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Canadian End-To-End Value Cannabis Stocks Present Opportunities For Short Sellers

Mar. 01, 2021 12:35 PM ETACB, CGC, TLRY, WEED:CA, TLRY:CA, ACB:CA4 Comments


  • End-to-end value cannabis stocks operating in Canada are flying high, but a retracement to near fair value is imminent.
  • The cannabis industry is changing due to vertical integration being scrapped and an influx of competitors.
  • Equity values of key players are well below the current market prices; EV/EBITDA multiples are not looking up.
  • The current options volume is unusually high with up to 100,000 options contracts traded on individual companies per day and 35% retail participation.
  • Rising interest rates will likely cause a growth stock bubble, which includes cannabis stocks.

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We've generally seen choppy waters when it comes to cannabis stocks, but high mean absolute deviations are perfectly normal within a new industry where regulatory implications often cause bumps in the road - for both the profitability of companies and the growth in their stock prices. However, there's more to the regulatory obstacles than meets the eye, and short-term market sentiment leads us to believe the industry provides brilliant short opportunities.

For the purposes of this article, we've focused on stocks that have adopted the end-to-end value model in Canada. We also focused on large-cap cannabis stocks and excluded analysis of small-cap stocks. In determining which stocks to use as benchmarks, we looked at factors such as market cap, growth over the past 12 months, and trading frequency. Inclusions have been analyzed as ex-post and ex-ante. There are references to political events during the article, but the article isn't an analysis of the political climate.

End-to-End Value or Vertical Integration

The Canadian Cannabis Act, which allowed for commercial production and sales of medical and non-medical cannabis came into effect in August 2016, the legal requirement was that vertical integration had to be adopted if an entity wanted to participate. Legislation meant that end-to-end value was a requirement for a Good Manufacturing Processes license (this was used as a seed-to-sale license) where participants had to provide a seed-to-sale solution. Since then, the industry has become somewhat fragmented as deregulation changed the construct of the supply chain. Our focus is on the part of the sector that is still adopting

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Analyst’s 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.

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Comments (4)

Thanks for the reminder, @pearl Gray Equity and Research. The Canadian cannabis sector is certainly set up for a fall. Having invested in the cannabis sector for five plus yrs, first in Canadian issues and gradually more in the US players, there have been multiple boom/bust cycles. I'm thinking the current boom runs a bit longer (especially in the US as there are multiple impending catalysts) while keeping a keen eye out for the inevitable bust!
Pearl Gray Equity and Research profile picture
@CannabisPat Thanks for the input. Our entire argument is based on the fact that the product will be produced with the ease consumer staples are with deregulation and demand will diminish as the idea of marijuana consumption goes out of fashion (Very unlikely that it will become a consumer staple).

From an accounting point of view, the end-to-end participants are expanding rapidly and will have a large amount of debt to cover in an industry with diminishing returns. From a more technical point of view: The above was reflected when Cannabis stocks first listed (among other reasons as well), the stocks have since been driven up by speculative trading, and when velocity in growth stocks decreases and the requirement for cash as well as a risk-off environment enters the fray, these will plummet to their fundamental values based on implied valuations.

However having said that, it's a subjective analysis and we couldn't find sufficient data to back up our argument for a published article due to the industry being in an early stage. We based our idea around economic, accounting, and behavioral fundamentals and produced a piece that correlated with our thought process as closely as possible!
US and Canada Marijuana Industry profile picture
Where do I start. You clearly don’t know much about the industry in Canada, recent acquisitions, reason for growth trends. I don’t see anything that talks about the fact that retail stores are expected to double in 12 months, there is no change in vertical integration.... maybe spend some more time understanding the market
Pearl Gray Equity and Research profile picture
@global not Canada focus Hi, thanks for the comment. The article is written to somewhat reassess expectations within the Cannabis space and Canada is used for industry life-cycle purposes. Retail stores are usually a coincidental/lagging indicator, we're looking at things from an implied basis. The vertical integration laws have changed as can be seen in our referenced report by PWC. Deregulation will subsequently create a fragmented industry, which will most likely become a global phenomenon.
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