The Kush Rush: A Lucrative Market for Pot Stock

Posted: 18th May 2017

By: Grace Hang

Overview

Since the enactment of the Narcotic Drugs Regulation 2016, the Australian Federal Government has eased restrictions on the importation of cannabis to treat illnesses such as multiple sclerosis and childhood epilepsy. This has led to the birth of a potentially highly profitable industry in medicinal marijuana and generated strong investor interest. ASX stocks for leading medicinal marijuana providers AusCann Group (AC8), Medlab Clinical (MDC) and MMJ Phytotech (MMJ) have market capitalisations between $90 million to $160 million. However, investors hungry to jump on the marijuana market may want to stave off the munchies as the legal cannabis industry remains nascent and saturated with early stage startups that operate with unproven business models.

Effect on the ASX and Market Potential

Source: Bloomberg, Red Leaf Securities

The shares of companies involved in the research, cultivation and distribution of medicinal marijuana in Australia have on average soared more than 150% this year. Nearly all of these companies have outperformed the wider market by a considerable margin. The AusCann Group is one of Australia’s largest cannabis pure-plays and held its IPO in February. The company debuted at $0.21/share via a backdoor listing through TW Holdings. It raised $5 million in the prospective offering and is allocating funds towards horticulture research, clinical trials and a joint venture with Fundacion Daya in Chile. Since February, the AusCann stock value has risen by 172% and is predicted to increase, if Chilean clinical trials are successful. It is debatable as to whether Australian medicinal cannabis companies will experience the same level of runaway sales growth recorded in the US market. The local industry for medicinal marijuana is still a fraction of the market size in the US and Canada. One of the main limitations to domestic market feasibility is the fact that Australian legislation states that firms can only import the cannabis unless a license to cultivate and produce cannabis is approved. The approval process is highly rigorous and firms must be listed on the Australian Register of Therapeutic Goods before products can be made available for clinical prescription. Adam Miller, Founder of Medical Cannabis technology BuddingTech, believes that despite the significant medical market in the US there is a lack of standardisation in its cannabis products. Hence, Australia’s stringent regulatory framework may prove to be compatible with a global market should it eventuate. Additionally, our trade relations and existing market access to China and Japan place Australia in the ideal location to develop a globally successful medicinal cannabis industry. Australia may also be in a prime position to enter the multi-billion dollar market because of its high level of supply chain logistics, space, land and reputation. MGC Pharmaceutical’s White Paper titled Medicinal Cannabis in Australia: Science, Regulation and Industry estimates the initial demand for medicinal cannabis in Australia could reach as high as 8000 kg of product, worth more than $100 million per year.

Risks

Considering the relative infancy of the medicinal cannabis industry, investors and speculators may want to curb their enthusiasm for the hyped pot stock boom. The 2017 Australian Stock Report warns that medicinal cannabis related shares could fail to translate capital investments into sustainable profits and that management teams are unlikely to be experienced to deal with such high consumer demands. There is a propensity for companies to expect high levels of demand and supply which may not occur, leading to inventory disruptions and unanticipated costs. The listed entities on the ASX are also thinly traded, meaning there is not much stock available to buy or sell. This creates high volatility as prices become inflated once investors secure stock and drop faster when investors decide they want to exit the market. Whilst medicinal marijuana stocks are providing a new investor high, it is important to realise that the local market still saturated with start-up firms. For instance, The Hydroponics Company (ASX:THC) is an Australian business focused on distributing hydroponics equipment and greenhouse designs and construction to pharmaceutical companies. THC has a low projected growth revenue of $15 million and many of its proposed business models have yet to be proven. For shareholders, this could mean that dividend yields may be highly variable and without guarantee.

Overseas Market Success

Source: Yahoo Finance

British biotechnology company GW Pharmaceuticals (NASDAQ: GWPRF) is the world’s largest stock on the Marijuana Index with a company valuation of $2.8 billion. According to Goldman Sachs, GW promising a cannabis-based drug pipeline could elicit a bidding war which may push to $150/share. However, GW’s first marketed cannabis drug ‘Sativex’ has struggled in the marketplace - generating only £5 million in annual sales and is yet to gain approval to sell in the US.

Source: NASDAQ’s ‘MarketWired’

Canadian-based prescription drug developer Aphria (NASDAQ: APHQF) is predicted to become the next billion-dollar pot stock with a market capitalisation of $630 million. According to NASDAQ’s news distribution subsidiary MarketWired, the company has been consecutively profitable in the last five quarters and its $5 million year-to-date income is a testament to the stock’s appeal. Aphria is also choosing to expand its growth internally, investing $100 million in capital to fund its 300,000 square metre cannabis harvest project. However, Aphria faces considerable local competition from Aurora Cannabis (NASDAQ: ACBFF) which is also launching a 800,000 square metre grow field boasting the latest horticultural technology.

Conclusion

So while the grass may be greener on the higher side, pot stocks still come with a fair share of risk and unpredictability. Notable companies such as the Auscann Group and Zelda Therapeutics (ASX:ZLD) already dominate the local market for medicinal cannabis. However, eager investors should question their decisions until undergoing thorough market valuations.