The Bubble That Is The Marijuana Sector

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Includes: APHA, CGC, CRON, NBEV, PYX, TLRY
by: Long Term Tips

Summary

The marijuana industry shows high volatility through events with little overall meaning.

With no proven sales, it is hard to see these companies being valued so highly.

The payoff is very little due to the overvalued nature of the current sector.

Investment Thesis

As the marijuana sector has started to rocket with examples like Tilray (TLRY), Aurora (OTC:ACB) and Pyxus International (PYX), I have come to the conclusion that the marijuana sector is a bubble. Although this comes with a completely negative connotation, it shouldn’t. Unlike other bubbles, the marijuana sector is filled with companies that will succeed and exceed. These companies will be made apparent in as little time as Q2 2019 (the reason this is the catalyst is because this is when sales will come out showing which companies succeed and which don’t). That being said, there are a bunch of companies that won’t succeed. Whether apparent or not, all marijuana stock prices are priced to perfection or success. This is a give-away that the marijuana sector is a bubble. To prove this theory, throughout the article I will provide examples in the business, industries previously in a bubble, and finally, personal opinion.

Image Source: Getty Images

No matter how we look at it, marijuana stocks are all priced in for amazing sales. Some companies have shown a good increase in revenue such as Tilray, boasting a 95% year-over-year revenue increase, but that should be expected in a new, legal market. This revenue growth is seen in every marijuana stock that I have seen and happens to be much less important than it is being played as. These increases in revenue are very unimportant when we realize that it won’t matter if they cannot hold these sales in Q2 2019.

Comparison

To first consider the marijuana sector as a bubble, we must define a bubble and list some previous examples. A bubble would be a financial term for a sector or area in a market that will fly and, eventually, pop. Throughout history, there have been a bunch of bubbles such as .com and cryptocurrencies. To use a more recent example, we will use cryptocurrencies. The crypto example I will bring up is Riot Blockchain (NASDAQ:RIOT). What previously was known as Bioptix, Riot Blockchain’s stock rose 500% purely off of the name change. This alone gives a reason as to why crypto was a bubble and will be my argument point through this section. Now, I will look at Tilray. Again, as I have stated before, the marijuana sector is filled with stocks that will succeed; yet, Tilray is the most volatile. In comparison to the Riot Blockchain’s skyrocket, when Constellation Brands (NYSE:STZ) invested in Canopy (NYSE:CGC), Tilray shot up nearly 170%. If it was the company that got invested in, this would be excessive yet since it wasn’t, this seems unwarranted. Some may try to make the argument that this shows that “big dogs” are getting into the marijuana business; yet, the rise is simply unjustified.

If we look at rises based off very little news or unimportant news, the marijuana sector is filled with them. For this, I will use New Age Beverages Co. (NBEV). The company rose 400% off of news that it is unveiling a new drink line. Yes, some may justify this with it having a low float, yet a 400% rise off of a new line of beverages is unjustified. This was soon retraced, yet the price is still well above its previous price. This is a compelling point as it shows the marijuana sector is mirroring the crypto sector.

Examples

To start this example area, I will call out New Age Beverages Co. For me, I see it very hard for New Age to succeed with growing competitors and a smaller market than its cannabis counterparts. When bigger beverage companies start going into the cannabis field, I find it impossible for New Age to pursue past them. Then, if New Age were to grow to new heights, a buyout is possible yet. I will save that for a different article. New Age's stock was able to run nearly 400% from $1.59 a share to $7.85 a share in 6 days. Although this had one of the biggest rises, it was led by Tilray, Aurora, Canopy and Aphria (APHQF). Although those will help prove my point, I will focus on New Age as of right now. To look at the grand scheme of things, the market for marijuana beverages is projected to hit $600 million by 2022. With competitors coming into the field, I find it hard for it to be profitable for a company with no customer loyalty. Not only do they not have customer loyalty, other companies joining the marijuana beverage field do have customer loyalty.

