Marijuana: Up In Smoke

by: Ron Struthers

Canada screws up legalization.

Tilray from a high to a downer.

Canopy Growth is a sector leader.

Valens Groworks starts a new oil pipeline.

RISE believes CBDs are good for sex.

Some younger folk might not know the Cheech and Chong movie, Up in Smoke. It was a 1978 stoner comedy film that received mixed to negative reviews at the time. Nevertheless, it was a success and is now considered a classic. I remember it like a couple of bumbling stoners who could not do much right and only a little more so when they were stoned. Picture is from Rolling Stone magazine.

It now reminds me of Canada's version of marijuana legalization. Perhaps the legislatures should have been stoned when they made this policy change because they sure screwed it up. There are excessive rules and legislation to grow and distribute marijuana. The biggest mistake, at least so far is a very poor retail market for recreational use. Ontario is the largest province in Canada with about 40% of the population and is now putting plans in place to open the first 25 marijuana stores. It was a lottery and many of the winners have no or very little retail or business experience.

The biggest joke is the low number. I can drive about 20 minutes down the highway from where I live to the First Nations reserve where there are more than 50 outlets operating, and they are all busy. Since legalization, users are not concerned with transporting marijuana they buy on the reserve. Many are driving one to two hours to get there and the product for the most part all comes from the black market. Just one outlet, Legacy 420 claims, they have revenue of about $20 million per year and that was before legalization.

Many have compared the size of the marijuana market to the beer and wine or alcohol market. According to the LCBO's latest report, there are 2,332 retail outlets in Ontario, compared to 25 future marijuana outlets. Are you laughing yet? I hope that when CBD-infused beverages are legalized later this year that they simply put them on the shelves of the LCBO, but that would be too simple and cost effective.

With inflated prices, bans on edibles, heavy regulation of cultivators and limits on private retailing, consumers continue dialing up their friendly neighborhood dealer to avoid all that. The Canadian and Ontario legal marijuana market is going to take many years to gain substantial ground on the black market. I believe it's important for investors to focus on companies that are expanding or focused outside of Canada, are establishing brands and are not affected by the restrictions in the Canadian retail market. This is also a follow up on my Oct. 4 report on the sector where I warned that over-inflated marijuana stocks were due for a correction.

Both the Canadian and U.S. marijuana indexes (OTC:HMLSF) witnessed a very significant plunge after my Oct. 4 report and have now bounced up. The Canadian Index peaked in January 2018 and had a bear market rally to the October 2018 high. It then plunged to new bear market lows in December 2018. The current rally looks like another bear rally.

By contrast, the U.S. marijuana index made a new bull market high in October 2018. The jury is still out on whether the index can make new highs, but as long as the index holds above the 105 to 110 area all is good. A drop below that level could signal a more substantial correction. The moves in both indexes are often volatile, moving more than 20% in either direction.

Let's look at some previous stocks I commented on and a couple of new ones.

Canopy Growth (CGC), market cap US$15.5 billion

Canopy has done a lot of diversification outside Canada. In mid-January, they made a $150 million investment to develop large-scale hemp production in New York State.

On Feb. 7, Canopy announced that they are increasing their interest in Canopy Rivers from 26.5% to 27.3%. Canopy Rivers works collaboratively with Canopy Growth to identify strategic counterparties seeking financial and/or operating support and affiliation with the Canopy Growth group of companies. This helps to build the Canopy brand and also provides diversification outside Canada.

Canopy Rivers has recently expanded its portfolio by making several innovative investments in the cannabis market worldwide, including:

  • An equity interest in Headset, a real-time data and analytics company;

  • Financing of Greenhouse Juice Company, a health and wellness beverage company;

  • Increasing its ownership in Canapar, Italy-based hemp production and processing platform capitalizing on the rapidly expanding European CBD (cannabidiol) market.

On Jan. 21, Canopy updated their operations in Poland and the U.K. In the United Kingdom, the company has formed Spectrum Biomedical U.K., a new company focused on providing access to cannabis-based medicinal products to United Kingdom patients with the severe unmet clinical need. Canopy Growth's Torun-based team, Spectrum Cannabis Polska in Poland, successfully completed its first import of medical cannabis. This came after completing a rigorous regulatory approval process to have the product assessed and approved for sale.

