How Canada Blew Its Chance to Be The Cannabis World Leader – Part 2

Dear Fellow Retail Investor,

 Ever see the docuseries American Greed?

 It features Americans who stopped at nothing to get rich… and paid dearly for their avarice.

 There should be a Canadian version of this show.

 But rather than highlight greedy Canadians, it should target Canada’s pot companies.

 See, their greed helped ruin Canada’s chance to lead the legal global cannabis market.

 And like the subjects of American Greed, they suffered severe consequences as a result.

 Of course, Canada’s government deserves much of the blame for squandering the country’s chance to be the world cannabis leader.

 

It made many stupid mistakes, like …

  • Making cannabis taxes too high
  • Using unfair lotteries to determine who could apply for retail licenses
  • Passing onerous licensing rules
  • Imposing huge upfront licensing fees
  • Saddling licensees with absurd advertising rules

 I went into detail about these mistakes – and much more – in my last Dear Retail missive (which you can read here).

 Now it’s time to analyze…

Watchlist

How pot companies in Canada helped ruin the country’s chance to become a world cannabis leader

No investment was hotter than cannabis toward the end of 2018.

 The catalyst, of course, was Canada’s legalization of adult-use pot.

 While that happened in October 2018, the bull market in cannabis actually began four years earlier.

 That’s when investors began betting big on Canadian pot producers.

 Between 2014 and the end of 2018, worldwide weed sales more than tripled (to US$10.9 billion, according to a State of Legal Cannabis Markets report).

 

Most pot stocks in those years benefited greatly from this explosion in demand…

  • Aurora Cannabis (TSX:ACB) rose 3,330%, from US$4.13 on July 24, 2016 (when it was still trading on the TSX-V), to US$141.67 on Jan 23, 2018.
  • Canopy Growth (Nasdaq:CGC) shot up 2,029% from July 24, 2016 to Sept 2, 2018, going from US $2.42 to US $51.53.
  • Tilray (Nasdaq:TLRY) rose 1,159% from its July 19, 2018 IPO price of US$17 to US$214.06 on Sept. 19, 2018.

 Action on Tilray was especially crazy.

 To wit, on Sept. 19, 2018 – just three months after the company went public – it actually hit an intraday high of $300!

 Wild Wall Street projections helped fuel investor frenzy.

 One even called for an 18-fold increase in legal pot sales by the end of the 2020s .

 Sensing an endless river of profits, Canadian pot producers expanded operations with reckless abandon.

 Big mistake.

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Canadian cannabis companies get WAY ahead of themselves

Between 2016 and 2019, Aurora made more than a dozen acquisitions.

 The biggest? Its purchase of greenhouse design firm Larssen in late 2017 for an undisclosed sum.

 After acquiring Larssen, Aurora had no need to hire third parties to design its new greenhouses.

 That seemed like a good strategy at the time.

 After all, Aurora assumed it would need to build new airport-sized grow facilities to satisfy consumer demand (and investor expectations).

 So why not save money by cutting out the middleman?

 Why not handle all new greenhouse construction in-house?

 

Expansion of Aurora’s production capacity was in full swing by the middle of 2019

 By then Aurora had the capability to produce about 650,000 kilos of weed a year.

 

Rival Canadian pot companies did everything they could to keep pace.

  • In late 2018, Sunniva (OTC: SNNVF) spent CA$25 million on its “Canada Campus,” which was supposed to accommodate a 759,000 square-foot greenhouse.
  • In January 2019, Tilray announced it was acquiring Natura Naturals for about CA$35 million, a purchase that included a 406,000-square-foot greenhouse.
  • And in April 2018, Canopy was on pace to exceed 5.6 million square feet of domestic growing space.

 As a result of this breakneck expansion, Canadian licensed producers were on track to crank out 3 to 4 million kilos of weed a year. 

 That was WAY too much.

Canada pot producers absorb huge losses from overexpansion

The problem was that even the most optimistic growth models never expected Canadians to consume more than 1 million kilos a year.

When Canada’s cannabis producers finally realized this fact, they had no choice but to close many of their grow facilities.

  • Aurora sold Larsen back to its original owner “for a nominal amount” in 2020. And in the filing announcing that sale, the company reported a net loss from discontinued operations of CA$9.8 million.
  • In mid-2020, Sunniva sold its “Canada Campus” property for CA$6.8 million. That represented a loss of CA$18.2 million.
  • Tilray closed its 406,000-square-foot greenhouse a year after acquiring it.
  • And Canopy closed all but a fraction of its 5.6 million square feet of grow space.

So why did these companies go so far overboard with expansion?

In the case of Aurora, executive bonuses played a role.

According to a regulatory filing, executive bonuses were tied in part to not only expanding production in Canada…

… but also in establishing new facilities outside of the country.

It’s likely that similar performance bonuses were offered to executives of other Canadian cannabis producers.

(It would all make a great episode of Canadian Greed, wouldn’t it?)

Investors get hammered

The damage to investors from the fallout was beyond belief.

 For example, Aurora had essentially financed all of its acquisitions through issuing more common stock.

