While I have consistently sounded an optimistic tone on the future of the global cannabis industry, I have also consistently warned investors to stay away from the shares of Canadian cannabis producer Tilray (NASDAQ:TLRY).
The bear thesis on TLRY stock is surprisingly simple. The global cannabis market looks poised to be as large as the alcoholic beverage market or the tobacco market one day.
But a few winning companies look poised to dominate the cannabis market. Right now, there are ton of cannabis companies out there, and more and more are springing to life every day. Thus, the chances of each cannabis company succeeding aren’t that high.
At present, Tilray isn’t doing enough to differentiate itself from the pack. As a result, the company looks more like an average cannabis company with a high chance of failure than a cannabis leader with a moderate chance of success.
Yet fears of missing out on a rally of Tilray stock, mass investor euphoria, and the scarcity of publicly traded marijuana stocks have combined to consistently make the valuation of TLRY stock far too high, given Tilray’s low potential.
Now, though, the market seems to be finally realizing the difference between marijuana stocks with more potential and those with lower potential. Tilray, unfortunately, finds itself deep in the lower-potential bucket. That should remain true for the foreseeable future. As as result, TLRY stock should continue to stumble even if other marijuana stocks rally.
Marijuana Stock Investors Are Getting Smarter
For the better part of the past 16 months, marijuana stocks have traded in sync with one another. That is, when one marijuana stock went up, they all went up. And when one pot stock down, they all went down. It appeared that investors weren’t analyzing each company. Put simply, they weren’t buying particular pot stocks; they just wanted to buy any marijuana stock.
Now, though, cannabis investors are getting smarter and becoming more selective. Consequently, all pot stocks aren’t moving together. Instead, the good ones are going up and the bad ones are going down. And that’s not great news for TLRY stock, which is in the “bad ones going down” category.
This big divergence of marijuana stocks started after the House Judiciary Committee passed the Marijuana Opportunity, Reinvestment, and Expungement (MORE) Act on Nov. 20. The law would, among other things, result in the federal government recognizing cannabis as a legal drug throughout the U.S. Since then, the shares of Canadian cannabis leader Canopy Growth (NYSE:CGC) have jumped 15%. TLRY stock, meanwhile, is down 15% since the committee’s passage of the MORE Act.
The huge discrepancy was caused by the fact that Canopy has a much higher chance of long-term success than TLRY. Thanks to the multi-billion investment that Canopy received from Constellation Brands (NYSE:STZ), Canopy’s huge, unparalleled growing capacity, its plethora of international distribution deals, and its broad exposure to the U.S. market, Canopy has a realistic opportunity to one day become a huge company. Tilray, quite simply, does not have such an opportunity.
I think investors will continue to favor some marijuana stocks over others in 2020, meaning that the newly found divergence between good pot stocks (like CGC) and bad pot stocks (like Tilray stock) will only widen.
Tilray Stock Isn’t a Cannabis Winner
The problems with Tilray stock are two-fold.
On the one hand, the cannabis market is simply too crowded, and TLRY hasn’t distinguished itself enough from the competition. In the still very young and rapidly expanding Canadian cannabis market alone, there are more than 12 cannabis producers.
Meanwhile, in the mature and stable global alcoholic beverage industry, there are less than ten producers that dominate the market with $10 billion or more in sales. In the similarly mature and stable global tobacco industry, all the sales are concentrated among six producers.
Thus, while the cannabis market will grow by leaps and bounds over the next several years, the number of stable cannabis producers will fall. That means that a ton of cannabis companies which exist today won’t be around tomorrow. Only a select few cannabis companies will become winners in the long-term.
Tilray simply isn’t doing enough today to separate itself from the pack. Its numbers aren’t that great. Its international business isn’t terribly unique. Its margins are decent, but nothing to write home about. Its management team is solid, but it’s not terribly special. TLRY hasn’t received a huge, multi-billion investment from an outside company. It also doesn’t have a clear pathway into the U.S. market.
All in all, Tilray just seems like an average cannabis company. And, since it’s an average cannabis company, its chances of success are low.
The second main problem facing TLRY stock is that its valuation prices in too high of a chance of long-term success.
The market cap of Tilray stock is $1.9 billion. Analysts’ average sales estimates for two years from now is less than $500 million. Thus, TLRY stock is trading at about four times its sales two years from now. That’s simply too big of a multiple for a company with this little certainty and no profits.
The Bottom Line on TLRY Stock
The global cannabis industry could rebound in 2020. But this rising tide won’t lift all boats. Instead, we are starting to see a clear divergence in performance between strong marijuana stocks and weak ones. Unfortunately, for various reasons, Tilray stock is in the weak category.
That means that TLRY stock could dramatically under-perform its marijuana stock peers in 2020.
As of this writing, Luke Lango was long CGC.
