Weekly Cannabis Report: Time To Overweight U.S. Stocks

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Includes: ACB, APHA, CGC, CRLBF, CRON, CTST, CWBHF, HEXO, HMLSF, HRVOF, HRVSF, IIPR, KHRNF, KSHB, MJ, OGRMF, PLNHF, TCNNF, TGODF, TLRY, VFF
by: Cornerstone Investments
Summary

The cannabis sector dropped last week amid record valuations and a reversal of rapid gains during the first three months of 2019.

Trulieve reported US$35 million in 2018 Q4 revenue and KushCo raised full-year revenue guidance to US$140-150 million.

We think investors should overweight U.S. cannabis stocks and reduce their exposure to Canadian stocks amid uncertain near-term outlook.

Cannabis, Marijuana, Hemp, Cornerstone Investments Welcome to our Weekly Cannabis Report, a reliable source for investors to receive the latest developments and analysis in the cannabis sector.

Trading Summary

Cannabis stocks struggled last week as momentum reversed after a strong first quarter. Horizons Marijuana Life Sciences Index ETF (OTC:HMLSF) dropped 4.4% and ETFMG Alternative Harvest ETF (MJ) lowered by 3.3%.

(Source: Bloomberg)

Canadian Large-Cap: Aphria (APHA) was the best performer after being flat for the week. The rest of the large-caps all dropped and Tilray (TLRY) was the worst performer with another 11% drop. Aurora Cannabis (ACB) dropped 3.2% after increasing the designed capacity at its Aurora Sun facility. Canopy Growth (CGC) was down 2.2% after Scotiabank revised down its calendar 2019 Q1 revenue forecast and predicted an upcoming earnings miss. Cronos (CRON) dropped 7.4% as valuation continues to overhang the stock.

Canadian Mid-Cap: The mid-cap space suffered losses across the board. OrganiGram (OTCQX:OGRMF) lost 2.5% after announcing several management changes. CannTrust (CTST) dropped another 6.4% bringing its total loss to 29% since it reported poor Q4 results. HEXO (HEXO) and Green Organic Dutchman (OTCQX:TGODF) both struggled along with its peers.

Canadian Small-Cap: Small-caps experienced higher volatility last week. Village Farms (VFF) dropped 15.1% while continuing its volatile trading in 2019. MediPharm (OTCPK:MLCPF) jumped another 23.3% after gaining 27.2% in the prior week (we recently called it our best cannabis extraction play). Harvest One (OTCPK:HRVOF) reversed 17.5% after a huge rally on the back of its recent supply agreement with Shoppers Drug Mart.

(Source: Author, based on public data)

U.S. Cannabis Operators: The weakness extended into U.S. cannabis sector and MSOs were hit particularly hard. Cresco Labs (OTCQX:CRLBF) dropped 8% after announcing its acquisition of Origin House the prior week. Harvest Health (OTCQX:HRVSF) dropped 12% despite making an acquisition to expand into four states on the East Coast. Trulieve (OTCPK:TCNNF) dropped 11% after announcing a record US$35 million revenue for 2018 Q4. Planet 13 (OTCQB:PLNHF) bucked the trend with an 8.6% gain as investors cheer its record US$5.5 million of revenue from the flagship store in March alone.

Ancillary and International: Charlotte's Web (OTCQX:CWBHF) dropped 11% along with the rest of the market. Latin American player Khiron Life Sciences (OTCQB:KHRNF) continued its recent correction with another 12% drop. KushCo (OTCQB:KSHB) lost 4.8% after announcing an accounting error which was offset by a strong quarter and raising its fiscal 2019 guidance. Cannabis REIT Innovative Industrial Properties (IIPR) held steady last week.

(Source: Author, based on public data)

Industry News

Looking Ahead

It was a relatively quiet week after several months of rampant M&A and regulatory changes in the cannabis sector. The sector came under pressure as shares dropped across the markets in Canada and the U.S. as investors scaled back their bets on pots. We think a few headlines affected investor sentiment including Scotiabank's warnings on Canopy's upcoming quarterly results and the accompanying downward revision to its forecasts. We have seen many analysts reducing their outlook for Canadian cannabis stocks as early data suggest legal sales have slowed down across the nation which is a worrying sign for the young industry. The sector continues to struggle with production and logistics issues and the government continues to restrict physical retail stores in the largest markets such as Ontario, B.C., and Alberta. We also think that the Canadian firms are likely to report lower than expected revenues for calendar 2019 Q1 and believe that Canopy will likely show much lower growth next quarter based on its inventory positions heading into 2019 and media reports that it is struggling to ramp up at its BC Tweed facilities almost six months into legalization.

For investors, we think the key takeaways are twofold. First of all, most people should taper their expectations for the upcoming quarters for Canadian producers as there are two major factors that will limit their growth. A lot of producers dumped a large portion of their inventories during the initial months of legalization in order to meet their commitments, only to leave themselves short on supply in the following months. Most producers are still struggling to ramp up their facilities and delays are common. For example, CannTrust and TGOD both experienced significant delays due to zoning and other issues with local authorities. Combined with packaging and labeling issues that we have been hearing, we think producers will remain under pressure to deliver more cannabis during the first half of 2019. Furthermore, the Canadian market is simply too small compared with the U.S. market. For reference, Canada had about 350,000 medical patients at the end of 2018 but Florida alone reported more than 200,000 medical patients in early 2019 and that number is expected to grow substantially this year. A small company called Planet 13 reported US$5.5 million of sales from its single location in Las Vegas in March alone while Cronos only reported C$5.6 million revenue from the entire fourth-quarter in 2018. The size of the U.S. markets is unmatched and U.S. operators will continue to outearn Canadian companies going forward.

As a result, we have seen cannabis investors shifting more focus to U.S. plays while reducing their exposure to Canadian stocks. We think cannabis investors need to strategically increase their exposure to the U.S. sector if they haven't done so already. The Canadian market has gone through a transformational period between 2015 and 2018 until legalization officially started in October last year. However, the initial rollout has been bumpy while the U.S. market is quickly gaining momentum. The ultimate catalyst for the U.S. cannabis market would be the federal legalization which we think is possible within the next one or two administrations. As a result, we think it makes sense to overweight U.S. cannabis stocks at this point given the different growth outlooks.

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 covers one or more microcap stocks. Please be aware of the risks associated with these stocks.