The Art of the Pair Trade- Cannabis Investing and Hedging your Investment
Everything is always better in twos, especially trades.
In this article we’re going to look at a hedge fund style trade idea for the cannabis space. This strategy will allow investors to hedge against a downturn in the cannabis market. The main risk in this sector is shorted companies getting a mainstream investment, like the Constellation-Canopy deal, so make sure to be fully aware of that risk. The companies we picked for longs all have one thing in common; we think they are dramatically undervalued compared to the overall market, especially compared to the companies paired with them, and have at least one key characteristic that will give it a long term edge over the company paired with it to go short.
Long APH, Short CRON
We would go Long Aphria based on a number of things, but mostly valuation. APH is one company which has a fairly consistent track record of positive EBITDA, a testament to how good Vic Neufeld and management is. The team has successfully managed to grow and keep APH somewhat profitable, but Aphria has far more than a good management team; Their Canadian capacity is projected at over 255 000 kgs/year. They have one of the largest overseas and international footprints, thanks in part to their South American purchase and their over-priced Nuuvera purchase. On top of this they have an Australian investment in Althea. Aphria’s international exposure is up there with the likes of Canopy and Aurora. All this is in addition to having one of the most supply deals in Canada, virtually every province, and being the low cost producer. All this means Aphria should be valued much higher compared to its peers.
***major Aphria catalyst will be their US listing, bringing in American investors ready to hop on the growing cannabis train. In addition, Aphria is one of the most attractive M&A targets in the sector.
Cronos on the other hand is a totally different story. positives on Cronos include smart management and good international plans, thanks to their investments in the likes of Israel, Germany, and Australia. The main issue is their valuation. They have a market cap of 2.4 billion, not diluted, but only have 6600 kgs of capacity, and with plans for 110k kgs more. While their future plans may be appealing, the timeline for completion may take significantly longer than Aphria’s, who should be online much sooner. Cronos also has significantly higher cost per gram, one of the biggest factors for profit margins and how successful companies in the sector will be. Finally it’s unclear about how large Cronos supply deals really are. It does have agreements in Ontario, BC, and a few east coast provinces, but numbers haven’t been released.
At the current valuations, we think Aphria should trade at a market cap closer to Aurora’s and Canopy’s, and Cronos should trade at one closer to the likes of HEXO and Canntrust.
Long TRST, Short ALEF
For starters, we are the most bullish on CannTrust over all other companies in the space. At a 1.3 billion market cap, they are one of the most attractively valued. CannTrust currently has over 45000 kgs online, and an expansion currently to have over 100k kgs/year capacity. They have a solid management team and the company has captured over 30% of new medical patients. They also hold a large mount of supply deals, with 19k out west alone, and plenty of different skews in Ontario as well. TRST has a growing international presence with Australia and Germany framework put in place, and with Apotex as a partner with worldwide distributions. They are our next target for a Constellations style investment, behind Aphria. The current CEO also shares our beliefs, even saying a few weeks back that he would be in shock should they not get a deal. All this while it seems increasingly probable that a US listing happens.
Alefia is a smaller company than CannTrust, with a cap around 500 million, but compared to CannTrust, it offers very little. A few months ago, Alefia received seeds and a purchase order from CannTrust. this caused the stock to skyrocket, but other than this, Alefia doesn’t offer much else of value to shareholders. Aleafia is projecting a rather modest 38 000 kgs by 2019, but even still, it suffers from the fact it doesn’t have much in supply deals other than CannTrust, and being fairly reliant on them for revenues.
No hate for Alefia, but there’s just so much more working in CannTrust’s favour. All the catalysts on top of its strong Canadian footprint, it should be at a valuation closer to Cronos, and Alefia closer to that of WeedMD, which will have even more in terms of supply deals and capacity come 2019, at around 200 million.
Long VFF Short FIRE
This pair trade is all about pure growing and wholesaling to other companies, in which we think VFF will significantly outperform.
Both companies have significant enough future capacity, but the reason we’d go long a name like VFF is purely based on cost to produce. We think VFF will have one of the lowest cost to produce and huge potential to expand to meet demand in the short term, with over 3 million sq feet of greenhouse at their current location, ready to switch over to pot. Fire on the other hand has a much higher cost to produce with their indoor growing, evident by their last quarter with gross margins at less than 25% of revenues. This is all while VFF will be producing under $1/ gram fully built out. We think Supreme is a good company with good supply deals, but long term as we see more capacity come online, and a shift to oils and value added’s over pure flower, production costs will be a key in profitability. This will be even more applicable with selling to wholesale to LPS, and VFF on this has a “Supreme” advantage.
Finally with VFF at a cap of 350 mil and Supreme closer to 600 million, VFF we think represents better value and potential.
Happy Investing – The Stock Boys
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