On Feb. 28 Canopy and Sequential Brands Group (SQBG) announced that Martha Stewart has joined the company in an advisory role to assist with developing and positioning a broad new line of product offerings across multiple categories. With decades of success in publishing, broadcasting, online and merchandising, Martha Stewart can make a difference promoting the Canopy brand.

Canopy reported excellent Q3 results on Feb. 14 in Canadian dollars. It was the first full quarter of recreational sales in Canada and revenue increased to $83 million, up 256% from the previous quarter, as they sold 10,102 kilograms of cannabis and oil equivalent. The company is still losing money and my first concern was that the great quarter was due to inventory drawdown in anticipation of legalization. However, inventory at Dec. 31 was $184,961,000 up from $150,406,000 reported Sept. 30, so that was good to see.

I have no doubt Canopy will be a leader and one of the best brands in the cannabis space, but investors already are paying the price for it. At the current annual revenue run rate and subtracting $4 billion cash from the market cap, the stock is trading around 50 times revenue. This is very expensive but is often the case with high growth stocks where investors are pricing the stock on much higher, future revenues and earnings. Once there's a whiff of slower growth, the stock will sell off hard. That's the risk before and on the next quarterly report because it will be very difficult for Canopy to report triple-digit growth over this quarter.

The chart is the US dollar price and I see heavy resistance in the $50 to $55 area which the stock has already tested in this rally. I see some support around $42 and strong support around $30. In my opinion, there's too much risk to be long at this level. If you are long, I would look to exit on a rally to $49 and a stop/loss at $42.

Tilray (TLRY), Market cap $6.5 billion

The stock has dropped more than -50% since my warning that it was way too expensive in early October 2018 and I still can't find a good reason to own it. There's simply too much hype on this stock, and even on their website, it's hard to wade through it and find the real news. They are making some good moves though by taking advantage of their high share valuation and cash.

On Feb. 28 they closed the acquisition of Manitoba Harvest. Founded in 1998, Manitoba Harvest is the world's largest hemp food manufacturer and a leader in the natural foods industry. It produces, manufactures, markets and distributes a broad-based portfolio of hemp-based consumer products, which are sold in more than 16,000 stores at major retailers across the U.S. and Canada.

On March 3 Tilray announced that its wholly-owned subsidiary Tilray Portugal Unipessoal Lda. ("Tilray Portugal") has completed a successful harvest of medical cannabis at the Company's European Union (EU) campus in Portugal.

To help build their brand, on Jan. 15 Tilray announced that they signed a long-term revenue-sharing agreement to market and distribute a portfolio of consumer cannabis products within ABG's brand portfolio in jurisdictions where regulations permit.

As the owner of more than 50 brands, ABG builds value by partnering with an expansive network of best-in-class manufacturers, operators, and retailers. With a global retail footprint of over 100,000 points of sale and more than 4,500 branded freestanding stores and shop-in-shops, ABG's portfolio generates approximately US$9 billion in retail sales annually.

Tilray is licensed to produce medical Cannabis in Chile and through their Tilray Latin America subsidiary can import and distribute products in both Chile and Brazil. Tilray currently has medical cannabis products in 12 countries through subsidiaries in Australia and New Zealand, Canada Germany and Portugal along with Latin America. The direction that Tilray is heading with global ambitions that should be compared to the likes of Canopy and Aurora (OTC:ACB), but it falls far short.

Tilray will report fourth quarter and year-end earnings on March 18. Their third quarter on Nov. 13, 2018, came in at US$10 million in revenue and they had cash of $104 million. Tilray completed a $475 million in convertible senior notes in October 2018 to bolster their cash position. At a $40 million revenue annual run rate, the stock is trading at 150 times annual revenue which is about three times the price of Canopy using this comparison.

The stock is still too expensive and the chart shows it could be on the verge of a technical break down. The stock price is just above a good support level at $65. A close at $64 or lower would be a bad sign without much support until it drops to around the $25 area. That's where I expect the stock is headed and the March 18 earnings report could be the catalyst to get it started.

