Cannabis Stocks: A Look at Valuations in October

Cannabis stocks remained under pressure in September. Sector ETFs were mostly down month-over-month. The Cambria Cannabis ETF (TOKE) closed at $18.85 on September 30, 12.49% lower than its level of $21.54 on August 30. The ETFMG Alternative Harvest ETF (MJ) also fell 12.48% from $23.72 on August 30 to $20.76 on September 30. Weak investor sentiment for the cannabis sector was also a factor in the last week of September.

Increasing trade war tensions proved to be a dampener for the overall US and Canadian equity markets. Political and macroeconomic concerns around the world have negatively affected cannabis stocks. Vaping concerns and subsequent bans on e-cigarettes in a few US states are proving to be a major obstacle for cannabis companies.

Cannabis stocks: Upside potential

However, a huge untapped opportunity awaits these companies after Cannabis 2.0 legalization in Canada.

Many countries are also considering legalizing marijuana for medical and recreational purposes. Amid this backdrop, Grand View Research expects the value of the global legal marijuana market to be $66.3 billion by 2025. This expectation implies a compound annual growth rate of 24.1% from 2019 to 2025. Hence, cannabis stocks remain an attractive investment opportunity despite their currently trading at lower levels than their historic valuations. To learn more about marijuana’s expected legalization in Mexico, read Marijuana Legalization: Mexico Will Seal the Deal!

A look at valuations

Let’s study how six key cannabis stocks are trading compared to their historic valuation levels and the sector median. We’ll also compare the median valuation of the cannabis sector to its historic levels.

Cannabis Stocks: Revisiting Their Valuations in October

The yellow line in the chart above shows the median EV-to-sales (enterprise value-to-sales) multiple for 12 major cannabis sector stocks. The sector’s forward EV-to-sales multiple saw a downward trend in September. The multiple has been gradually falling since May. On September 30, the median forward EV-to-sales multiple was 3.25x. The multiple was 3.40x on October 2. On September 30, the forward EV-to-sales multiple was trading at a discount to the average of 6.85x since January 2017.

Next, we’ll compare the EV-to-sales multiples of six cannabis stocks with each other and with sector median. These stocks were also considered while calculating the median multiple of the cannabis sector. Cannabis companies are currently in a high-growth phase and have been reporting robust revenue growth. However, the majority of these companies haven’t achieved break-even. Hence, we’ve zeroed in on the EV-to-sales multiple instead of the more widely used PE multiple. The EV-to-sales multiple also allows us to assess companies irrespective of their capital structures.

Comparing six cannabis stocks

Here we’ll be comparing the relative valuations of Aurora Cannabis (ACB), Canopy Growth (CGC) (WEED), Tilray (TLRY), Green Thumb Industries (GTII), MedMen Enterprises, and KushCo Holdings. All these stocks are currently trading at discounts to their historical averages.

Cannabis Stocks: Revisiting Their Valuations in October

WEED, ACB, and TLRY

On October 2, Canopy Growth was trading at a forward EV-to-sales multiple of 6.87x, significantly lower than the company’s historical average multiple of 14.45x. The stock has been mostly in negative territory since August. It reported lower-than-expected revenue and EBITDA in the first quarter of 2020.

Subsequent analyst downgrades have further put pressure on Canopy Growth stock. To learn more about analysts’ ratings for the company in September, read Canopy Growth Stock Falls after Downgrade.

On October 2, Aurora Cannabis was trading at a forward EV-to-sales multiple of 6.21x—lower than its historical average of 10.71x. The stock also crashed after it released weaker-than-guided revenue performance in the fourth quarter of fiscal 2019. Vaping concerns have further proved to be a dampener for the stock. Read Aurora Cannabis Stock Fell Approximately 9%: Time to Buy? for more info. Aurora, however, is expected to rebound after Cannabis 2.0 legalization.

On October 2, Tilray was trading at a forward EV-to-sales multiple of 7.50x, a steep crash from its historical average of 36.98x. The stock has been one of the worst affected in the cannabis sector in 2019. A weak financial performance and multiple analyst downgrades have pulled the stock down this year.

GTII, KSHB, and MMEN

On October 2, Green Thumb Industries was trading at a forward EV-to-sales multiple of 2.41x, almost half the company’s historical average multiple of 4.81x. The company has continued to impress investors with a better-than-anticipated financial performance. Analysts also seem upbeat on the stock. However, the overall weak sentiment for the cannabis sector seems to have pulled down the company’s valuation.

On October 2, MedMen Enterprises was trading at a forward EV-to-sales multiple of 2.77x, significantly lower than its historical average multiple of 3.64x. The company has suffered due to its dismal financial performance in 2019.

On October 2, KushCo Holdings was trading at a forward EV-to-sales multiple of 0.71x, significantly lower than its historical average multiple of 3.18x. A weaker-than-anticipated financial performance has affected the stock’s growth trajectory in 2019.

Conclusion

It seems that the valuations of these cannabis stocks have come down from their stratospheric levels. They’re no longer driven by investor euphoria alone. Instead, they’re more reflective of the growth and risk profiles of these companies.

MarketRealist

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