Investors in Canadian pot stocks are hopeful for a rally on October 17.
Developments of obvious impact and which were not guaranteed beforehand tend to move the market.
Rallies have been far more modest or non-existent with expected "news."
October 17 might actually be a good time to close a long, or start a short.
October 17, 2018, the day Canada's legalization of recreational cannabis become effective. With bill C-45 passing this year and Canadian cannabis producers making big deals with beverage makers and pharmaceutical companies, it is no surprise that Canadian pot stocks have been pretty hot in 2018. That has given confidence to investors that October 17 will be met with a rally and we will all be rich! Too bad it's probably not true, this article will explain why.
Developments need have an obvious impact
August 1, 2018, saw the announcement of a deal between Molson Coors Canada, the Canadian arm of Molson Coors Brewing Company (TAP), and The Hydropothecary Corporation, now Hexo Corp (OTCPK:OTCPK:HYYDF, TSX:HEXO). When the TAP-HYYDF deal was announced, it involved the formation of a joint venture between TAP and HYYDF to develop cannabis-infused beverages, but it didn't involve a large upfront payment or the purchase of defined quantity of stock. Instead the press release noted in the last sentence before the "About" section that there were some warrants being purchased.
In connection with the closing of the transaction, subject to the final approval of the Toronto Stock Exchange, HEXO will issue to Molson Coors Canada warrants to purchase shares of HEXO. - August 1, 2018, press release on TAP-HYYDF joint venture.
Figure 1: Year-to-date chart for HYDFF. Note the pop from the announcement of a joint venture with TAP did not last long. Source: Stockcharts.com
HYYDF having closed at $3.28 the day prior to the news opened at $4.04 on August, a 23 percent gain. The stock closed at $3.74 however, and within two weeks was back at pre-announcement levels. Then the next deal came along for the sector.
On August 15, Constellation Brands (STZ) announced it was acquiring 104.5M shares of Canopy Growth Corporation (CGC) at $48.60 CAD, which in combination with exercise of existing warrants would take STZ's stake in CGC to ~38 percent. That press release also announced STZ would receive additional warrants which if exercised would take the company's stake in CGC to over 50 percent.
The clear impact of this press release (a $5B CAD investment in a Canadian pot stock) caused CGC and the whole market to go on a sustained rally. The impact of the CGC-STZ deal can even be seen in the HYDFF chart above, actually its impact is more apparent than the HYYDF-TAP deal, despite the fact the deal doesn't apply to HYYDF who already had a deal with TAP at the time. The message here, an event of obvious impact, like the CGC-STZ deal, to which we can apply some numbers ($5B CAD investment), is going to have more of an impact than an event of uncertain financial value like the TAP-HYYDF deal. It is harder to put a number on that deal. What is it worth to HYYDF shareholders?
October 17, 2018, is the date of an event of obvious impact to Canadian cannabis producers and you can also apply some numbers to it, although those numbers are based on estimates. Those estimates have the market size in the billions, for example, a recent presentation from STZ notes the addressable market in Canada to be $11B, albeit at the retail level, within 15 years.
So October 17 is going to begin a rally in the Canadian pot stock space, right? I don't think so. Both the TAP-HYYDF deal and CGC-STZ deal were not guaranteed beforehand. It wasn't common knowledge that TAP would put out that press release on August 1. STZ already had a stake in CGC prior to the August 15 press release, but it wasn't known that STZ would now increase that stake to ~38 percent at prices of $48.60 CAD (a 51.2 percent premium to the closing price the day prior).
There was no major rally will approval of C-45 It can be seen in the HYYDF chart above that the June 19 Senate approval and June 21 Royal Assent did little to stimulate that Canadian cannabis producer. To look at the sector as a whole, we can have a look at an ETF with a number of major holdings in the space, the ETFMG Alternative Harvest ETF (MJ).
Figure 2: Screen capture from MJ website noting top ten holdings as of October 15, 2018. Source: etfmj.com
The MJ ETF traded between $30 and $32 throughout most of June, dipping below that range following Royal Assent of Bill C-45. The trading is unsurprising, a sell the news reaction is likely when everyone knows an event is coming.
Figure 3: MJ chart shows that approval of Bill C-45 was not met with a major rally in the space. The CGC-STZ deal was far more influential. Source: Stockcharts.com
There was no ACBFF rally on October 9 On October 9, 2018, Aurora Cannabis Inc (OTCQX:ACBFF) announced it had filed an application to list on the New York Stock Exchange (NYSE), ACBFF currently trades on the OTCQX and on the Toronto Stock Exchange as ACB.
Aurora anticipates that, subject to receipt of all required approvals, trading in its common shares on the NYSE will commence before the end of October 2018. - Comments from the October 9 press release.
Uplisting can have several advantages for a stock. Seeking Alpha contributor Sergio Heiber analyzed more than 40 uplistings to the NYSE, NASDAQ or AMEX (now NYSE MKT) during the first three quarters of 2015. Heiber noted that stocks that uplist tend to experience an upside spike of 25% or more following the uplisting. It is unsurprising then that the mere application to list on the NYSE/NASDAQ/AMEX is often met with upside in the stock concerned.
