Marijuana stocks run out of puff: local firms have work cut out

The following article appeared in The Australian on August 26, 2017
By · 26 Aug 2017
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26 Aug 2017
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Investors in Australia’s listed medicinal marijuana stocks know all too well that market highs don’t necessarily last.

Many of those who bought into the sector early, before the federal government legislated in March to make the prescription of medicinal cannabis legal in Australia, had a chance to treble their investment if they sold quickly.

Among them were shareholders of Zelda Therapeutics — which does research in the use of medicinal cannabis to treat a variety of ailments including sleep disorders, dermatology conditions and cancer — who watched at one stage as the value of their holdings jumped close to 500 per cent.

Similarly, investors in MGC Pharmaceuticals, which grows marijuana for medical purposes, and those in Stemcell United, which is focused on plant stem cell biotechnology, experienced gains of more than 400 per cent.

AusCann Group, which has been licensed to manufacture and supply medicinal cannabis and ranks as the biggest local so-called “pot stock”, with a current market worth of $150 million, rocketed from an issue price of 20c to a high of 94.5c, just shy of a 400 per cent return. Medlab Clinical, which is developing cannabis-based medicines, Creso Pharmaceuticals, which is researching cannabis and hemp-derived therapeutic products and treatments for humans and pets, and MMJ Phytotech, which makes cannabidiol capsules, were also in the 350 per cent-plus return league.

But after soaring into the stratosphere soon after the change to the Narcotic Drugs Act 1967 to decriminalise the use and supply of medicinal cannabis, the share prices of the dozen or so companies on the ASX associated with the industry seem to have run out of puff.

On average the “pot stocks” are down more than 40 per cent from their peaks, with several down by more than 60 per cent since March. Even so, most are still well up on their listing prices.

In a nutshell, it’s still very early days here. In what has been termed by biotechnology analysts as the “green rush”, investors in Canada and the US have been pouring billions in capital into listed companies involved in the research and development of marijuana products, including drugs, creams, food, and hydroponics systems. Law changes in both nations have seen a proliferation of listings over recent years.

Now, with more than 300 stocks already listed in North America, the cannabis-associated sector there is on track to achieve a compound annual growth rate of 25 per cent until 2021. By then the market is expected to top $US20.2 billion ($25bn) in value.

In April, the first marijuana exchange-traded fund was listed on the Toronto exchange. By comparison, Australia’s market is much smaller, with the stocks listed on the ASX collectively only worth about $600m.

Most, involved in medicinal cannabis research and development, are yet to generate any revenue, let alone turn a profit for shareholders. And they are competing against scores of other companies overseas, some doing very similar research.

A threat to the industry in the US could be any meddling at the federal level by Donald Trump and his Attorney-General, Jeff Sessions, who both oppose state laws legalising marijuana use. “I think our stocks may have sold off on the back of that,” says Zach Riaz, a director of Banyan Tree Investment Group, adding that profit taking has probably also contributed to the recent pullback.

“I think existing investors who are still there from the IPOs are now waiting for management to successfully execute on their strategy (clinical trial results etc) and other investors are waiting on the sidelines to see what business models will last before they start putting their money into the sector — essentially they want to see a track record,” says Riaz.

That’s likely to be some way off, given most, if not all, cannabis-­related stocks listed on the ASX have a lot of work to do. As such, we can expect the share prices of these stocks to remain volatile and investor turnover to be high.

With all cannabis stocks having different business models, their growth profiles will vary. Some have gone down the path of growing and supplying cannabis, but investors need to consider how government bodies may regulate this supply and what that means for the overall market.

Riaz says that significant deregulation, allowing for the granting of more licences to grow and supply cannabis products, is likely to lead to marijuana becoming a highly commoditised, low-price, high-volume, product. He notes some ASX-listed cannabis businesses have gone down the “regulatory light” path, such as skincare, which is quicker to market, has lower price point products and relatively low capital intensity.

“Others are focused on tapping the highly lucrative market of big pharma and are looking to prove marijuana applications in the treatment of diseases such as cancer and epilepsy.”

Riaz says this is highly regulated, very capital-intensive and requires many years of trials before any revenue may be derived. In other words, a lot can go wrong.

“Investors need to decide which business model offers the best risk/reward,” he says. “While the overall industry appears to have a bright future, as it stands today execution risk at the individual company level is high and investors should regard them as highly speculative.”

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Tony Kaye
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