Going up in smoke
11 December 2018
David Lewis of FIS discusses the newly legalised cannabis market in Canada, and some US states, and how it has opened the floodgates for investors and producers alike
Image: Shutterstock
Environmental change is very much in the news at present, not least as a result of the climate conference that recently took place in Argentina. Whatever your position on climate change, it is hard to argue that our inability to adapt to an environment that may be changing beyond all recognition is a significant risk to us all. Commercial organisations share much in common with living organisms in this regard, and their ability to adapt to their environment is key to their growth and success, or even survival.
One of the industries that has come under significant regulatory as well as fashion or trend pressure is the tobacco industry. An increasing focus on health and vitality has taken its toll on the health of the tobacco producers as more people shun their products and the risks associated with them. However, like any successful business, the tobacco industry has shifted its focus to replacing its disappearing clientele with new markets and more modern products to service them. The success of vaping and other non-traditional tobacco-based products, which are said by some to be less harmful than their more traditional cigar and cigarette counterparts, can be credited with reversing the fortunes of some of the world’s largest tobacco producers.
Just five years ago, the share price of $100 billion market cap Altria Group, owner of the famous Phillip Morris brand of cigarettes and tobacco products, including the famous Marlboro brand, was trading around $35. By June 2017, it was worth more than double that at over $77 apiece.
More recently, however, the US Federal Drug Administration (FDA) has been looking at the tobacco companies’ targeting of young adults and lower age groups. It is logical for the producers of any product or service to look at ways of replacing or even growing its client base wherever it can, but new restrictions around targeting vaping products at the under-21 age group has potentially closed off an avenue of growth, and the impact on the share price is obvious. Altria shares closed last week below $54. So, where next?
The legalisation of recreational cannabis in Canada, and some states of the US, has opened the floodgates for investors and producers alike. One of the most well-known, Tilray, came to the market via an IPO in July of this year, launching at $17 apiece. Last week saw the shares close at over $102. While this is a long way below their post IPO peak close of $214, it is a significant way above the IPO price and brings this newly public company into the same market capitalisation bracket as The Gap and Macy’s. Perhaps unsurprisingly, Tilray is a significant target for short sellers who consider the shares significantly overbought.
Altria wants in on this growth space and is targeting Cronos, another Canadian cannabis company, whose share price five years ago was around CAD$0.60, rising to CAD$5 apiece by the end of 2017. However, with the legalisation of cannabis and interest from Altria, the shares are now trading at over CAD$14. Again, short sellers are focusing on shares that they believe have become overpriced, as figure one shows. The tie-up between the companies appears to make a great deal of sense, with the infrastructure, marketing and distribution expertise that Altria can provide to access a burgeoning market that Cronos is looking to address.
As figure one shows, a significant quantity of short interest activity suggests that many think the shares should not be as high as they are, and a correction may be due. Figure one shows indexed short interest volume since April 2017, and the steep rise in activity over the last five to six months. It should also be noted that utilisation over the same period has been consistently over 80 percent, and the maximum 100 percent for much of the time between April and September.
Altria and Cronos are not the only pairing up that is occurring in the cannabis sector. Aphria, a Canadian pharmaceutical company, is also in the news at the moment as it looked to expand its operations by acquiring the interests of LATAM Holdings, a Columbian cannabis producer. This deal has also tripped the noses of the short selling community, as figure one shows.
Taking the five-year trend as before, Aphria shares can be seen advancing from CAD$0.75 to a peak of around CAD$23 in January of this year.
At around the same time, short sellers began to aggressively build up their positions, quickly pushing utilisation over 60 percent and between 80 percent and 90 percent by the middle of the year. Some sceptics are suggesting that share issuances by Aphria, timed to take advantage of the stratospheric share price gains, may not be all they appear to be. Irrespective of the share issuances purpose, short sellers were quick to take up any new shares that came to market, keeping utilisation levels high.
Quintessential Capital Management’s Hindenburg Research has suggested that the purchase of LATAM has been simply to divert the newly raised capital “from the shareholders into their pockets,” a suggestion strongly refuted by Aphria.
Whatever the truth of the matter, the shares have certainly come back to earth with a bump, trading under CAD$18 by November and closing this week at under CAD$6. This downward slide will have delivered significant gains for those holding short positions in Aphria, while leaving those who had bought into the frenzy surrounding the potential of the newly legalised cannabis market with a substantial headache. The accusations and rebuttals will, no doubt, continue to fly, but once the haze clears and the truth is known, there may well be some long investors nursing losses from investments that did, indeed, go up in smoke.
