The upcoming legalization of recreational cannabis has been the biggest bullet point in the investment case for cannabis in Canada, driving growth of more than 200% at the three largest pot companies last year. But as investors continue to pile in, experts are raising new warnings of a bubble forming in the industry.
“The combined market capitalization … of Canada’s three largest weed firms, Canopy Growth Corp., Aurora Cannabis and Aphria Inc., topped $14.5 billion at the end of 2017,” reported Vice News. “But the combined revenue of the three largest firms was less than $110 million in that same period.”
A report from the Parliamentary Budget Office (PBO) last year estimated total expenditures on cannabis would reach $5.5 billion in 2018. That’s not insignificant, but it falls short of expectations priced in by investors, according to portfolio manager Rob Tétrault with National Bank of Canada.
“We’re already seeing the valuation for the entire sector being higher than what we’re forecasting for a mature market,” Tétrault told VICE News. Canopy Growth, the largest player, was valued at about $6.2 billion in 2017 — more than 100 times its revenue over the period. The estimated value for Aurora Cannabis was even more optimistic, exceeding 200 times its revenue.
The PBO has forecast an increase in demand following legalization, from between 378 and 1,017 metric tons in 2018 to 403 to 1,190 metric tons by 2021. Still, analysts said that’s not likely to provide firm support for current marijuana company valuations in Canada, at least in the medium term.
Export opportunities are also dwindling as other countries like Denmark, Colombia, and South Africa move into the legal market. And prospects for market expansion are extremely limited, even as hopes that weed companies will produce more edibles or pharmaceutical-like products persist.
Currently, there are more than 70 publicly traded Canadian cannabis companies. But there’s bound to be consolidation as competition in the sector rages and questions about regulation and taxation hang overhead, according to Nic Easley, managing partner of Multiverse Capital, a Colorado-based firm investing in cannabis stocks.
Easley acknowledged that active managers with inside knowledge or investors with special insights into the management teams and products of certain firms might do well. However, he said he expects many firms to fold or see their valuations drop over the next two years.
“There is going to be a moment of truth here,” Easley said.
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