3 Big Reasons Why the Sizzle Has Fizzled for Marijuana Stocks
With one-fourth of the year already gone, 2018 has turned out to be a pretty dismal year for marijuana stocks so far. None of the largest Canadian marijuana stocks have positive year-to-date returns. Aphria's (NASDAQOTH: APHQF) share price has plunged nearly 40% this year.
Theoretically, 2018 should have been a great year for many marijuana stocks, with an expanding global market for medical marijuana and Canada planning to legalize recreational marijuana. So why has the sizzle fizzled? I think there are three big reasons behind the disappointing performance for marijuana stocks so far this year.
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1. Stock dilution
Anyone could see this issue coming from a mile away. I wrote in late January about the one thing that should worry marijuana stock investors the most. That one thing was stock dilution.
Within the span of a few weeks in January, nearly all of the biggest Canadian marijuana growers announced bought deal financing transactions. These deals are stock offerings where an investment bank or syndicate agrees to buy all of the securities to be issued by a company at a predetermined price.
Aphria closed on a bought deal financing that generated $115 million. Aurora Cannabis (NASDAQOTH: ACBFF) announced a $200 million transaction soon afterward. MedReleaf (NASDAQOTH: MEDFF) had a $132.5 million deal. Canopy Growth (NASDAQOTH: TWMJF) announced a bought deal financing transaction valued at $175 million.
The math of these stock offerings is simple: More new shares means the value of existing shares decreases. It shouldn't be surprising that these marijuana stocks fell.
2. Concerns about a supply glut
The second reason why the share prices of Canadian marijuana growers have dropped is related to the first reason. Companies wanted to issue more stock to raise more cash, in large part because they wanted to expand production capacity. However, it didn't take long for two scary words to begin circulating: supply glut.
Again, the math is pretty simple. Professional services firm Deloitte estimated annual demand after Canada legalizes recreational marijuana will be around 600,000 kilograms. Canada's Parliamentary Budget Officer, which is similar to the Congressional Budget Office in the U.S., projected annual demand of 650,000 kilograms. The highest estimate that I have seen is demand of 900,000 kilograms per year. If we only looked at the top five largest marijuana growers in Canada, the combined projected annual production capacity totals a little more than 1.5 million kilograms.
That projected annual production capacity isn't a reality yet. Most of the big marijuana growers are still in the process of building new facilities and expanding existing ones. However, it's pretty evident that the supply of marijuana in Canada is going to far exceed even the most optimistic estimate of demand.
Marijuana prices in Canada have fallen significantly already, down 7.7% year over year in 2017, according to data published by Statistics Canada. Even with higher demand coming, higher levels of supply could mean that marijuana prices will drop even more. That's obviously less-than-ideal news for marijuana growers.
3. Delay in legalization of recreational marijuana
July 2018 had been the time frame given for legalization of recreational marijuana in Canada. However, that turned out to be overly ambitious. In February, Canadian health minister Ginette Petitpas Taylor acknowledged that Canadians won't be able to buy recreational marijuana until later, probably in early September instead of July.
There are two aspects of this delay that weighed on marijuana stocks. First, time truly is money. A September date could mean hundreds of millions of dollars of revenue that marijuana growers won't make this year.
Second, the delay stoked fears that legalization could be derailed even more. Although Prime Minister Justin Trudeau should have the votes he needs to win approval of legislation to allow recreational marijuana, a few hurdles remain to be jumped.
Ready to roar back?
I think these marijuana stocks will enjoy a huge rebound. And you can circle a date on your calendar for when it could happen: June 7, 2018. That's when the Canadian senate is scheduled to vote on the bill to legalize recreational marijuana.
Most of the stocks have already experienced the full brunt of dilution. Unless the companies issue even more shares, dilution shouldn't be an issue going forward. One exception, though, is Aurora Cannabis. The company's big transaction in January involved issuance of 200,000 convertible debentures, which can be converted into stock later.
But what about that looming supply glut? Looking at the supply and demand projections for the Canadian marijuana market might make you wonder if marijuana growers' executives might have been partaking a little too much of their companies' products. Why would the companies ramp up production capacity to levels far beyond anticipated demand? Didn't they take economics in high school or college?
Before we get too fired up, let's remember something from high school geography class: There are more countries in the world than Canada. The fact is that quite a few of those other countries have legalized medical marijuana, including Germany, which has a population more than twice the size of Canada.
Canadian marijuana company CEOs are fully aware of the global potential for marijuana. That's why they are expanding capacity beyond what is needed for the domestic market in Canada. There could be a supply glut down the road, but I suspect it's not nearly as big of an issue as some might think.
My prediction is that many Canadian marijuana stocks will end 2018 much higher than they are now -- and some will be much higher than they began the year. The sizzle will return.
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Keith Speights has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