The reasons for positivity on news of uplisting are several fold. Firstly, some institutions may only buy stocks on the NYSE or NASDAQ rather than lower tier exchanges. ACBFF already trades on the highest tier within the OTC Markets system (Figure 4), uplisting to the NYSE was a logical step to allow additional institutions to make purchases, potentially boosting the stock.
Figure 4: Three tiers of the OTC Markets system. At the lowest level, listing on Pink comes with no financial standards or disclosure requirements. OTCQB requires companies be current in reporting, not be in bankruptcy and meet a $0.01 bid test. OTCQX has differing standards for international companies, US companies and US banks, although in all cases the company has to overcome the penny stock rules laid out by OTC Markets to qualify. Source: OTC Markets website.
Uplisting is also met with increases in liquidity and volume (these factors may be partially related to increases in institutional buys). Other benefits of include increased visibility and an enhanced perception of credibility. Given the hype already surrounding Canadian pot stocks, enhanced visibility would seem hard to come by, but I won't rule it out as a possibility. The hype may have some wondering if these pot stocks are legitimate companies with real business goals or just a group of smart business people exploiting the hype. For that reason enhanced credibility seems like a potential benefit for ACBFF.
Now despite all these factors, ACBFF opened down on Tuesday following the pre-market press release noting the application for uplisting.
Figure 5: Can you tell ACBFF notified investors on Tuesday morning (October 9) that it planned to graduate to a major exchange? Source: CNN Money chart.
Why didn't ACBFF rally on October 9? Everyone already knew this was coming. A strong hint came on Friday October 5 when it was pointed out late into the trading session that ACBFF had filed a form 40-F noting it was registered to list on the New York Stock Exchange. That news did seem to send the stock on a little run. In September, ACBFF's Chief Corporate Officer told the Financial Post that the company was targeting the month of October to establish a US listing. In March, Terry Booth, CEO of ACBFF, said the company was looking at trading on a larger exchange such as the NASDAQ, the NYSE or the AIM (a division of the London Stock Exchange).
We’ll look at all exchanges, we’ll look at New York Stock Exchange. - Terry Booth, ACBFF CEO, March 2018.
The language from the CEO, along with the possibility of listing in London, rather than the US, does not seem to have been enough to send the stock on a run. With each confirmation that the company would seek uplisting, and greater clarity on the timeline, such as executives saying October was the target, the stock traded up. By the time we got to the October 9 press release, the news was all built in and a sell the news reaction ensued.
Figure 6: ACBFF chart year-to-date. Note that approval of the Cannabis act was met with a minor rally which soon sold off. The TAP-HEXO (OTCPK:HYYDF) announcement did little to support the stock whereas the CGC-STZ deal seemed to start the recent run-up. Source: Stockcharts.com
What is going to happen on October 17?
There will be press releases along the lines of "CannaHype (OTCPK: HYPE) is pleased to announce the launch of recreational cannabis in Canada." I don't think that is going to move the market, we already know that. There may be news stories of lines out the door at retailers selling cannabis products.
Figure 7: Legalization of recreational cannabis in California produced predictable headlines and images of people forming a long queue to get cannabis. Source: New York Post.
Such lines are likely because only a handful of retailers are ready for the launch. Jen Skerritt at TheGrowthOp.com notes that just one store in British Columbia and none in Ontario will be up and running on October 17. So while a long line to get legal cannabis for recreational purposes might seem bullish in terms of demand, a lack of product to supply is not so bullish. The best case scenario would be purchasers paying a very high price per gram due to limited supply, this has already been seen in other markets where recreational cannabis launched, but it is unclear how much of this price hike will be passed on from the retailer to the wholesalers.
Conclusion
Two factors seem influence the magnitude of a rally triggered by a development relating to the pot stock space (the same likely applies to stocks in general). Firstly, the news has to have an obvious impact. If investors are asking how meaningful an event is, asking what a development is worth to their stock, then a huge rally is not likely. Secondly, the news has to report something that was not guaranteed beforehand. When everyone knows an event is coming who is going to jump in an buy when "news" of that event breaks? Further, when everyone is already in on a trade, what happens when the trade goes nowhere and some decide to get out?
October 17 meets the "obvious impact" test. It is a big day for Canadian cannabis producers. Unfortunately October 17 fails the "not guaranteed beforehand" test. The market already knows this is coming. For investors hoping for big gains on October 17 and shortly thereafter, I ask you, do you really think the market will give you money for free? I've tended to make money in the markets when I predict something others didn't see coming, something which wasn't guaranteed.
I would suggest investors and traders should be cautious about buying into any rally on October 17, I believe the rally will be short-lived, as we saw with Bill C-45 approval, if it ever even materializes. October 17 might actually be a good chance to get out if there is a brief rally.
Better yet, if names in the space start to head lower following a brief or absent rally on October 17, an opportunity for an intra-day short sale presents. The best potential short candidates would likely be those which have the most hype built in to their current price, such as Tilray (TLRY), or those that seem to mislead investors and have lawsuits to show for it, such as Cronos Group (CRON). Of course you should have a look at the actual charts to select names to short, but TLRY and CRON seem like more obvious names than CGC.
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