Dear PGM Capital Blog reader,
On October 17, recreational cannabis became legal in Canada, with adults aged 18 or 19 (depending on the province) and over able to purchase dried flower and/or cannabis oil products.
The large sales projections thrown around prior to legalization are primarily what have fueled massive gains in pot stocks since the beginning of 2016.
However, something head-scratching has occurred since weed became legal in Canada: Marijuana stocks have fallen as can be seen from below chart of the North American Marijuana Index.
The big question, investors are asking themselves, is it time to buy or time to sell.
CONTRARIAN INVESTING:
The worse things seem in the market, the better the opportunities are for profit is contrarian investing at its heart.
Baron Rothschild, an 18th century British nobleman and member of the Rothschild banking family, is credited with saying that “the time to buy is when there’s blood in the streets.”
He should know. Rothschild made a fortune buying in the panic that followed the Battle of Waterloo against Napoleon. But that’s not the whole story.
The original quote is believed to be “Buy when there’s blood in the streets, even if the blood is your own.”
Going Against the Crowd:
Contrarians, as the name implies, try to do the opposite of the crowd. They get excited when an otherwise good company has a sharp, but undeserved drop in share price. They swim against the current, and assume the market is usually wrong at both its extreme lows and highs.
Bad Times Make for Good Buys:
Contrarian investors have historically made their best investments during times of market turmoil. During the crash of 1987 (also known as “Black Monday”), the Dow dropped 22% in one day in the U.S. In the 1973-74 bear market, the market lost 45% in about 22 months.
The September 11, 2001, attacks also resulted in a sizable market drop. The list goes on and on, but those are times when contrarians found their best investments.
THE CANNABIS SECTOR’S BLOOD IN THE STREET:
The North America legal marijuana market is expected to reach USD 146.4 billion by end of 2025, while the Global market is expected to grow over USD 250 billion in the coming 5 – 7 years. Growing adoption of marijuana in several medical applications such as cancer, mental disorders, chronic pain and others is expected to propel revenue growth in near future.
Below chart shows the expected growth of the North American legal marijuana market.
Although, the cannabis sector will continue to grow for many years, blood is definitely in the streets for cannabis sector.
We believe that the cannabis sector isn’t getting a more bullish outlook from investors. We see this period of time as a great opportunity to take a position in, or boost the amount of shares already held in the biggest cannabis companies.
Below tables shows the financial data – as stated in their respective earnings report of this quarter – of the world’s five largest cannabis producers.
Table 1:
| Company | Revenue most recent quarter | Revenue growth (YOY) |
| Aurora Cannabis (ACB) | US$30 million | 262% |
| Canopy Growth (CGC) | US$23 million | 33% |
| Tilray (TLRY) | US$10 million | 85% |
| Aphria (APHA) | US$13 million | 118% |
| Cronos (CRON) | US$ 4 million | 187% |
Data from respective earnings reports.
All of these companies will benefit from cannabis legalization during the current quarter and during all future quarters, which is why sales will rise considerably going forward. This will, in turn, lead to a substantial decline in each company’s price to sales ratio going forward.
Table 2:
| Company | Market cap | Revenues (most recent Quarter annualized) | price to sales |
| Aurora Cannabis | US$ 5.70 billion | US$120 million | 48 |
| Canopy Growth | US$11.36 billion | US$ 92 million | 123 |
| Tilray | US$ 9.45 billion | US$ 40 million | 236 |
| Aphria | US$ 1.98 billion | US$ 52 million | 38 |
| Cronos | US$ 1.62 billion | US$ 16 million | 101 |
Market cap, obtained form yahoo finance’s data of November 30, 2018.
Price–sales ratio, calculated by Author, by dividing the company’s market cap by annualized revenue.
PGM CAPITAL’s ANALYSIS & COMMENTS:
Fundamentals:
When analyzing table 1, we see that Aurora Cannabis has generated the highest revenues during the most recent quarter, and at the same time, the company is also generating the fastest growth rate by a wide margin.
Based on the above, one would expect that – Aurora Cannabis – fastest-growing company and the one that produced the highest revenu in the quarter to be the valuable, measured by market cap. Nevertheless it is surprisingly that Aurora Cannabis, which had the best growth pace during the most recent quarter by far, is the second cheapest company among those five.
Market Growth:
Marijuana markets across the world are set to grow by dizzying levels over the next few years.
The cannabis industry consists of two main businesses, medical marijuana, and recreational marijuana. Recreational marijuana will be the more important market going forward. 
As can be seen from above chart, the potential market size for marijuana today is nearly US$200 billion in size. Of this, US$12 billion is in Canada, with US$3 billion in the medical area, while the remaining US$9 billion is on the recreational side. However, the real growth isn’t in Canada, it’s outside of it as follows:
Germany:
Germany should rank as the fastest-growing marijuana market of all over the next few years. The country legalized medical marijuana in 2017. However, the estimate is that marijuana sales in Germany last year totaled only around US$9 million. By 2022, though, this figure is projected to skyrocket close to US$1.6 billion, which is an astounding increase of 17,678%.
Florida & Colorado:
California and Colorado are the biggest marijuana markets in the U.S.A, with both states allowing the legal use of medical and recreational marijuana. However, Florida is projected to come in third by 2022 with marijuana sales of US$1.74 billion despite legalizing only medical marijuana. This would represent an 806% increase over Florida’s 2017 marijuana sales of US$192 million.
Analytics and projected growth provided in this section are from BCD Analytics.
Which Company to invest in:
Canadian marijuana growers have been exporting cannabis to the European country in the meantime. The two largest exporters to Germany, – world’s market with the highest growth potential – at this point appear to be Aurora Cannabis and Canopy Growth.
Aurora acquired German medical cannabis company Pedanios in 2017. Canopy acquired Germany-based MedCann in 2016. These acquisitions should put Aurora and Canopy in good shape to compete in the German market for years to come.
When combining these info with the information from table 1 and 2, we can draw the conclusion, that the two companies which are best positioned to profit from the growing cannabis market, are Aurora Cannabis and Canopy Growth.
We believe that thanks to its strong fundamentals/financials – as shown in table 1 and 2 – Aurora Cannabis is well-positioned to come out as one of the winners in this market. Based on this, we maintain our Strong Buy Rating on Aurora Cannabis and a Buy Rating on Canopy Growth.
Disclosure:
I/We are long holders of Aurora Cannabis and Canopy shares.
Last but not least, before taking any investment decision, always take your investment horizon and risk tolerance into consideration. Keep in mind that share prices do not move in a straight line. A Past Performance Is Not Indicative Of Future Results. Technology stocks and stocks of startups and maturing companies, experience a higher volatility than the ones of developed market big-caps.
Yours sincerely,
Eric Panneflek