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Friday 30

June, 2017 1:53 AM



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Are Pot Stocks the Next Big Thing

Are Pot Stocks the Next Big Thing

By Bob Kohut 20.03.2017


In 1996 the state of California in the US legalised the use of marijuana for medical purposes focusing on pain relief from cancer, AIDS, and other forms of chronic pain.  The US was the early leader in adopting the use of medical marijuana, and now has 28 states having legalised medical use of the drug and eight states going so far as to legalise marijuana for recreational purposes as well.

The flood of companies charging into marijuana-related businesses began in 2009, swelling to the point respected financial organization Bloomberg created a “weed index”, with other indices of marijuana stocks adding to the mix. The first such index appeared in 2015 and of the more than 200 medical marijuana stocks trading at the time only 23 were included in the index due to the standards (minimum trading volumes; market cap; and stock price) designed to minimise inclusion of the highest risk stocks in a high-risk sector. The following graph from Bloomberg runs through mid- April of 2015.


Proponents of legalised marijuana as the “next big thing” would point to the hefty rise in the index since 2012 while advocates of marijuana stocks as punter’s delights would point to the extreme volatility and the steep declines since peaking in mid-2014.

Indices tracking US based marijuana stocks show an upward spike going into the US elections of 2016 when nine states had legalization initiatives on the ballot. 


Some newcomers may view dramatic rise in stock prices as evidence of a potential next big things, but those who have been in the game for a while are aware rising prices simply mean increased demand for the stock itself, not necessarily demand for whatever it is the company behind the stock does or will make.

In the US, the rush to pot stocks saw a big spike in 2013 as more and more companies jumped in with accompanying increases in the hype level of the potential for medical marijuana.  By 2014 the Financial Industry Regulatory Authority (FINRA) -- an “independent, not-for-profit organization authorized by the US Congress to protect America’s investors by making sure the broker-dealer industry operates fairly and honestly” – was once again warning investors about diving into the exploding sector.  Here is what they had to say:

Update: In early January 2014, new laws regarding the legalization of marijuana for medical and recreational purposes went into effect in a number of states. At the same time, media coverage of the issue increased, as did investor interest in shares of marijuana-related companies. In some cases, volumes for the stock of otherwise thinly traded, marijuana-related companies increased dramatically—and prices became quite volatile. In May 2014, the SEC issued an alert and accompanying trading suspensions for numerous companies that claim their operations relate to the marijuana industry.

We are reissuing this alert to warn investors not only about the potential for fraud in this arena, but also to reiterate the risks of investing in thinly traded companies about which little is known. Regardless of industry sector, any so-called "hot" stock can burn your portfolio. Rather than getting swept away, take time before you invest to learn more about the company, its products or services and the people running it. And be sure you carefully assess the company’s prospects for success.

Considering the relative infancy of medical marijuana stocks on the ASX it may take some time before investors see any parallels between our situation and what is happening in the US beyond the rush of investor enthusiasm and spiking share prices.

As an example, consider one of the most recent medical marijuana entries to list on the ASX – Auscann Group Holdings Limited (AC8).   After a reverse takeover, the company began trading on 3 February, opening at $0.22 per share and then it was off to the races.  Here is the price movement chart.


Although the sector is gaining limited credibility in the US, investors there as well as here in Australia would be well advised to look back at another “next big thing” stock sector catching fire beginning in 2009 – stem cell research.

In 2001 under the administration of US President George W Bush federal funding for embryonic stem cell research was banned.  In late 2008 speculation abounded that incoming US President Barack Obama would lift the ban, piquing investor interest in any stock that had anything at all to do with stem cells.

The stampede was well underway prior to the ban being lifted, with some investors unaware of exactly what an embryonic stem cell actually was! Penny stocks trading on the US Over the Counter Markets where financial reporting regulations were lax at best flooded the exchanges along with reputable biotech firms long involved in developing treatments using stem cells.  

In 2009 the ETF Innovators Emerging Stem Cell Index of 40 U.S.-listed stocks heralded Cord Blood America (OTPK: CBAI) as the top year to date gainer just prior to the lifting of the ban.  CBAI’s stock price had jumped 279% to $0.016.  The sector remained hot, and so did CBAI, rising to $0.022 before the bottom began to fall out in 2013.  The stock now trades at $0.0028.

Today investors are bombarded with eye-popping numbers on the market potential of medical marijuana, as was the case with stem cell stocks.  However, market potential needs to be defined in specific terms, with specific treatments aimed at specific ailments.

