Smoked! Govt Finally Admits No Marijuana Legalization by July

The cannabis market continues to be a trader’s market. It’s not for investors. The difference is the inexplicable random gyrations in the trading of the public marijuana companies’ shares. Up three dollars, down two, up four, down two, then sideways… that’s the average weekly chart in the cannabis space.

It’s a strange market. Good news can send share prices down. News that should crater the stock instead pushes it up. It brings back memories of the internet boom in the late 1990‘s.

Canopy Growth Corporation (TSX: WEED) is the largest cannabis company in Canada. Its current market cap is $5.5Billion, with close to 200,000,000 shares outstanding. Its year high was $44 a share, but those same shares can be bought today for around $28. That’s a $14 per share difference, and that share price difference represents about $2.8Billion in market cap difference. But the company is substantially the same – that $2.8B market cap delta was not driven by a fundamental change in anything except investor sentiment. Value created and destroyed by mere perception, not facts. And that, is a trader’s market.

If further proof is needed, look at Aurora Cannabis Inc. (TSX: ACB | OTCQX: ACBFF). It’s one of our long-term favourites to survive the inevitable carnage in this sector. Its low over the past 12 months was $1.90. One hundred and ninety pennies. Today, it’s trading about $11, after stretching to hit a high of $15.20. With 470M shares out, the market perceives Aurora having created about $4.7B of value over the past 12 months. Not even Aladdin with his magic lamp could do that.

The main reason for the irrational exuberance (thank you Alan Greenspan) is the federal government’s campaign promise to decriminalize cannabis. Investors know the medical market is limited in size, and the real $$$ will be in the recreational space, if it ever happens. Almost everyone takes it for granted that decrim will happen, on schedule, on July 1, 2018, despite the well-known fact a politician on a campaign trail makes more empty promises than does Harold Hill.

Also take into account the potential size of the market. Don’t trust the numbers from people in the market who have a clear vested interest in a huge number. Instead, look to independent data sources, such as the survey of 1,500 Canadians conducted by Abacus Data on behalf of Maclean’s as part of The Canada Project. It found that 84 per cent of respondents over 18 never smoke marijuana, and of the 16 per cent that do, daily users amount to only 5 per cent, and 3 per cent say they use a few times a week.

5 per cent of 32 million Canadians is 1.6M daily users. That sounds like a lot, but consider there are 89 licenced producers with many more applications in the pipeline. That’s not a lot of users to spread around, and it gets worse when you consider that taxation and price controls have not yet been finalized. For many of the LP’s, the only end game will be consolidation or bankruptcy.

Public consultation by the feds only closed three weeks ago on January 20, 2018. The infrastructure issues are so deep, so broad, so regulated by at least three other levels of government, that there is no way decrim can be implemented on the Liberals’ schedule.

We’ve been warning about this since the Liberals started promising in 2014. This will be the fourth year that we’ve warned investors not to trust the government. Every time we’ve pointed this out, traders have objected: “The Liberals promised it and the govt needs the tax revenue. Of course cannabis will be decriminalized.”

The Senate has already indicated it will not simply accept the Liberals’ legislation, and there are still the persistent barriers created by international treaties like the Single Convention that need to be overcome. Even if those huge challenges are overcome, the implementation of the legislation requires a previously unheard-of level of co-operation at the municipal level, across Canada, across ten provinces and three territories.

But the federal government just told the market, NO. The first paragraph from an article in last week’s Globe and Mail summarizes the facts: “Canadians will have to wait until late in the summer before they will be able to legally consume cannabis under a new timeline laid out by the federal government – even if the Senate votes in favour of the legislation by May or June.”

In a slippery bit of news that fell sideways into the media, Health Minister Ginette Petitpas Taylor told certain members of the Senate that the feds will wait 8 to 12 weeks after the legislation is passed (if it ever is passed) before actually decriminalizing cannabis, to give provinces and municipalities the time to create an implementation structure. If the legislation is passed for July 1/18, that means the earliest you can buy weed legally would be for your Thanksgiving party. This dovetails with our warnings that the government’s timeline was impossible (see for example our detailed article from Sept/17).

That interim period is important. It matters because it negatively impacts cash flow. It negatively impacts balance sheets. It impacts business plans and human resources decisions. And those impacts will play out in the market. The market is always wrong in the short term and right in the long term.

If you’re looking for comfort, the Liberals are not the place to look for it. How about this recent blumphus from Public Safety Minister Ralph Goodale: “Our goal is this summer in an orderly fashion with all the pieces sequenced in the right order so that they are effective.” What does that even mean?

So what to do. One, be realistic. Recognize the reality of the real timetable for decrim. You will not be able to legally buy marijuana outside of the medical market on July 2, 2018. Second, avoid business plans whose survival depends on decrim happening at all. Third, avoid business plans whose survival depends on decrim happening in 2018. Fourth, be a nimble trader, not an investor. Wait to be an investor after the cannabis market has its inevitable severe correction.

Or, you can believe the government’s election promise.