Now, to dive deep into what makes NBEV the perfect example of a bubble stock, we will look at its financials. NBEV is trading at over 4X 2019 projected sales. The reason this is so bad is because of the lack of profit and the growing competition. For companies with a certified business and guaranteed income, trading at these values is normal; yet, for a company with so many obstacles, it’s overvalued. This is the same with a bunch of other cannabis companies like Canopy Growth Corp. which is trading at 10.7x 2020 sales of $1.05 billion, Cronos Group (CRON) which is trading at 12.3x 2020 sales of $160m, Aurora Cannabis which is trading at 8.6x 2021 sales of $1.1 billion, Aphria which is trading at 9.4x 2021 sales of $360m and Tilray which is trading at 43.8x 2020 sales of $350m. To me, this is a huge piece in proving that the marijuana sector is in a bubble. In the technology sector - a known sector for being overvalued - companies like Nvidia (NVDA) and Amazon (AMZN) lead the pack as being considered overvalued. Amazon is trading at roughly 3X 2021 projected sales of $316 billion and Nvidia is being traded at roughly 10X 2019 projected sales of $15 billion. So, to put it short, companies which have a guaranteed future are being valued lower in comparison to their sales than companies with a huge potential to fail.

Extra information explaining reasoning: The reason that the sector being overvalued is important is due to the fact that when a drop comes, it will drop a lot. If it were to be valued normally, depending on the news, it wouldn’t drop drastically but when a market is overvalued, all news affects it and volatility is shot through the roof.

Public Opinion and Opposition

With a statement this bold, it comes with lots of contradiction. Many will say that there will definitely be stocks that do work out and, for that reason, it’s not a bubble. To that, I understand and propose a new way of thinking of the marijuana market. This new way would be an egg. And yes, this sounds silly, but when we dive deeper, it begins to make sense. I still believe the market represents a bubble - yet, an egg is easy to explain. With a strong outside, we really won’t see a drop until the financial reports come out sometime in Q2 2019. Although there is a general idea of which companies will succeed, all marijuana stocks are priced as if they will. I have already talked about their market valuation in comparison to sales in an earlier section, so I won’t bring that up. The thing about my egg analogy is that yes, some will stay strong, but like an egg, some will crack and get destroyed.

Risks or Holes In This Theory

Obviously, I could be wrong. These marijuana stocks can continue to fly and seemingly disobey gravity. Once sales come out, we can find out that the marijuana market is doing a lot better than projections, allowing a bunch of companies to succeed. That being said, there is a lot these companies and the marijuana sector as a whole have to do to stay afloat. Not only will the sector have to deal with potential internal problems such as low demand for the product, it has to deal with a consolidating market. As we all know, the tech industry was overvalued up until our recent consolidation and shareholders felt the burn. For Nvidia, it almost hit $290 a share only a month ago and is now barely above $200. Some saw this drop coming due to the overvalued nature of Nvidia stock. The marijuana sector is seemingly following the tech sector and a drop should be expected. Then again, the tech sector ran a lot more before coming to a halt.

How Does This Affect The Stocks?

To put it shortly, this affects marijuana stocks a lot. As it may be clear through this article, I don’t see New Age Beverages standing the test. As for Tilray, Canopy, Aurora, Aphria, etc. it’s a toss-up. Tilray doesn’t have the production capacity that Canopy and Aurora have and as of right now, only 150,000 kg of yearly production in comparison to Aurora’s 570,000 kg a year; yet, as we’ve seen, the market doesn’t seem to care. For me, I think it is hard to invest in any of them as the payoff seems very limited for such risk. If their sales are bad, the stock will crash. If their sales are good, their stock shouldn’t see a noticeable change since good sales are already priced in. All in all, I think the marijuana sector is profitable if played correctly, yet eventually, it will see a huge drop. That being said, investing in the sector will be based off of the investors risk tolerance.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.