After taking a deeper look into cannabis stocks, I quickly notice that stocks here emulate a classic “hype cycle.” But this isn’t necessarily a bad thing. And during my investigation into the space, Tilray (NASDAQ:TLRY) stock in particular caught my attention.
Here’s why it should grab your attention too.
Long-time growth investors are well aware of the hype cycle. Although more commonly used in the tech industry, this framework can be used for any nascent hyper-growth industry. The hype cycle goes from the “trigger” to “peak expectations” to the “through of disillusionment” to the “slope of enlightenment.”
After the massive run-up in 2018 and subsequent crash, cannabis stocks are now going through the “slope of enlightenment” phase.
When it comes to TLRY stock in particular, it followed this pattern after it showed signs of life in February, then tumbled down more than 60% from its 52-week highs.
This run-up was most likely fueled, at least partially, by the announced merger with Aphria (NASDAQ:APHA). But while some investors might be turned away after the sharp decline, the price today is now far more reasonable for those interested in taking a long-term position in the combined marijuana company.
The U.S. Cannabis Legalization Effort Is Accelerating
With a Democrat-led government, there seems to be a sustained push toward the legalization of cannabis in the U.S. Since 2012, the majority of states have legalized marijuana in some way either for medical use or recreational use. Last November, New Jersey, Arizona, Montana and South Dakota legalized recreational cannabis. New York recently signed a bill legalizing marijuana in the state.
Support for marijuana legalization is extremely popular. According to a Gallup poll, 68% of Americans back the measure. Therefore, it should be only a matter of time before the drug becomes legal, or at least decriminalized, at the Federal level. If cannabis becomes legal at the Federal level, overnight the U.S. will become the largest market for the industry.
Illegal cannabis sales in the U.S. are estimated to be more than $100 billion annually. Legal weed is catching up though as legislation continues to get passed. BDSA, a cannabis sales data platform, expects the legal U.S. cannabis market to reach $41 billion by 2026. A combined Aphria and Tilray would be better equipped to take advantage of this market opportunity.
Why Tilray Is Bound to Remain a Major Industry Player
Individually, both Aphria and Tilray are leading players in the cannabis industry. Combined though, the new Tilray will be the world’s largest global cannabis company with revenues of $685 million. This will give Tilray a massive advantage in terms of economies of scale. Simply put economies of scale mean that as companies become larger they are able to better spread out the fixed costs of production over a large number of goods, driving per-unit costs down. This will allow the new Tilray to compete more effectively in a consolidating cannabis market.
The newly merged company will also solve a lot of the issues currently plaguing Tilray and holding back its full potential. The new Tilray will have a much stronger balance sheet and cash flow enabling it more favorable access to capital (i.e., debt at more favorable rates). More capital will fuel the company’s expansion plans and accelerate growth.
Management expects the combined company to immediately deliver value post-merger through cost synergies. These cost reductions are in the key areas of cultivation and production and are expected to be worth $78 million annually. The new Tilray will use Aphria’s state-of-the-art facilities in order to have product cultivation costs below $1 per gram. Aphria has a massive 2,400,000 square foot state-of-the-art facility capable of reaching 255,000 kg of production annually. Post-consolidation, the new Tilray will have enough demand to fully advantage this facility.
Based on the deal structure and the run-up of both TLRY stock and APHA stock, there isn’t that much arbitrage benefit from owning one or the other. I would caution some patience before diving head-in to buy these stocks though. The risk still remains that government regulators will torpedo the deal. However, assuming the deal gets regulatory approval, I believe the new Tilray will be a solid player in the cannabis industry.
Investors should keep this company on their watch lists.
On the date of publication, Joseph Nograles did not have (either directly or indirectly) any positions in the securities mentioned in this article.