Since the Liberal government announced in April that it will introduce a new legislation bill legalizing marijuana consumption in Canada, companies related to this industry saw their stock prices skyrocket.
After seven US states legalized pot consumption, six Canadian pot companies had their stock trading halted after they tipped a circuit breaker during a sharp increase in their stock price; This system was implemented in 2012 as part of reforms to help control short-term volatility in stock prices. So basically, if a security moves 10% in any direction in the space of 5 minutes, the stock will be halted for a while to cool off the speculation.
The surge of capital flowing to this industry is not justified by anything but pure speculation, a repeat of the dot-com bubble. A quick back of the envelope valuation on Canopy Growth, the largest player in this industry, reveals the following:
Sales revenue of 24 million with cost of goods sold of 27 million, making a negative 3 million in gross losses. No company will be a going concern if it cost them more to produce a commodity or product than what they can sell it for, yet “investors” are giving this company a valuation of $1.2 Billion! (source: Morningstar.com)
Add the other expenses as salaries, rent, insurance, … yielding a negative 33 million.
How does the company finance its operations you ask? Simple, issue more inflated shares to the public. In 2013, the company had 1 million shares outstanding, this fiscal year they have 101 million shares. And that’s not enough, the company just released a press release on December 5th that it’s planning a new round of share issuance. Here’s an excerpt:
“Canopy Growth Corporation (CGC.TO) (“Canopy Growth” or the “Corporation”) announced today that it has entered into an agreement with a syndicate of underwriters led by GMP Securities L.P. and Dundee Capital Partners (the “Co-Lead Underwriters” and, collectively with the syndicate, the “Underwriters”), pursuant to which the Underwriters have agreed to purchase, on a bought deal basis pursuant to the filing of a short form prospectus, 5,662,000 common shares (the “Common Shares”) of the Corporation at a price of $10.60 per Common Share (the “Offering Price”) for aggregate gross proceeds to Canopy Growth of $60,017,200 (the “Offering”).“
There are no fundamentals supporting the stock valuation but hype, when someone purchases an asset hoping to sell it to someone else at a higher price, it’s called speculation.
What if marijuana becomes legal? The company will grow and surpass this valuation you say.
Well, maybe it will maybe it won’t, what’s certain is the company is not worth anywhere near its current valuation. The most a careful disciplined investor would pay is maybe 50 million, and I’m being generous. As for Lembirik Group, we invest solely on current valuation and we discount any promises or events that are out of the control of the management or the economy. We value today’s profits not next years’ promises.
People hoping to ride the green rush should learn from the dot-com bubble and the trillion of dollars in losses when that bubble burst.
Disclosure: I’m not holding or intend to hold any security in this industry for the next 99 years.
Sid El Mehdi Lembirik
Lembirik Group Investments