I’ve been waiting for this moment for years: the potential to earn 1,000x returns on Tilray (NASDAQ:TLRY) stock and the legal marijuana market. And with the 2020 election around the corner, right now could be the perfect time to buy into this beaten-down growth industry.
Please don’t think that I’m being glib or taking this lightly. I’m a huge skeptic of emerging growth companies when they can hurt investors.
But Tilray is different. That’s because the company’s future hinges on two competing marijuana bills making their way through the U.S. Senate. The Republican-backed option means near-certain death for the industry, while the Democrat-backed one looks a lot like the 21st Amendment, which ended alcohol prohibition.
Investors with insight into the 2020 elections should place their bets now. TLRY stock might be off to the races on November 3.
TLRY Stock Desperately Needs a Democrat Victory
Marijuana investors have had a terrible year. Tilray stock, among other Canadian cannabis companies, has dropped almost 70% since the start of the year, and that’s on top of the 89% loss from the 14 months before.
For all of Donald Trump’s popularity among Republican voters, the Republican-controlled Senate has been unapologetically anti-marijuana. Today, America has a patchwork of cannabis regulations that essentially locks out Canadian companies.
The drug remains a Schedule I narcotic, so public companies can’t touch cannabis in the U.S. without fear of getting delisted. That’s why even states with legal recreational marijuana, such as California and Colorado, rely on thousands of small mom-and-pop outfits to produce and sell weed.
And Canadian marijuana companies need the U.S. market.
The Canadian Marijuana Market: Too Small for the Large Players
When Canada legalized recreational marijuana in 2016, young companies went on an expansion bonanza. Today, a handful of large companies compete in the market. Among these are:
- Canopy Growth (NYSE:CGC)
- Aurora Cannabis (NYSE:ACB)
- Cronos Group (NASDAQ:CRON)
- Aphria (NASDAQ:APHA)
There’s just one problem: the Canadian market turned out to be far too small, particularly for Tilray. In 2019, Canadians spent only $5.9 billion on marijuana, or less than 10% of what Americans did.
At their peak, however, the five Canadian companies were worth over $40 billion combined. Tilray itself was worth $12 billion. That’s a princely sum for an industry where gross margins are even lower than in the mining industry.
Tilray’s management understood the stakes — they expanded aggressively in adjacent markets, such as medical marijuana in Europe, Canada, Australia and New Zealand. But they couldn’t gain the requisite scale. In 2019, the company lost $60 million on sales of just $388 million.
Other pot companies have only compounded the problem. In August, Aurora Cannabis closed all but four of its 18 plants on oversupply concerns. But it was too late: the expansion had already flooded the Canadian market with too much cannabis. In Q2, Tilray reported its average selling price per gram had plummeted from $4.61 to $2.64. In response, shares nosedived 35%.
The Republican Party Promises Four More Years
Between the coronavirus pandemic and the 2020 election, the U.S. Senate has largely sidelined most federal marijuana legislation efforts. Only one bill has made it anywhere: the Strengthening the Tenth Amendment Through Entrusting States Act of 2019 (STATES Act), which promises to remove the drug from the Controlled Substances Act.
But there’s a catch. Unless a state fully legalizes marijuana, the drug will remain an entirely prohibited Schedule I narcotic. In other words, the bill will delegate final authority to individual states. It’s a move Donald Trump has publicly endorsed, and won’t fundamentally change current laws.
While on the face of it, this opens some doors for publicly-traded marijuana companies, Canadian marijuana companies will still struggle to do business in the U.S. under patchwork regulation.
Democratic Legislation Would Be A Win for Tilray
That’s why Tilray’s hopes rest on a Democratic win in 2020. Specifically, they need a lesser-known bill to pass: the Marijuana Opportunity Reinvestment and Expungement (MORE) Act of 2019. The bill, sponsored by Senator Kamala Harris (yes, the Vice-Presidential nominee), fully decriminalizes marijuana at the federal level and will likely allow Tilray and its Canadian counterparts to enter the U.S. market finally.
There’s just one problem. The bill will also need a Democrat-controlled Senate to pass. Republican Senate majority leader Mitch McConnell is a staunch opponent of marijuana legalization, and even has a history of voting against his fellow Republicans on decriminalization laws.
Could a Republican minority still filibuster a Democratic Senate? Certainly. Even with their current polling leads, Democrats have a low chance of reaching a 60-seat filibuster-proof majority.
But will they? Perhaps not. Republicans from Colorado to Ohio have already backed other marijuana-legalization reform laws.
Tilray: The Big Winner of Biden 2020
That’s particularly good news for Tilray. If the U.S. legalizes marijuana, Tilray will outperform for three reasons:
1. High operating leverage. The company is a higher-cost producer of marijuana, which means price increases will have an outsized effect on gross margins. In 2019, the company had $2.36 cash costs per gram of marijuana.
2. Focus on cultivation. Tilray has focused on selling dried cannabis and hemp, rather than cannabis oils and vapes. That makes its financial situation particularly sensitive to demand, since dried cannabis has a 6 to 12 month shelf-life.
3. Financial leverage. Tilray has an outsized $475 million convertible note due in 2023. With just $137 million in cash and negative cash flow, the company will need to show better health to refinance upcoming debts.
In other words, Tilray sits on the edge of either bankruptcy or massive success. There’s not much in between.
What’s TLRY Stock Worth If Biden Wins?
Assuming a mid-range yield of 40g per square foot and wholesale cannabis prices of $3 per gram, that means the company could produce almost $1.0 billion in gross revenues at the wholesale level. Considering Americans spend nearly $70 billion on marijuana per year, there’s a good chance Tilray could even increase cultivation.
Considering a 10-year two-stage discounted cash flow (DCF) model sheds some light on possible outcomes.
Assuming revenues of $6.0 billion by 2029 and an EBITDA margin of 40% (about the same as branded tobacco companies), fair value for Tilray comes to $93, a 1,670% upside. That’s still lower than its peak 2018 value of $148, suggesting even further potential upside.
In the worst-case legalization scenario, I assume Tilray generates $3 billion by 2029 and an EBITDA margin of 23% (midway between commoditized mining companies and branded tobacco companies).
In that case, fair value for Tilray comes to $22.50, a 326% upside. That’s still a quite good outcome.
What Should Investors Do?
This summer, investors anticipating a Democrat-controlled White House and Senate have loaded up on firearm and ammunition stocks. Gunmaker Smith & Wesson (NASDAQ:SWBI) is up 132% this year, as customers have rushed to buy firearms.
Yet as the Obama years showed, panic gun-buying only provide a temporary sales boost. Shares of Smith & Wesson dropped almost 90% in the year following Obama’s election as stockpiling demand dried up.
Investors looking for a longer-term play for a Biden win should look no further than the legal marijuana industry. Even if Biden doesn’t support the MORE Act, his running mate, Kamala Harris, will make it harder and harder for the presidential hopeful to ignore.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.