A company that has something in common with both Canopy and Tilray is Valens Groworks (OTCQB:VGWCF). Valens expertise is in extraction to produce oils and resins with a current annual capacity to process 240,000 kilograms of dried cannabis. They are recognized as a leader in this regard and have agreements with many large cannabis producers.

Valens Groworks, 93.2 M shares out, Market cap C$280 million, Cash on hand $41 million

On Dec. 13, 2018, Valens announced a deal to provide multi-year extraction services for Canopy Growth and on Feb. 26, 2019, a multi-year deal with Tilray for a minimum of 15,000 Kgs dried cannabis per year.

Valens has announced numerous similar deals with OrganiGram (OTCQX:OGRMF), Sundial Growers, Harvest One (OTCPK:HRVOF) and most recently on March 11 with Green Organic Dutchman (OTCQX:TGODF). Valens will process an annual minimum of 30,000 Kgs in the first year and 50,000 Kgs in year two for the Organic Dutchman.

Valens does not require big grow facilities and will benefit from the much higher margins on cannabis oil. Their proprietary extraction process is boasted as the best and most efficient on the market. Investors are able to attest to this with their ISO 17025 certification, the Thermo Fisher award and a supply deal with Canopy Growth, Tilray, and many others.

This graphic is a slide from the Valens presentation.

There are many advantages with a focus on oils and resins, such as:

  • A longer shelf life compared to the flower;
  • Aging flower can be bought at a discount;
  • Numerous uses as shown above;
  • Higher margins on oils and resins.

An obvious way you can verify the higher margins is looking at any of the LPs recent financials that are selling oils. They are all claiming increased dollar values per gram sold and attributing this increase because of higher ratios of oil and concentrate sales.

There has been much hype in the market about the Constellation deal with Canopy for beverages, Molson Coors Canada and speculation about Coca-Cola (NYSE:KO). Valens already is positioned as well or better than anyone for the upcoming beverage market in 2019. Their multi-year deal with Tarukino Holdings gives Valens access to Tarukino's proprietary emulsion technology that transforms cannabis into water-soluble form for beverages while masking any cannabis taste. Valens also has the distribution rights in Canada for Tarukino's popular "Happy Apple" drink, Washington State's No. 1 selling cannabis-infused drink 3 years in a row. Valens also has the rights to Pearl20™ that can be used to mix drinks and edibles.

Tarulino's SōRSE emulsion technology surrounds oils, transforming the entire solution into water-compatible forms. This means you can add cannabis to products including beverages without that "weed" taste or smell and has:

  • Shelf stable for over 180 days (not proven anywhere else).
  • Zero cannabis taste, color or odor.
  • Provides effective, consistent dosing.
  • Lower dosage sufficient due to increases in bioavailability when consumed.
  • Faster onset and offset, making it the safer and more trusted edible option.

Oil usage has proven to grow at faster rates than flower usage soon after recreational legalization. You will find this the case in Colorado, Washington, and other legal states. Also, note that Canopy reported oils at 33% of revenue up from 23% in the same period last year that further attests to this.

Canopy sold 10,102 kilograms of cannabis equivalent in the latest quarter, which would be 40,408 kilograms in a year. Valens is able to process 250,000 kilograms per year and just their deal with Green Organic Dutchman and Tilray is 45,000 kilograms in the first year. In essence, Valens will be processing and selling more kilograms of cannabis equivalent than a number of the major producers combined.

Valens will not post the large revenues from selling a lot of consumer end product (flower) but will be capturing large margins on converting flower to oil. Valens input costs are much lower and they are more likely to be more profitable than the big LPs. In their presentation, Altacorp Capital is shown as initiating coverage with revenue estimate of $43.5 million in 2019 and $118.7 million in 2020.

Subtract $40 million cash from the $280 million market cap and the stock is trading at only 5 times projected 2019 revenues. That is very cheap in comparison to most.

It's also worth noting that Valens Labs has a Health Canada Dealers license. It is the first ISO 17025 accredited lab in Canada for a cannabis matrix and is named "Center of Excellence in Plant Based Science" by Thermo Fischer Scientific.

