Market Buzz - Marijuana Stocks Are Becoming the New Rage – Will Investor Capital Go “Up in Smoke”

It’s no secret to anyone following the Canadian stock market that the TSX Venture exchange has fallen on hard times over the last three years. Comprised largely of speculative, junior resources stocks, the exchange has lost over 55% of its value over this period. Fortunately for the exchange this loss has been somewhat mitigated by the few small cap stocks that are actually producing real earnings and growth. But for the people who have made a habit of buying heavily into the speculative junior resource plays, it would appear that a mere 50% loss (however nauseating this may be) is the least of their worries when liquidity has dried up to the point where they can’t even sell the shares they have (essentially equating to a 100% loss).

It is no secret what KeyStone thinks of revenue-less and profitless, capital-sucking predators. In our view, the junior resource sector in Canada has been fought with what are essentially shell companies, never generating a penny of economic value and existing solely for the purpose of raising capital from unsuspecting investors and then funneling this money into management salaries and corporate expense accounts. With very few exceptions, they have been nothing but capital-destroyers and essentially represent the antithesis of our fundamental, cash flow based investing strategy.

After years of collapsing share prices and deteriorating liquidity, most of these so-called companies are largely losing their ability to raise additional capital with many now sitting on the verge of financial destitution. But in the wake of their darkest hour, a glimpse of light has risen on the horizon…or as the case may be…a puff of smoke. Sweeping regulatory changes with respect to the production and distribution of medical marijuana have taken effect this month. The industry is becoming industrialized and many people smell an opportunity for businesses that can take advantage of the change. This transition has piqued the interest of investors and speculators which has prompted dozens of “resource companies” to issue new releases over the past few months outlining their intentions to investigate the prospects of being reborn into the new marijuana industry.

Of course almost none of these three dozen or so companies actually have a plan for entering an industry which essentially has little to no similarities to their own. But thankfully for them, in many cases that doesn’t seem to matter. The mere mention of a strategic refocus into medical marijuana has resulted in a significant increase in the share prices for many of these companies. It is completely unknown to us how these companies plan to leverage what experience and expertise they have into this completely new marketplace. But speculation surrounding the new industry has created a new buzzword in the stock market and simply replacing the word “gold” (just for example) with “medical marijuana” in a corporate presentation may be exactly what some of these nearly destitute corporate capital-killers need in order to hit the street for a few quick capital raises.

What we do know about the industry right now is that there are approximately 40,000 individuals that are licenced to use medical marijuana in Canada and this number is expected to grow. Up until now, most of these people were able to grow their supply in their own homes or else contract another individual (who is licensed) to grow it for them. But these rules changed as of April 1st under a federal government initiative to industrialize marijuana grow operations into commercial facilities.

Health Canada has so far received thousands of applications for licenses to grow commercial marijuana and (to our knowledge) to date has issued only 12. The number of licenses issued to public “resource-to-marijuana” companies is currently exactly zero. This may be an industry with good long-term potential but currently there are too many unknowns to actually conduct a fundamental analysis. First off, none of the public companies that are planning to be in medical marijuana have generated a dime of profit or revenue.

They are unproven at best and many are simply opportunistic (and not in a good way). Government regulations, costs, distribution, and a plethora of other factors are all currently unknowns as well. Plus there is price sensitivity…how much money are these 40,000 patients (many of whom are on disability) able to pay for medical marijuana when many are accustom to growing it themselves. The list of uncertainties goes on. There is currently one single company which recently became public (not a resource convert) that does have a federal license and plans to build out a production facility. But once again, this particular company has yet to produce a dime of revenue to prove out its business model but still somehow commands a market capitalization of almost $100 million.

In spite of all these unknowns, investor interest and the prospects for further speculation appears to be increasing. Over the next several months, we expect to see many more new releases from unsuccessful companies in unrelated industries, announcing their intentions to pursue a medical marijuana focus. Our advice to investors is to be cautious (or in plain English…don’t buy them). Getting wrapped up in the “hype” of a sector or technology, without consideration of the underlying fundamentals, typically proves to be disastrous over time. This becomes especially true when many of the companies have a track record of doing little more than destroying investor capital.

KeyStone Financial