It’s still possible to get healthy returns without the mania-propelled risk, according to one firm
Tilray, the BC-based cannabis company, has become the poster child of a sector in the throes of mania and volatility. Several weeks after its July IPO, it took the title of world’s biggest cannabis company from Canopy Growth, only to lose it again over days of violent swings and corrections.
The irrationality of the run was not lost on analysts who balked at the multi-billion-dollar valuations Tilray had gotten. While some might take that as an omen of collapse in the cannabis space, Everett Knight has a different take.
“I think it’s the second inning of a long-term growth situation not only in Canada but around the world,” said the Matco Financial portfolio manager who runs the Matco Cannabis Fund. “Obviously, October 17 is coming quickly, and what you have is a lot of excitement. But most of the players that investors in this space really know — Tilray, Canopy, Aurora — are just a few names in the market.”
According to Knight, Matco has over 700 public and private names in its cannabis fund’s industry universe. That’s allowed the firm to create a diversified portfolio that, instead of just concentrating on highly valued names in the public markets, also explores holdings in businesses that are less risky but still potentially lucrative.
“Some of our largest holdings are companies that are actually testing for pesticides in cannabis,” he said. One testing company they included in January has already been taken out for a 75% premium by Aurora. And as the current testing checklist of 56 pesticides is set to grow to 96 when legalization takes effect, Knight said, “testing companies stand to double their revenue overnight, and they’re not trading at the multiples of the licensed producers.”
There are also hidden gems in data analytics and technology. One of the fund’s largest holdings, a software company that tracks cannabis products from the mother plant to the end patient or consumer, holds a 70% share of its market. “Everyone sees the tip of the iceberg, but there’s another 90% that’s largely hidden,” Knight said.
That attention to ancillary businesses is all part of Matco’s risk-averse investment philosophy, which may be bitter but necessary medicine for investors chasing highs from dizzying gains. “By default, the cannabis space is a risky industry that will over time be just another business,” said Matco President and Chief Operating Officer Jason Vincent. “What people forget is that at some point in time, it’s going to be viewed on the same metrics as other industries. I think people need to be aware of those risks associated with that.”
With the increased interest in the space, more eyes and money have flowed in; institutional participation has expanded considerably from just a handful of pioneers a year and a half ago. For Knight, that has led to increased portfolio opportunities.
“We had 16 public companies a year and a half or two years ago on our watchlist, and now we have over 200 companies that are directly or indirectly involved in the cannabis space,” he said. “And you see other big companies like Coca Cola coming in, which I think is inevitable. Cannabis is taking market share from the alcohol companies; alcohol sales have dropped 15% in some states. Those backyard risks are what have pushed Constellation Brands to drop five billion dollars into Canopy Growth. You’re seeing businesses that haven’t been involved in cannabis coming in and increasing our universe substantially.”
Still, explosive expansion comes with risks, particularly where licensed producers are concerned. There are 115 LPs today, Knight observed, and he estimates only 25 will be around after five years of consolidation and fizzling performance. That’s what he keeps in mind as he goes afield in search of risk-adjusted access to the industry.
“When you look back at the gold rush, the people that made money weren’t the miners, but the people who sold them the picks and shovels,” he said. “Cannabis is no different. There’s manufacturing companies, there’s testing companies, there’s data analytics companies, there’s actual retail supporters that sell the cannabis — I think the ancillary businesses will actually be bigger than the cultivation industry.”
