Pot luck: Investing in Israeli medical cannabis stocks is guesswork

The growing number of shares trading on the Tel Aviv Stock Exchange have soared based mostly on investors' inchoate hopes - not on fundamentals

There are few superlatives that fail to describe the Tel Aviv Stock Exchange's medical-marijuana mania. In the last few months, and especially after the government approved exports three weeks ago, investors couldn't get enough of the shares. Day after day they traded heavily and their market caps grew by the hundreds and even thousands of percent. Virtually nothing seemed to stop them.

That was until last week. Without news of any developments that threatened to undermine their potential for capitalizing on exports, cannabis share prices began to teeter and by Thursday most of them were down sharply.

On Sunday, they traded mixed, with the notable exception of the shell company Herodium, which enjoyed the buzz from Panaxia Pharmaceuticals, the cannabis company with which it is merging, had named the Noble laureate Aaron Ciechanover as an adviser.

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Herodium was up 11.9% at 9.60 shekels ($2.65) on Sunday after plunging 20% and 15% in the day trading days before. Its market cap is 134 million shekels, but its post-merger valuation is in the order to 480 million shekels.

Investors who identified the trend early have earned returns in the hundreds of percent - the latecomers are stuck with double-digit losses on companies that often had markets caps in the hundreds of millions of shekels without any revenues, much less profits to show for it.

InterCure, which had a market cap of as much as 1.2 billion shekels, thanks in part to having former Prime Minister Ehud Barak as chairman, plunged 13% on Thursday, marking a 25% drop from its peak. On Sunday, it rebounded to close 8.5% higher at 11.61 shekels.

Other falling cannabis stocks included Together, which dropped 8.1% on Thursday, clawing back some of that to end at 6.40 on Sunday; Dunivo, which fell 10.9% before recovering half that loss on Sunday; and Canassure, which dropped 7.5% and continued lower on Sunday.

As Sunday's rebound for some shares showed, the dream of cannabis profits isn't quite over. Two companies - Medigus and Tamda - reported plans to enter the industry, causing their shares to power higher 7.6% and 85%, respectively, on Thursday. Medigus retreated 9.8% on Sunday to 53 agorot, but Tamda jumped more than 33% to close at 2 shekels.

The old market cliché "the trend is your friend" has worked wonders for investors in New York and Toronto as well as in Tel Aviv, but the question is whether there is anything valuable in these companies apart from the trend?

The problem with cannabis stocks in Israel and elsewhere in the world is the lack of analyst coverage and quality valuations. It's a new sector and the gap between expectations and actual performance is yawning. In the U.S. some medical marijuana companies have market caps in the billions of dollars even though they are not profitable.

On the other hand, in contrast to Israeli companies, they do have revenues because the U.S. states have legalized marijuana, have seen non-medical use increase, and have also attracted investment by companies like Coca Cola and the tobacco company Altria.

Any attempt to value Israel's publicly traded medical marijuana companies quickly turns into a fool's errand. Most of the companies have no revenues at all. The revenues of the few that do, for instance InterCure and Whitesmoke, are not relevant to the new era of exports. They amount to a few millions of shekels from the tiny Israeli market they have been serving via direct sales to users.

Under the new regime, from April 1, they will be able to sell their products in Israel through pharmacies, which should lift sales. The real market for these companies, however, is in exports and those are unlikely to really begin until the end of 2019.

Meanwhile, all the companies claim there is huge demand for their product, but investors haven't been able to see the contracts these companies have signed or often the names of the counterparties overseas. The sales, much less the profits, they will generate are just a guessing game.

In fact, Together last year reported signing several binding agreements with companies overseas to sell them medical marijuana, but that was before the company had finished erecting a single hothouse. It hasn't named the buyers.

"Everyone is betting on which companies will grow and be around in the future," said the CEO of one of the companies in the business, who asked not to be identified. "Those who make the wrong choice will lose badly - maybe everything."

Those trying to value a cannabis company can use some very rough calculations.

One is to assume that a dunam (quarter acre) can yield about a metric ton of flowers. At a sale price of $4-5 a gram ($15 by the time it reaches the end user overseas), every dunam could yield as much as $5 million annually.

Direct growing costs, say those in the business, are less than $1 a gram. But there are fixed costs as well, which give an advantage to bigger growers. Nevertheless, if a dunam can yield 16.5 million shekels in revenues, they say profit per dunam should be 10 million. Medical marijuana products, like oil and capsules, are more profitable.

Against that, investors should assume that young, inexperienced companies will end up dumping a large portion of their harvests because it won't meet quality standards.

In addition, there is no certainty that the companies, despite their bullish declarations, will be able to sell all their product, certainly not at the outset of operations. They will have to show buyers they can provide a consistent, high-quality product and do it at competitive prices. The few companies with facilities that meet official standards already in place will have a better chance at profitability over those that don't and may have to subcontract out production. Subcontractors will capture much of the profit.

The most successful of Israel's medical marijuana companies will be able to increase their valuation by listing their shares overseas.

That said, betting on marijuana companies is not akin to betting on a bitcoin. The global market for marijuana, both medical and recreational, is almost certainly set to grow rapidly. The gamble isn't on the marijuana market but on which companies will succeed in it.

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