Cannabis: A New Opportunity for Value Investing Amidst the Ashes
There’s an interesting development happening among smallcap companies in the beaten-down cannabis sector, one that does not happen too often but presents a rare opportunity to find value amid a heap of debris.
This opportunity starts with the fact that nobody wants anything to do with cannabis companies. In fact, just saying the word “cannabis” carries risk. Try it next time you are asking for capital, and you will be laughed out of the board room.
This is understandable, considering the term carries the memory of a recent, epic speculative mania, which ramped up around the 2018 legalization in Canada, only to collapse spectacularly in the following years.
Up in Smoke
There are many examples of companies collapsing around the Canadian legalization excitement, punishing countless retail investors who jumped on the hype train. The best known is Aurora Cannabis (TSX: ACB), which had a market cap in the billions at its peak and is now approaching penny stock status, with a stock price down 99%.
The company embodied the hype that was ripe at the time. They aggressively bought companies in an attempt to be the dominant player, branding themselves as the “Pepsi” of weed, and had no problem convincing investors to send money their way. A whole lot of capital went in, but with little earnings there wasn’t a lot of real value.
The high began to wear off, as it always does, when the financials became clearer. At the same time, the industry struggled to compete with the black market, with red tape and costs causing many Canadians, used to buying their stuff from illegal sources, to carry on in the same manner.
There was also the overestimation of consumer demand for such a new industry, as is often the case. It all went south, and many retail investors lost money.
But some companies held on
The cannabis sector went from a couple hundred functional companies to just a few as capital was sucked out, and this led to a social pariah status for anyone who dared to tout cannabis investments.
But with such negative sentiment, an interesting thing happened. These few companies who didn’t get to participate in the early euphoria managed to hold on, keeping their business afloat by being forced to do the opposite of bubble behaviour and actually make a profit.
Anecdotally, the cannabis industry is alive and somewhat well, after its sudden debut and rocky start. Communities across the country have various cannabis stores, selling a wide range of products, and the advantages are starting to gain traction. It’s clearly not going anywhere, and that means someone must be doing well.
Profitability & 52-week highs
In a recent article, we discussed the value in resisting the temptation to look for 52-week lows and instead look for 52-week highs. This takes diligence as it means going against common, “buy low” investor psychology, but the evidence is there.
Stocks that meet all or most of our criteria (revenue growth, profitability, shares outstanding, etc.), have been through a significant decline and are now hitting highs are the leaders you want to look out for.
Right now, there are just a few in the smallcap cannabis space. Some are growing and selling it, some are producing products and running storefronts. The select few cannabis companies that are profitable and growing, are being rewarded by the market market as they are increasingly becoming attractive to bottom-up investors, despite the most recognizable and previous market darlings dropping to new 52-week lows. When stocks with improving fundamentals are bucking the industry trend, it’s a market signal to pay strong attention to.
Flying under the radar
Last year, we covered Grown Rogue International Inc. (CSX: GRIN) as our first cannabis company interview. They are a craft cannabis company, based in Oregon, with premium flower and flower-derived products and a strategy to pursue capital efficient methods to expand into new markets.
Since our interview, the company has continued to execute on their strategy, and they have been rewarded, with the stock price up 100% (And in the last year, they are up 400%.). Their recent Q1 results show this growth will likely continue, with a 21% increase in revenue, a 176% increase in operating cash flow, and almost $ 1 million of free cash flow—all for a company with a market cap of $30 million.
Considering the company just became profitable this year and is still largely unknown (with a quick look showing just one analyst in the U.S. giving it a 54 cent, 12-month price forecast), there is definitely room to grow.
Another relatively unknown smallcap we recently covered is CanadaBis Capital (TSX.V: CANB), a vertically integrated Canadian cannabis company focused on achieving large-scale growth, from cultivation to retail. We have been following CANB closely after adding it to our 2023 Cheapies with a Chance list, and with the latest Q2 numbers we believe the company is in a very attractive position for investors.
Like GRIN, CANB is largely flying under the radar. And that means opportunity.
In addition to these two companies, there are only a couple others that are flying under the radar, cash-flow positive and in a strong position to break out. We will be covering them in the near-future, but as a teaser they are all achieving solid growth, increasing profit and revenue, and most importantly—they are in a great position to buy assets for pennies.
Thanks to the recent popping of the cannabis stock bubble, there are now a lot of cheap cannabis assets laying around, and we believe there will be significant consolidation coming very soon. These cash-flow positive businesses, which have survived the tough times, are in a perfect position to be leaders in the next market upswing.
It’s reminiscent of past market trends. For instance, after the dot com bust, it took a number of years before companies showed themselves to be a solid investment and before positive investor sentiment returned. But when it did, it was explosive.
As we always say, the leaders in the next bull market are not the same as the leaders in the previous one. It’s good to see some life returning to the cannabis market after such a dramatic downturn, and it’s even better to see our investment criteria proving itself in the emergence of several small, relatively unknown players that may just make some big moves in the months ahead.
Don’t miss out on the opportunity to find value in beaten-down sectors. CanadaBis Capital is a perfect example of how some of our subscribers doubled their money since January by looking for profitable growth companies. Sign up now to discover our next great idea.