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Three hidden gems stashed away in a cannabis market that just keeps rolling higher

If your Spidey Sense tells you not to load up on Tilray and Canopy after their big stretch higher, check out CannTrust Holdings, Khiron Life Sciences and Kush Bottles

A woman holding a marijuana leaf
In the mid-tier space, CannTrust Holdings is a 'solid, profitable company' with 'great management and brand,' says analyst Ben Smith of Midas Letter

Multibillion-dollar marijuana companies at the top of the market-cap rankings like Tilray Inc (NASDAQ:TLRY) and Ontario-based Canopy Growth Corp (NYSE:CGC, TSX:WEED) are, by definition, those that are riding a wave of popularity among cannabis investors. Therefore, there's a good chance that they are overvalued.

Almost on cue, Northland Capital analyst Mike Grondahl, downgraded Tilray Wednesday to market perform from outperform. He said that following Tilray's big stretch higher, "we believe the risk/reward is far more balanced at this time."

In other words: bigger isn’t always better.

Uncovering hidden gems

“I would be more inclined to look at the mid-tier or select junior names at this time, since the Tier-1's are currently expensive," said Ben Smith, a research analyst and capital markets professional with Midas Letter, a business channel in the cannabis and cryptocurrency space. "In the mid-tier space, CannTrust Holdings Inc. (TSE:TRST) is a solid, profitable company with great management, brand, and growing medical enrollment patient base.”

Smith believes the company could easily trade much higher if it uplists to an American exchange and captures US inflows.

CannTrust Holdings Inc is also a strong candidate to partner-up with Big Pharma, thus increasing shareholder value, he added.

READ: Are marijuana stocks too high for an investor tempted to join the party, or do they have room to run?

CannTrust, which booked revenue of C$20.7mln in the last fiscal year, is the only pharmacist-controlled-and-operated producer of medical cannabis in Canada. Its products are sold online and delivered to registered patients.

Its 450,000 square feet Niagara facility has a projected production of 100,000 kgs a year by 2019. The company’s innovative CANNCUP medical cannabis beverage pods use a patent-pending method to produce single-serve coffee, tea and hot chocolate containing high-quality cannabis.

“A name I like on the small-cap side is Khiron Life Sciences Corp (CVE:KHRN, OTCMKTS:KHRNF). I actually view them as a strong acquisition candidate, as their Latin America focused-execution and cheap valuation should make them [an acquisition] target,” Smith told Proactive Investors.

Along with additional licenses from the Ministry of Justice in Colombia secured in October 2017, Khiron is fully approved to cultivate, produce, distribute domestically and export both tetrahydrocannabinol and cannabidiol medicinal cannabis. Smith said that aside from Khiron’s ready-to-go licensing capabilities, its “growing patient portfolio” should be an attractive asset to acquirer companies.

Bullish on cannabis  

Wall Street analysts, like Cowen’s Vivien Azer, say Big Brewers are worried about losing market share to cannabis companies and they also do not want to miss out on the next big thing.

Companies like Anheuser-Busch and Diageo plc (NYSE:DEO) have all been meeting with Canadian cannabis producers over the past few months to discuss bringing their respective cannabis beverages to market.

Azer, a beverage, tobacco and cannabis analyst, expects Canopy Growth and Kush Bottles Inc (OTCMKTS:KSHB), a medical-cannabis packaging company, to outperform. This week she reiterated an Outperform rating on Canopy, raising the price target to C$74 from C$56. She expects the record US$4bn cash infusion from Constellation Brands (NYSE:STZ) to give Canopy a head start in international markets.

Read: Kush Bottles Inc reports third-quarter revenue up 173% to US$12.9mln

The maker of Corona beer said the global cannabis market is evolving rapidly and would grow to greater than US$200bn in revenue within 15 years.

"Fundamentally, we believe cannabis is going to be a big business worldwide … not going to be limited to Canada. This will be undoubtedly a market that develops in the United States, it's already done so on a state-by-state basis here,” Constellation COO William Newlands told the Barclays Global Consumer Staples Conference in Boston. “It's developing around the world, in places like Germany and Australia and other markets. The whole combination of things is shaping up in a way that this is going to be a big business."

According to Forbes, some of the latest data shows that THC-infused beverages could be worth in upwards of US$15bn in the US if the federal government would legalize nationwide. Other reports show that the introduction of cannabis drinks to the Canadian market could drive annual sales from US$5bn to somewhere in upwards of US$22bn.

Venture fund inhales

Rapper and business mogul, Snoop Dogg’s venture firm, Casa Verde Capital, just closed its debut fund with $45mln and is eyeing marijuana stocks.

“We’re writing seed-stage to Series A-size checks, so US$1mln plus, with roughly half our fund reserved for follow-on investments, where we can write another US$3mln to US$5mln [to a limited number of breakout companies]," Casa Verde Capital managing partner Karan Wadhera recently told TechCrunch. "And we’re only focused on the ancillary part of the cannabis industry, so we won’t invest in companies that touch the plants. No dispensaries or cultivators or manufacturers. We’re investing in the picks and shovels.”

Wadhera said the firm's biggest investment to date is LeafLink, a marketplace for retailers and brands. "If you were Walmart and logging onto a platform to order from vendors, that’s what LeafLink has created for the cannabis space. A dispensary can log in and order from vendors on one consolidated platform.”

Leaflink, which runs the cannabis e-commerce website is currently private, but analysts say they wouldn’t be surprised if it goes public at some point.

October legalization rally

The upcoming October 17 legalization of marijuana in Canada is a positive catalyst to be sure, but the big-cap marijuana stocks are pricey.

“I believe most cannabis stocks are very steeply priced and forwardly discounted quite far in the future (2020). Especially after this latest sector run, with leaders such as Canopy Growth up 110% and Tilray 350% in just three weeks,” said Smith.

“On a valuation basis, the Canadian recreational market alone simply cannot justify such sky-high enterprise values. So on an overall valuation basis, it's hard to see much upside presently. But that said, it's still an early-stage growth market, and valuations are the primary driver of the market — as Tilray's move clearly demonstrates.”

Canadian cannabis stocks have already floated to a collective stock-market value above C$30bn. That’s already about half the market capitalization of Canada’s gold mining industry.

READ: CannaRoyalty’s focus beyond Canada is more than just California Dreamin’

However, the market may still have upside after a period of consolidation as the hype surrounding Big Alcohol/Big Tobacco partnerships continue to generate headlines.

“Although we're probably heading into a phase where an actual deal has to occur to move the needle higher,” said Smith. “While I'm not completely convinced the big October legalization rally is coming — especially if no big beverage or pharma deal occur by early October — another up leg into October 17 is also a distinct possibility.”

A Health Canada report disclosed this week that demand for pot will be much higher than anticipated. This could generate momentum after a “probable period of consolidation” or “backfilling plays out,” says Smith.

“Valuations are high, the trade is well telegraphed, legalization will be a tiered rollout. But never anticipate Fear of Missing Out (FOMO) investor mentalities and possible demand dynamics stoking further inflows into the market,” said Smith.

Contact Uttara Choudhury at [email protected]

Follow her on Twitter@UttaraProactive 

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Price: $2.88

Market: OTCMKTS
Market Cap: $255.86 m
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