Marijuana stocks are rising on a wave of giddy news. It started in August, when booze biggie Constellation Brands(STZ) agreed to add $4 billion to its investment in Canada’s lead weed company Canopy Growth (CGC). The hysteria got a new boost Monday, when Coca-Cola(KO) confirmed an interest in spiking sports drinks with cannabidiol, a soothing but non-psychoactive ingredient of marijuana. When Bloomberg reported that Coke’s partner could be the Canadian grower Aurora, shares of Aurora Cannabis(ACB.Canada) jumped 17%, to close Monday at 10 bucks Canadian.
All this even before legal recreational sales in Canada finally start on Oct. 17.
Don’t get too high on all these surging pot stocks. Our skeptical cover story in March may have been premature. But even the industry’s biggest bulls now acknowledge the bubbles floating all around them.
Most of Canada’s big pot stocks doubled in August before taking a breather. Then there’s Tilray(TLRY). With barely a backward glance, Tilray stock has shot up six-fold since July 19, when the British Columbia outfit became the weed industry’s first initial public offering on a major U.S. exchange, the Nasdaq. At a Monday closing price of $120 per share, Tilray’s $11.5 billion market capitalization is a whopping 300-times the annualized sales of its most recent quarter — which, by the way, was not a profitable quarter. Tilray stock surged yet again on Tuesday morning, rising 10% in premarket trading after the U.S. Drug Enforcement Administration approved a plan to import pot from Canada to test its efficacy at treating a neurological disorder.
“It seems like each time we do something, it’s good for the sector’s stocks,” Canopy chief executive Bruce Linton tells Barron’s.
Read more: Mariuana Stocks Could Be a Buzzkill
Good news for Canopy shouldn’t necessarily bode well for its rivals, Linton warns. Along with Constellation’s backing, Canopy has more than a third of all outstanding purchase orders in Canada, as well as substantial market share abroad. “Our objective is to dominate the sector and to do the best globally,” he says. “That will not be good for all the other companies. When I see the valuations being attributed to places that have virtually no production, virtually no off-take agreements, which don’t operate in multiple countries and have a very limited scientific research team…”
Linton predicts that his rivals’ deals with consumer packaged goods conglomerates will mostly be joint ventures, instead of multi-billion dollar combinations like that of Canopy and Constellation. In August, for example, Molson Coors Brewing(TAP) agreed to a venture with Hydropothecary (HEXO.Canada) to develop cannabis-infused drinks. Global booze companies aren’t done seeking cannabis partners, Cowen & Co. analyst Vivien Azer said in a Monday note. Other large Canadian producers, such as Tilray or Aphria(APH.Canada), could plausibly partner with PepsiCo(PEP) for products under Pepsi’s line of Gatorade drinks, Azer added. As for Coca-Cola, when it was asked about cannabis drinks, a spokesperson said, “The space is evolving quickly. No decisions have been made at this time.”
Whether cannabis stocks are a bubble driven by retail investors, or an emerging industry with steep growth ahead, it’s foolish to put too much weight on valuation measures at this point, says William O’Neil & Co. analyst Andrew Kessner, who launched coverage of the industry amid August’s heat.
“It’s hard to pull out a financial model and rationalize the stock prices right now,” Kessner says. “If you have you head stuck in your model and say, ‘This company looks too expensive based on next year’s earnings or sales,’ then you are not going to be able to navigate this space.”
Tilray seems to have impressed its IPO roadshow audiences with the global growth story for cannabis. The little company has distribution deals across Canada, exports to a dozen countries, and deals with the likes of Novartis.
What’s really sent Tilray shares into space has been their scarcity, as American investors rush to board the weed train. Only 6.5 million shares came on the U.S. market in July’s IPO, and that small float has made Tilray stock hard to buy, borrow or sell short.
In the stock market, such technical bottlenecks tend to be self-limiting. Insiders who hold 66 million Tilray shares are locked-up until mid-January 2019 — unless underwriter Cowen releases them sooner.
Tilray didn’t respond to a request to discuss its business.
Meanwhile, the manifest hunger of American investors for U.S.-listed cannabis stocks has catalyzed other big Canadian firms to secure U.S. listings. While Canopy and Cronos Group(CRON) are already dual-listed in Toronto and the U.S., the top-five producer Aphriais reportedly close to a dual listing. And nearing an IPO in Canada is the New York-based cannabis operator Acreage Holdings — which gained attention by recruiting to its board of advisors the former House Speaker John Boehner and the former Massachusetts Governor William Weld, both Republicans.
With recreational pot use in Canada just around the corner, a new surge of investment vehicles is appearing. Sometime this week, Canopy is expected to spin off its minority investments in various startups as the separately-trading shares of Canopy Rivers, with the ticker “RIV” on the TSX Venture Exchange. Canopy Rivers will bankroll new ventures around the world through cannabis “stream” agreements — a kind of forward purchase contract in which Cannabis Rivers makes an upfront cash payment for future volumes of cannabis product at a fixed cost.
Another financing play on North America’s cannabis enthusiasm is the royalty trust, a traditional source of capital in Canada’s speculative junior mining sector. A co-founder and former CEO of Cronos Group, Paul Rosen, is striking deals with growers licensed in U.S. states like California and Massachusetts, where recreational use by adults is legal under state law (marijuana remains illegal under federal law). Rosen’s Tidal Royalty, itself listed on the TSX Venture Exchange, will back growers in exchange for 15% of revenue over 99 years.
Kessner, the O’Neil analyst, notes that his roots are in value investing. But with cannabis stocks rising on a draft of retail sentiment, he finds himself paying attention to resources like Facebook groups and even online forums on Reddit. Instead of leaning on relative valuation, he is picking stocks based on a company’s’ strategic positioning, its management team, and its physical presence around the globe.
On that basis, he is recommending the industry leader Canopy Growth and OrganoGram Holdings (OGI.Canada), a New Brunswick-based producer listed on the TSX Venture Exchange. Kessner notes that OrganoGram is one of Canada’s 10 largest licensed producers, but its shares have not gone to the extreme valuation of the country’s other producers.
Canopy’s Linton advises investors to be wary of North America’s crowded field, where he sees no other growers worth buying. “There’s a good race going on and Constellation Brands got the thoroughbred,” he says, referring to his own company Canopy. “The rest of the people are running around trying to figure out what the pony ride is going to be about. There are a lot more companies than there are businesses.”