloomberg reported that Coke is in talks with Aurora to develop weed-infused beverages. Additionally, Aurora Cannabis sent an email to CNBC that they would be planning a U.S. stock listing in October. Any partnership between the two would likely develop health-focused beverages aimed at easing inflammation, pain, and cramping, the report said. Coca-Cola, in turn, offered this statement:

“Along with many others in the beverage industry, we are closely watching the growth of non-psychoactive CBD as an ingredient in functional wellness beverages around the world. The space is evolving quickly. No decisions have been made at this time.”

Other big-name companies that have strategic plans and partnerships in place include Scotts Miracle-Gro (SMG), a leader in the hydroponics industry. The company is a dominant player in the horticultural supplies that growers depend on for producing high-quality cannabis. Though the move in marijuana stocks is mostly headline-driven thus far, Coke wouldn’t be the first beverage titan to test these waters.

AbbVie Inc. (ABBV) is a pharmaceutical giant with a syntheticcannabis-based drug on the market. The FDA has approved Marinol, which helps alleviate nausea or vomiting for chemotherapy patients. The drug also helps AIDS patients who have lost their desire to eat. Marinol is not AbbVie’s flagship drug. That makes investing in the company a way to play the pot card without 100% exposure to the plant itself.

Several beer makers are getting involved. Corona beer maker Constellation Brands (STZ) upped its bet on the industry last month, announcing an additional $4 billion stake in Canopy Growth (CGC). Molson Coors (TAP) also announced in August that its Canadian unit is entering into a deal that will develop cannabis-infused beverages in Canada. Molson Coors Canada is partnering with Canadian cannabis producer Hydropothecary Corp. (HEXO) to create a joint partnership “to pursue opportunities to develop non-alcoholic, cannabis-infused beverages for the Canadian market following legalization.”

The latest offering by Heineken N.V. ADR (HEINY) in the pot market is the Lagunitas’ IPA-inspired and THC- and CBD-infused sparkling water called Hi-Fi Hops. Heineken completed the Lagunitas acquisition in 2017, after initially taking a 50% stake in the company. Lagunitas has tied up with the medicinal marijuana company CannaCraft to add THC/CBD ingredients to the product that will be distributed initially through dispensaries in California.

(Please note: Bryan Perry does not currently hold a position in KO, ACBFF, SMG, ABBV, STZ, CGC, HEXO, or HEINY and Navellier & Associates does not currently own a position in KO, ACBFF, SMG, ABBV, STZ, CGC, HEXO, or HEINY for client portfolios).

Not to be left out, it’s probably just a matter of time before global pharmaceutical companies must think about partnering with cannabis producers as a “hedge” against the entire space. And one has to openly wonder when the global cigarette companies, with their well-established distribution channels will enter the fray with their own trendy versions of “wacky tobacky.”

From my vantage point, professional money is targeting the blue-chip companies noted above that pay juicy dividend yields averaging 3.0% and then see how the market for their marijuana-based products develops. Blue-chip companies that are partnering up with the pure-play pot producers or marijuana-business-related services companies have already done a lot of due diligence into what might be investible companies once the “smoke” clears after the initial bubble bursts.

For an industry with essentially no barriers to entry and seeing new stock listings growing like “weeds,” there is a lot of dot-com-like risk. States legalizing recreational pot – like Colorado, Washington, and Oregon – bear major red flags. In all three states, oversupply ran rampant within just a few quarters, pushing the per-gram price for retail and wholesale dried marijuana down as much as 80%.

Commoditization of dried cannabis is likely to negatively impact margins and make it very difficult for Canadian marijuana stocks to hit investor expectations of overnight fortunes. It’s my view that the bursting sound of the big green bubble (above) will soon be heard across the investing landscape!

About The Author

Bryan Perry

Bryan Perry
SENIOR DIRECTOR

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. *All content of “Income Mail” represents the opinion of Bryan Perry*

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