Figure one: Short interest volume indexed to April 2017
One of the industries that has come under significant regulatory as well as fashion or trend pressure is the tobacco industry. An increasing focus on health and vitality has taken its toll on the health of the tobacco producers as more people shun their products and the risks associated with them. However, like any successful business, the tobacco industry has shifted its focus to replacing its disappearing clientele with new markets and more modern products to service them. The success of vaping and other non-traditional tobacco-based products, which are said by some to be less harmful than their more traditional cigar and cigarette counterparts, can be credited with reversing the fortunes of some of the world’s largest tobacco producers.
Just five years ago, the share price of $100 billion market cap Altria Group, owner of the famous Phillip Morris brand of cigarettes and tobacco products, including the famous Marlboro brand, was trading around $35. By June 2017, it was worth more than double that at over $77 apiece.
More recently, however, the US Federal Drug Administration (FDA) has been looking at the tobacco companies’ targeting of young adults and lower age groups. It is logical for the producers of any product or service to look at ways of replacing or even growing its client base wherever it can, but new restrictions around targeting vaping products at the under-21 age group has potentially closed off an avenue of growth, and the impact on the share price is obvious. Altria shares closed last week below $54. So, where next?
The legalisation of recreational cannabis in Canada, and some states of the US, has opened the floodgates for investors and producers alike. One of the most well-known, Tilray, came to the market via an IPO in July of this year, launching at $17 apiece. Last week saw the shares close at over $102. While this is a long way below their post IPO peak close of $214, it is a significant way above the IPO price and brings this newly public company into the same market capitalisation bracket as The Gap and Macy’s. Perhaps unsurprisingly, Tilray is a significant target for short sellers who consider the shares significantly overbought.
Altria wants in on this growth space and is targeting Cronos, another Canadian cannabis company, whose share price five years ago was around CAD$0.60, rising to CAD$5 apiece by the end of 2017. However, with the legalisation of cannabis and interest from Altria, the shares are now trading at over CAD$14. Again, short sellers are focusing on shares that they believe have become overpriced, as figure one shows. The tie-up between the companies appears to make a great deal of sense, with the infrastructure, marketing and distribution expertise that Altria can provide to access a burgeoning market that Cronos is looking to address.
As figure one shows, a significant quantity of short interest activity suggests that many think the shares should not be as high as they are, and a correction may be due. Figure one shows indexed short interest volume since April 2017, and the steep rise in activity over the last five to six months. It should also be noted that utilisation over the same period has been consistently over 80 percent, and the maximum 100 percent for much of the time between April and September.
Altria and Cronos are not the only pairing up that is occurring in the cannabis sector. Aphria, a Canadian pharmaceutical company, is also in the news at the moment as it looked to expand its operations by acquiring the interests of LATAM Holdings, a Columbian cannabis producer. This deal has also tripped the noses of the short selling community, as figure one shows.
Taking the five-year trend as before, Aphria shares can be seen advancing from CAD$0.75 to a peak of around CAD$23 in January of this year.
At around the same time, short sellers began to aggressively build up their positions, quickly pushing utilisation over 60 percent and between 80 percent and 90 percent by the middle of the year. Some sceptics are suggesting that share issuances by Aphria, timed to take advantage of the stratospheric share price gains, may not be all they appear to be. Irrespective of the share issuances purpose, short sellers were quick to take up any new shares that came to market, keeping utilisation levels high.
Quintessential Capital Management’s Hindenburg Research has suggested that the purchase of LATAM has been simply to divert the newly raised capital “from the shareholders into their pockets,” a suggestion strongly refuted by Aphria.
Whatever the truth of the matter, the shares have certainly come back to earth with a bump, trading under CAD$18 by November and closing this week at under CAD$6. This downward slide will have delivered significant gains for those holding short positions in Aphria, while leaving those who had bought into the frenzy surrounding the potential of the newly legalised cannabis market with a substantial headache. The accusations and rebuttals will, no doubt, continue to fly, but once the haze clears and the truth is known, there may well be some long investors nursing losses from investments that did, indeed, go up in smoke.
Figure one: Short interest volume indexed to April 2017
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