With Canadian weedstocks bumping up against overhead resistance, Tilray Inc (NASDAQ:TLRY) post-earnings reaction should be an important proxy of whether additional short-term price extension can be achieved. It’s an important signal to observe, with the sector (as defined by HMMJ) showing signs of fatigue as towering forward valuations and tepid domestic sales provide a formidable counterweight.
However way you slice it, Tilray’s Q4 and FY 2018 financial results—set to be released Monday, March 18 after close—aren’t likely to produce euphoric optics. With a consensus quarterly estimate of $14.45 million (5 analysts) supporting a $7.5 billion dollar market cap, many investors continue having trouble wrapping their head around TLRY’s monstrous valuation. This is especially true in light of domestic dry flower sales that continue to disappoint (↓3.8% month-over-month according to Health Canada), and slow international sales adoption. In Q3 2018, Tilray’s foreign revenues only constituted 9.44% of the total pie, so that channel is a work in progress.
Even with investors discounting future growth, the numbers still look daunting. According to the sage Alan Brochstein, analysts project core 2019 sales of $134 million with an EPS of -$0.31, suggesting a forward price-to-sales ratio of 53X. Jumping ahead to 2020, forecast sales of $276 million and EPS of $0.17 still imply a price-to-sales ratio of 25.7X and PE of 411X—aggressive levels considering the cannabis sector will entering the middle innings of its growth cycle.
Although these metrics will soon be revised with the company’s recent closing of Manitoba Harvest—a hemp-based CPG company which posted C$94 million in gross revenue in 2018—C$419 million of cash & equity will be drained from company coffers for the privilege of engaging this lower-margin and heavily trafficked marketplace. While the acquisition is prescient and likely value-producing for shareholders over time, it’s probably not needle-moving in terms of expanding Tilray’s industry-high valuation thresholds.
Picking up on this theme recently is Jefferies Group, which initiated Tilray with an underperform rating and $61 price target—12% below its then-current trading level—based on valuation. Specifically, Jefferies struggled to justify its current valuation, with analyst Owen Bennett noting, “We appreciate it is well placed in medical but future value here will be driven by IP for which (there is) little visibility near term.”
For all the good things Tilray will presumably deliver on the pharma side—the company’s core business—it remains a long cycle growth driver.
Tilray’s Post-Earnings Reaction a Proxy For Continued Sector Multiple Expansion
Although Tilray is the lead elephant in terms of exorbitant sector pricing, it’s by no means alone. With the Top 10 Canadian LPs valued at approximately C$61.84 billion collectively, there’s plenty of froth to go around.
If we generously assume that Canadian LPs capture the midpoint of their estimated 3.5-6 billion ($4.75B) in sales by 2020, I come up with a forward-looking value ratio of 13.01 times every dollar of revenue. Keep in mind, this is non-diluted market cap of the Top 10 LPs only, discounting the rest of the non-U.S. participating cannabis complex. Domestic legal sales will be fortunate to top $2 billion in 2019, owing to a muddled retail rollout, supply chain issues, and slow capture from the illicit market.
In comparison, large tobacco companies are valued an average 4.8 times their annual revenues; pharmaceuticals companies average about 4-times; Big Alcohol average about 3-times. Obviously, none of these mature industries have the premium-enhancing growth profile of cannabis stocks, but investors must consider the disparities.
Although it’s difficult to make the case for near/intermediate term Canadian cannabis sector valuation expansion based on fundamental considerations mentioned above, the rally could conceivably continue. Even in the absence of transformative news events, shares could still surge due to a lack of selling conviction and/or short capitulation on issues that have material short interest. This NYSE based-list includes Aurora Cannabis (7.7%), Canopy Growth (6.56%), Aphria (7.04%), and of course, Tilray (4.16%; 2.13 days to cover). The recent euphoria in Village Farms International (+441.17% year-to-date) provides good indication of how powerful the momentum/short covering feedback loop can carry individual stocks.
The outsized move in Village Farms $VFF can largely be explained by this one chart. Total volume and Short volume have increased dramatically, with momentum working in tandem with a tight float structure to demolish anyone caught on the wrong side. pic.twitter.com/nnTqExXEdH
— Benjamin A. Smith (@BenjaminA_Smith) March 11, 2019
As we can glean from the chart below, some of HMMJ’s most violent upside moves (long white triangles) have historically come when volatility suppression has been most acute. These are mini “long tail” price events that tend to occur at volatility extremes. And there’s nothing to suggest that the volatility smash will end anytime soon; it could even make new lows in VIXY (short-term VIX Futures) when theta-burn is taken into consideration. This is all abetted by U.S. President Donald Trump directly, as his interventionist market proclivities are hard to ignore.
S&P or Dow? https://t.co/iPpt0SZOK3
— zerohedge (@zerohedge) March 14, 2019
As additional cannabis companies dual-list on U.S. exchanges, the Canadian MJ volatility profile is transforming. The sector is becoming less volatile and more correlated to U.S. broad market indexes as the bulk of trading shifts stateside. For example, Canopy Growth will typically trade 1.75-3.5X more volume on the NYSE versus the TSX, as larger U.S. capital pools exert their influence. Pre-legalization, the list only included three Canadian LPs—Canopy Growth, Tilray and Cronos Group. Now, five additional members have entered the fray, with Village Farms International listing on NASDAQ on February 21, 2019.
As evidence to the stabilized volatility profile, Canadian weedstocks (HMMJ) have moved +/- 5% only twice so far in 2019—and zero to the downside—versus 13 times for the comparable period in 2018. While it’s too early to draw conclusions, it appears that a maturing sector along with broadening U.S. participation is stabilizing the sector. This outcome would support prolonged “melt-up” type moves that we’re witnessing today.
Final Thoughts
Regardless of whether Tilray beats revenue forecasts by a couple million—or misses by a similar amount—the result is immaterial in the greater scheme. Based on what investors know today, the stock appears fully valued (and then some) for at least two years out at today’s prices.
Thus, Tilray’s post-earnings price action should deliver a good proxy on the short-term direction of Canadian cannabis stocks. Should investors bid TLRY higher—irrespective of the result—it could ignite additional sector upside momentum/short covering by signaling that frothy valuations aren’t a primary market consideration at present. If so, what’s to stop Village Farms or OrganiGram Holdings from surging ever higher? What’s to stop Canopy Growth from breaking out of a technically-clear ascending triangle formation?
Sitting in #LA traffic @Uber $CGC 🚩👀👀
🚩 typically 🔛 trend
/position pic.twitter.com/o9oPduxkkp
— Todd Harrison (@todd_harrison) March 16, 2019
Should Tilray get sold heavily post-earnings, it might be good indication that valuation concerns are seeping-in at the top end of the market. There’s plenty of evidence suggesting the Tier-1 space isn’t acting in unison and responding to cues. Recent downgrades of Cronos Group, Tilray and Hexo Corp. on valuation concerns don’t exactly support continued multiple expansion either. Neither do the fundamentals, but we’ve already gone there.
We won’t have to wait long for the verdict, as Tilray’s earnings report is scheduled for Monday after close. While I don’t expect TLRY’s outcome to carry enough torque to trigger an protracted sector rally or selloff by itself (the market is too entrenched and complex to blindly follow one industry leader anymore, circa WEED pre-legalization), it should give investors important clues on whether valuation/fundamentals matter right now.
If they do, expect continued against-the-grain resistance to the broad risk asset melt-up; if not, HMMJ may revisit January/October 2018 high water levels in relatively short order, as “risk-on” sentiment has been given an implicit “all clear”.