 Result – shares outstanding exploded from 16 million to more than 1.3 billion from 2013 to 2019.

 Talk about share dilution!

 Since then, Aurora stock has cratered all the way down to around US $9 (its April 6, 2021 close, after a 12-for-1 stock split back in May of 2020).

 A massive drop from its all-time closing high of US$141.67.

 Tilray closed at around US$21 on the same day – a huge haircut from its high water mark of US $214.06.

 And Canopy ended that day at around US$31, a far cry from when it was hovering around US$50 back in September of 2018. 

 In the face of the current industry shakeout, what’s a retail cannabis investor to do?

Don’t make the two big mistakes most cannabis investors made in the late 2010s

Their first mistake?

 They got WAY ahead of themselves.

 When Canada legalized adult-use pot in 2018, investors assumed the country would become the world leader in cannabis.

 They invested accordingly… and (if they held on too long) paid a painful price.

 After legalization, the Canadian government botched its legal cannabis rollout in a variety of ways (as outlined at the beginning of this article).

 At the same time, Canadian pot growers expanded production far beyond the market’s ability to absorb it.

 Don’t be surprised if investors get ahead of themselves again.

 Right now many are salivating at the prospect of U.S. legalization of recreational cannabis.

 Many “experts” think it’s inevitable… and maybe even imminent.

 As a result of such expectations, many cannabis investors believe they’re in for huge paydays once the U.S. legalizes weed.

 Once again, they’re getting ahead of themselves.

 Yeah, yeah… I know that the Democrats control all three branches of the U.S. federal government now.

 And I admit it’s true that the odds of federal U.S. cannabis legalization are far higher than they would be under the Republicans.

 But it doesn’t mean the U.S. will make recreational cannabis legal anytime soon…

 or even at all.

 Don’t forget, for many years President Biden was adamantly against legalizing marijuana nationwide.

 And I don’t hear him talking about this issue at all – do you?

 Bottom line – don’t make any cannabis play whose profit prospects rely on U.S. government legalization.

Don’t ignore the issue of share dilution

Remember what Aurora did to fund its ill-fated acquisitions?

As I said earlier, over six years its outstanding share count skyrocketed from about 16million to more than 1.3 billion.

That’s an increase of about 8,025%!

Think that hurt investors? You bet it did.

Then there’s Tilray, which recently signed a pair of deals with lenders.

Those deals call for the company to exchange around $197 million of debt for newly issued stock.

This isn’t the first time Tilray has diluted shareholder value with new stock.

For example, in March 2020 the company sold 7.25 million shares at a cost of US$4.76 each.

That was 20% below the previous day’s closing price.

Obviously, that didn’t make many Tilray investors happy.

Bottom line – take into account a pot company’s debt load and history of share dilution before investing your hard earned money in it.

Common sense advice for pot stock investors

First, start with some old-fashioned due diligence on the people.

Who are the key players involved in the company?

Like everyone, some people are more skilled, honest and hard-working than others.

Look for evidence of competence, knowledge, experience and – most importantly – a track record of success.

You can get a lot of this kind of information on company websites.

You can also talk to the managers themselves, or their investor relations staff. That’s the beauty of small-capsretail investors stand a much better chance of speaking directly with management.

The key here is to bet on winners.

Second, look at the company’s financing.

The goal is to match up the company’s objectives with its ability to finance them.

For this assessment, you have to again take management into account.

(Money tends to follow success, right?)

The past successes of the executive team directly ties into how easily they can find future financing.

The takeaway here is you need to understand where the money to move the company forward is going to come from…

… and at what cost to shareholders.

Third, consider the issue of “paper.”

Paper and financing go hand in hand.

That’s because capital is often raised through issuing new shares.

So it’s critical to analyze the structure of the company.

Two vital points to consider are:

Are shares outstanding growing at a rapid rate? This is important information because a fast-rising share count can dilute the value of all other shareholder stakes in the company (to find out this information check out the company’s quarterly reports)

Who owns the shares? It’s often a good sign to see institutions and management owning significant positions in a company (this shows they’re confident in its prospects)

Third, what’s going to move the stock?

Is the company developing a new brand of CBD oil, for example? Or launching a new signature strain?

Is it doing business in a jurisdiction that’s about to loosen pot laws?

Is it about to enlist a rock star executive?

Is it a buyout candidate that’s ripe to reward investors with a quick windfall?

These are just a few potential developments that can pop your cannabis stock.

Here’s one last thing to keep in mind…

Cannabis is a unique industry that’s only been publicly tradable for a few years

Like any industry, cannabis has its own nuances. For example…

· There are two types of cannabis (medical and recreational)

· There are three main types of pot stocks (growers/retailers, biotechs focused on cannabis, and providers of ancillary products and services to the cannabis industry)

· There are unique risks to the industry (notably the fact that adult-use marijuana is federally illegal in the U.S.)

You need to thoroughly understand the above points if you want to consistently profit on cannabis.

But make no mistake – many investors will get rich investing in this space.

That’s it for today – thanks for reading.

To your financial independence,

 

Doug Fogel
Contributing Editor, Dear Retail

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