Breathless proponents of the “next big thing” argument extoll the virtues of medical marijuana as a potential remedy for everything from hair loss to dementia, ignoring the fact some providers working on specific compounds to treat everything under the sun will at some point must target a market for clinical testing and approval.  

Investors should not ignore the size of the market a company’s products will address.  On 24 January of 2009 the US FDA approved the first clinical human trial using embryonic stem cells as a medical treatment. The company was respected biotech firm Geron (NASDAQ: GERN) and the announcement sent the share price skyrocketing.  By late 2011 lack of funding led to the company abandoning the trials.  While cost was undoubtedly an issue, the financial commentary at the time paid very little attention to the salient fact that the condition to be treated – acute spinal cord injury – affected at best 500,000 people per year around the world.  Not exactly a robust market.

The takeaway from the stem cell sector is simply that investors need to stay focused on not only the “cure”, but also on the presence of the “disease” in the broader population.  With that in mind, let’s look at some of the top medical marijuana stocks on the ASX beginning with the first to list – MMJ Phytotech Limited (MMJ) which began trading on the ASX in January of 2015.

The issue price was $0.20 per share; the stock opened at $0.40 and closed at $0.78.  Here is the share price performance since its first day.


The company touts its “farm to pharma” business model with subsidiaries to grow marijuana, develop therapeutic products, and commercialise and distribute products in international markets where medical marijuana is legal.

MMJ Phytotech’s Canada based growing operation – United Greeneries – along with its Switzerland based distribution subsidiary – Satipharm -- were recently sold to Harvest One, a privately held Canadian Capital Investment firm, with the share price spiking as a result.  

The third leg in the company’s farm to pharma business model is Israel-based PhytoTech Therapeutics, responsible for the company’s clinical research and development activities.   PhytoTech Therapeutics has completed a Phase 1 clinical study of one of Satipharm’s products.

Investors loved the move but it calls into question the company’s stated business model as it is unclear what role MMJ would play in the new Harvest One operation, other than as a minority owner (10%) of the newly created entity called Harvest One Cannabis.  Canada is reportedly about to assume world leadership in medical marijuana and is also said to be close to legalizing recreational marijuana use.

Punters rarely pay attention to issues long term investors consider when looking at investing in start-up companies.  Arguably, three of the most critical issues are:

Market;

Money; and

Management

In terms of potential market, it appears MMJ will assume a research and development role, with two products in its pipeline – a cannabis capsule as a nutritional supplement and a cannabis vaporizer.  The company offers no guidance on the market potential of these products.  

MMJ is flush with cash and has low debt and low gearing – 2.17%.  Checking the company’s website shows the company has reputable medical and scientific researchers on board.  In an ideal world, managements of start-up companies would include not just those with experience running a business, but those with experience successfully leading a start-up to revenue generation and profitability.  MMJ does not appear to have anyone like that in top management although they do have management with expertise in finance.

Auscann Group Holdings, as its name implies, has a well-established Canadian partner – Canopy Growth Corporation (TSE: WEED), the first publicly traded medical marijuana stock in Canada.  Canopy holds an 11% interest in Auscann and its CEO has a seat on the Board of Directors as well.  Canopy’s CEO and two of the Auscann board members have direct experience bring start-up companies to profitability.  

Money is not yet an issue as the company has yet to begin to implement its commercialization strategy, beyond announcing its intent to import existing products from Canopy for sale in Australia.  Canopy’s existing product line includes Tweed; Bedrocam; and Mettrum.  Auscann states the Canopy products will be aimed at patients with chronic neuropathic pain, chronic pain, and treatment resistance epilepsy.  All Canopy products are medical grade marijuana strains prescribed by physicians, primarily as an herbal pain reliever.  Market potential is in effect controlled by the prescribing physicians.

Auscann also has a relationship with Murdoch University in Perth for research and development of, among other things, greenhouses to replicate optimum conditions for yield and quality consistency of medical cannabis compounds.

The Australian government has now made it legal to grow marijuana here, with the companies lining up to get cultivation licenses and minimise the costs of importing marijuana from countries where cultivation is legal.  There are other ASX listed medical marijuana stocks from which to choose if you have a punter’s soul and more stocks to come.  Longer term investors would probably be better off waiting until these companies begin to generate revenue from specific products.  In addition, it strains credulity when some boldly claim they are going to crack the Canadian and US market where the competition is already ferocious, but who knows?  A breakthrough discover of some kind could give Aussie companies an opening.

If you are inclined to take a punt, the combination of secure existing supply from Daya in Chile and established products from Canopy in Canada would seem to make Auscann a likely choice.

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