Valens Farms - B.C. cultivation

This was a great deal for Valens because of a zero cash outlay with Kosha contributing 100% of land, building and equipment costs. All hard assets will be split 50/50 between Kosha and Valens, thereby providing $37.5 million of net assets to Valens' balance sheet with no cash outlay or liability incurred. Valens and Kosha will split profits on a 50/50 basis following cost recovery by Kosha. Valens Farms is expecting Phase 1 production of up to 56,000 kg per year of premium mono crop cannabis, primarily for extraction purposes. This will be exclusively extracted by Valens and made into Valens branded products.

The stock trades more volume on the Canadian side under symbol "VGW." The chart above is US dollar price and shows a higher close and trading above US$2.25 in February so a technical break out. The recent pullback is a decent entry level and the stock has established some support around $1.80. A close above $2.45 would be very positive break out.

A quite interesting and hidden gem is RISE Life Science (OTC:MCUIF).

Volumes are light so it may take some patience to buy below US$0.25, the stock also trades in Canada as (CSE:RLSC). Market cap C$13 million.

If you speak with any pothead, they will tell you that cannabis can cure anything and is good for everything, including better sex. RISE does not have any cannabis production but has developed their own brand of wellness products, including some for sexual enhancement. They say "sex sells" so this could be a nice advantage for RISE.

RISE just started sales in Southern California in June/July so their last financials only reflect about one month of sales, which was C$141,783. They have just raised C$5.5 million and have expanded into Mexico. We will need to see at least a couple of quarters of sales revenue to get an idea of how their products are moving.

End of January, Greg Mills, formerly head of RBC's global equities, joined the RISE board of directors. Mr. Mills joined RBC Capital Markets in 1998 as head of equity trading and in 2005 was promoted to head of global equities and served in that position until 2018. Mr. Mills' key responsibilities included business planning, risk management, global profit and loss, client relationships employee governance, and equity research.

In early February, RISE selected Solcanna SA de CV to act as a distributor of its Life Bloom Organics brand of cannabidiol-based health and wellness products in Mexico. The initial purchase order executed with Solcanna will see Life Bloom Organics' wellness formulation initially placed in three key Mexican markets: Mexico City, Guadalajara, and Monterrey. Solcanna and RISE have planned this launch in the Mexican marketplace with an initial order of approximately $350,000 to place product at retailers in Mexico City, Guadalajara, and Monterrey. The expectation is for recurring orders to be placed, additional Mexican markets to be launched, and additional products to be added to RISE's Mexican portfolio.

Delivery of product to Solcanna is subject to regulatory approval from COFEPRIS, the Mexican Secretariat of Health's agency responsible for the regulation of a variety of food- and health-related products in Mexico. Mexico is a huge market with a population of over 123 million people and the government is moving towards legalization. The government controls the house so no major setbacks are expected with the legislation.


Life Bloom Organics' proprietary nano hemp extract oral sprays can be found at natural health food markets, chiropractic offices, specialty retailers and medical dispensaries in Southern California, as well as online. Below is a couple of screenshots from their website.

The US Farm bill is a direct and significant benefit for RISE Life Science

RISE's lifestyle product brands, Life Bloom Organics and Karezza, feature hemp-extracted cannabidiol oil. Using industrial hemp - the same material legalized by the 2019 Farm Bill - has allowed their products to be available to all US consumers, with shipping offered to all 50 states. Using industrial hemp in their formulations also means that the RISE Life Science brands will benefit from continued and even greater access to quality raw plant materials. The Farm Bill helps to support hemp farmers providing them with agriculture benefits and support not previously available.

I believe the Karezza product line differentiates RISE from most or all competitors. On July 12, 2018, RISE acquired Cultivate Kind. This added significant in-market expertise, provides immediate revenue to the company and brings U.S. distribution capabilities in house. Cultivate Kind was born from the traditional CPG agency world and brings more than 30 years of consumer marketing experience and brand launch strategy to the RISE portfolio. For any startup with products, marketing experience is essential.

I believe RISE is positioned very well in this new cannabis market and the stock prices have not reflected that yet. There is more trading on the Canadian side so I show a chart in Canadian dollars. There is an uptrend in place and the pullback from recent highs gives a better entry price. It will probably take prices over $0.40 for liquidity to improve.

Disclosure: I am/we are long VGWCF, MCUIF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.