Hardly a meeting goes by these days when we don’t get asked about cannabis stocks and why we don’t own any. Our explanation typically begins with a review of the attributes that Cambridge considers when making an investment, namely:
• An established business model with a competitive advantage
• A high rate of return on assets or invested capital
• An established management team with a track record of effective capital allocation
• A valuation that provides an attractive return/risk profile.
Despite our best efforts to explain our discipline to investors, we’re often met with disbelief that we wouldn’t make an exception to invest in this “tremendous opportunity”. On one occasion it was suggested that perhaps our process was too archaic for today’s dynamic investment environment.
The discussion around cannabis stocks tends to be polarizing. We’re not suggesting that investing in these stocks is bad necessarily, rather that they don’t fit the profile of the Cambridge investment process. So, for illustrative purposes, I’ll compare two rapidly growing Canadian companies to demonstrate our preference for one over the other.
Table 1 compares key financial metrics for Canada Goose (TSX:GOOS), a company we previously held in some of our institutional portfolios in 2018 and Canopy Growth (TSX:WEED), a leader in the cannabis sector. Figures are based on 2018 data and 2019 Bloomberg L.P. (“Bloomberg”) consensus estimates.
Canopy was listed in mid-2016 and began generating sales in 2017. Its current market capitalization is $21.8 billion, nearly three times that of Canada Goose’s valuation of $7.3 billion. Based on Bloomberg consensus estimates, Canada Goose is widely viewed as overvalued yet the stock trades at a fraction of Canopy.
Both companies have accelerating sales and high gross margins, but based on consensus expectations compiled by Bloomberg, Canopy may in the short to mid-term continue generating losses in operating income and earnings per share, and record negative free cash flow. Bloomberg consensus expectations for Canada Goose suggest they will grow earnings more than 50% in 2019, continue to generate attractive returns on equity and will have nearly $100 million of free cash flow to reinvest in their business. Based on the only comparable valuation metric, Price to Sales, Canopy trades at an expected multiple of 86 times versus 9 times for Canada Goose.
While it is difficult to predict the future of either company and the industries they compete in, it’s probably safe to say that Canopy has greater exposure to changing regulatory and competitive forces. The entire cannabis industry will be required to invest large amounts of capital to build these businesses, without the advantage of having uniquely differentiated products. As investment capital floods into the sector in the form of mergers and acquisitions, initial public offerings and secondary offerings, the ability to achieve attractive rates of return will become more challenging.
Cambridge has consistently adhered to our investment discipline. As quality fundamental investors, we remain focused on identifying durable, compounding businesses through our bottom-up research process. We remain committed to our investment process as we strive to grow wealth for our clients.
Principal & Portfolio Manager.
Robert Swanson is a Portfolio Manager to certain Cambridge funds. He does not have a material interest in the securities discussed herein; however, he is an investor in certain Cambridge funds which may hold these securities.
This commentary is published by CI Investments Inc. The contents of this piece are intended for informational purposes only and not to be used or construed as an endorsement or recommendation of any entity or security discussed. The information should not be construed as investment, tax, legal or accounting advice, and should not be relied upon in that regard. Inpiduals should seek the advice of professionals, as appropriate, regarding any particular investment. Investors should consult their professional advisors prior to implementing any changes to their investment strategies. These investments may not be suitable to the circumstances of an investor. Some conditions apply.
Certain statements contained in this communication are based in whole or in part on information provided by third parties and CI Investments Inc. has taken reasonable steps to ensure their accuracy.
Certain statements in this document are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend upon or refer to future events or conditions, or that include words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “intend,” “plan,” “believe,” or “estimate,” or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained herein are based upon what CI Investments Inc. and the portfolio manager believe to be reasonable assumptions, neither CI Investments Inc. nor the portfolio manager can assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rates of return are the historical annual compound total returns net of fees (except for figures of one year or less, which are simple total returns) including changes in security value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.
CI Investments, the CI Investments design, and Cambridge are registered trademarks of CI Investments Inc. Cambridge Global Asset Management is a pision of CI Investments Inc. Certain funds associated with Cambridge Global Asset Management are sub-advised by CI Global Investments Inc., a firm registered with the U.S. Securities and Exchange Commission and an affiliate of CI Investments Inc. Robert Swanson is a portfolio manager of CI Global Investments Inc. and is associated with Cambridge Global Asset Management.
Published March 25, 2019
The data shown is the increase in the closing price of the respective stock as at December 31, 2018 compared to the closing price as at December 31, 2017.
The data shown is the decrease in the closing price of the respective stock as at December 31, 2018 compared to the closing price as at December 1, 2018.