A Timeline for Decriminalization of Marijuana

Even though KellyAnne Conway claims otherwise, a fact is a fact, and there can be no ‘alternative facts’. And it is a fact that unless you have a medical exemption, your use of marijuana in Canada is illegal. The loosening of social mores does not change the fact of illegality.

The price of the shares of public marijuana companies have risen and fallen in tandem with Supreme Court decisions, the Allard decision out of the Federal Court, and policy announcements from Health Canada. The companies’ only real value is in the licence – the real estate and cash exist only because of the licence. In such a highly regulated space, being an intelligent investor demands a knowledge of the legal arena.

One need look only at Canopy Growth, the largest such company in Canada. Its shares took an insane streak up to almost $18 in November, creating a market cap of roughly $1.6B. The unaudited six month revenue number ending Sept 30/16 was $15M, implying a full year run-rate of $30M, or a bit under 2% of that market cap. That was a valuation equal to 50 times go-forward revenue, reminding us of the ludicrous and eventually unsupportable valuations of the dotcom era.

Canopy Growth’s share increase was directly attributable to market expectations that the federal government would loosen restrictions for medical purposes, and would soon introduce legislation to decriminalize marijuana in Canada. That would increase the size of CGC’s market and cash flow. Shareholders were giddy. Then reality intruded. Health Canada actually announced certain restrictions on how much marijuana would be funded for veterans, the reality of which brought the stock back to a more defensible value. Over the course of a month, roughly $800,000,000 was ground off CGC’s market cap.

This isn’t to pick on CGC. It’s the  largest and likely best known Licenced Producer, so it stands as a good proxy for the industry as a whole. The shares of other LP’s and applicants endured similar roller-coaster rides in their respective share prices, for similar reasons.

So what’s next on the legal front? With each of Smith and Allard affirming patient rights, and the new ACMPR regulations reflecting those expanded rights despite international treaties governing the sale of marijuana, investors’ sights should be set on the timing of decriminalization.

Note there is a massive difference between the introduction of legislation to decriminalize, and the actual final act of decriminalizing. Decrim will be a slow political process, not an event. There likely will be an uncertain number of years between the introduction of proposed legislation and the final date of enacting the statute.

Even the federal Health Minister, Dr. Jane Philpott, doesn’t know. Earlier this month she was specifically asked if marijuana would be fully legal and available in Canada before the next federal election in 2019. She answered, “At this point, I can’t give you a specific timeline.”

She added, “We need to make sure that there is a strict regulatory process in place and that there are restrictions in terms of access. We also have work to do on the public education front.”

It’s clear from the rest of her interview the feds aren’t in a rush to push the legislation through the system.

In Canada at the federal level, here is how a new statute is created under that system. The process involves many stages and many different forms of review.

A new bill is first proposed in the House of Commons, usually but not always by the party then in power. That bill is introduced to the House and is deemed to have been given a ‘First Reading’, almost always without debate. The Second Reading involves a more detailed look at the proposed statute by the House, including a review of the philosophy behind the bill and an overall review of the actual wording used in the bill to express that philosophy. There is public debate at this stage among the members of the House.

After edits, the bill is sent to a Committee of the House for a much more granular examination of the bill, its intents, the precise wording, and the impact it may have on other existing statutes. The Committee can seek the advice of the public and of outside experts, and can make proposed amendments to the bill. This can be a lengthy process.

After the Committee stage, the bill goes back to the House for Third Reading, debate and amendments before a final vote is called on the final wording.

That’s halfway through the process. The bill then has to follow the same byzantine routine through three readings and a committee in the Senate. The Senate as a house of sober second thought is supposed to look at the proposed legislation from a less partisan viewpoint.

Assuming the bill makes it all the way through that, it is then submitted to the Governor-General for royal assent and to convert that bill into a law. It is a lengthy process, and will be especially complicated for as sensitive an issue as marijuana.

This timeline has an additional complication, which is the the thorny issue of the Single Convention, a treaty signed by Canada and 180-some other countries governing international marijuana laws. The government has not given any indication how it intends to escape that treaty.

There will likely be a small market bump in the share prices when the legislation is announced. Some insiders are expecting that announcement to come on April 20, the annual “4-20 day” which is a key part of marijuana culture. That announcement, whenever it is made, has already largely been priced into the market so don’t expect a large bump. From then on, expect a multi-year experience as the bill winds its way through readings, committees, and the Senate, and as the share prices bump up and down in response.

Don’t overlook the real risk that decrim may take place many years in the future. To protect your investment dollars, find public companies that can survive purely on their respective medical marijuana sales. Their survival should not depend upon near-term legalization of marijuana. If their predicted success is predicated upon an assumption of imminent decriminalization, that is a clear indicator of a weak business plan, a short-term thinking management team, and a flawed risk assessment process. Find the companies that can survive for the next several years purely on medical, and for whom decrim would be a bonus.

If pushed for a favourite, we’d point to CGC, the first and largest of the LP’s, and to Aurora Cannabis.