Like many men of genius, Jim Simons has set his aptitude to a wide array of applications. At age 23 he received a PhD in mathematics from UC-Berkeley, and in 1964 went to work for the National Security Agency as a cryptographer. He transferred those skill to IBM in 1973, and founded his hedge fund, Renaissance Technologies, in 1982. Since then, his fund has grown to hold over $130 billion assets under management. Simons retired in from active work with the fund in 2009, but remains on the board as non-executive chairman and adviser. Simons’ great contribution to the hedge fund industry was the introduction of quantitative investing.
In the second-quarter, Simons made a move into Canada’s newly legalized cannabis sector. At that time, Simons’s fund had put 905,000 shares of Aurora Cannabis and 241,000 shares of Aphria into the portfolio. The third-quarter 13F filings, released this week, showed that Renaissance has repeated its Q2 performance, in spades. The fund has added to its existing holdings of cannabis stocks, and brought a third company into the mix — Canopy Growth.
We’ve used TipRanks’ database to look behind the curtain on ACB, APHA, and CGC; we’ve found that 4-star Cantor analyst Pablo Zuanic has initiated coverage on all three of these cannabis companies. While the analyst sees “green days” ahead for the cannabis sector, he says “we prefer to value the Canadian LPs based on realistic projections.” Let’s take a closer look:
Aurora Cannabis (ACB)
Aurora Cannabis was the first cannabis stock that Simons’ Renaissance bought into, and in the Q3 13F filing, the fund reported an increase in its holding of 584,995 shares – a US$2 million investment.
Aurora’s funded production capacity of over 600,000 kilograms of cannabis and extract products annually is primarily based in Canada, but the company is expanding into Europe and Latin America as well.
Despite the company’s efficiencies of scale, Aurora reported just plain bad news for Q1 fiscal 2020. Net revenues in cannabis declined sequentially from C$94.6 million to C$70.8 million, while in the non-wholesale segment, Canadian consumer revenues declined 33% to C$30 million. The declines come after heavy production in the wake of legalization led to oversupply in the Canadian provincial markets – distributors are still trying to work through existing inventories, which cuts into sales. CEO Terry Booth pointed this out: “During the summer, the provinces feasted on the supply that was available and stocked their shelves to the limits.” ACB shares fell sharply after the earnings report, losing up to 11% during the session.
There were two important bright spots, however. Aurora pushed its production costs down by 25%, to just 85 cents per gram. This was an important milestone, as the company had previously pledged to get production costs below C$1 per gram. Also, EPS came in at 1 cent. While this was down from 12 cents EPS one year ago, it was still a net profit which differentiates ACB from many players in the cannabis industry.
While Simons sees reason to buy into ACB, Zunaic at Cantor initiated coverage of the stock with a neutral, or hold, rating. He puts a US$3.85 price target on the stock, for a 17% upside, saying, “We expect the Canadian LP group to rally in the coming months on more positive than negative catalysts, but for now see more upside in other stocks.” (To watch Zuanic’s track record, click here)
ACB’s consensus rating is aligned with Zunaic’s: a Hold, based on 5 buys, 6 holds, and 3 sells. This split reflects the uncertainty in the cannabis sector, as the newly legal industry works out issues of supply and distribution efficiency. However, the $5.41 average target still implies an upside of 82% from the $3.06 trading price. (See Aurora stock analysis on TipRanks)
Aphria, with a market cap of US$1.1 billion, is ranked #4 among Canadian cannabis companies. However, like much of the industry, it is struggling with growing pains and instability. The company generates a profit, like Aurora, but Aphria uses fair-value adjustments to boost the profitability figures. This is more an issue of trust than accounting, which gets to Aphria’s other weakness.
This company is simply perceived as, if not untrustworthy, at least slightly shady. CEO Vic Neufeld left the company in January, after claims that Aphria had purchased several Latin American assets at prices far above market value – while an advisor to Aphria had interests in all three properties.
To make matters worse, it was not the first time that an Aphria deal didn’t look fully kosher. Back in March of 2018, the company purchased Nuuvera for C$425 million, a straightforward deal that should have posed no problems. However, Aphria executives held equity investments in Nuuvera, which were not disclosed until the day before the closing. While not illegal, the timing of the announcement certainly raised eyebrows.
On the positive side, Aphria was recently granted a cultivation license by Health Canada for its new Diamond facility. At full capacity, the new grow facility will boost Aphria’s production to 255,000 kilograms per year, a 100% increase. At that capacity, Aphria will become the third largest producer in the Canadian cannabis market and hold a 12% market share.
Those are the numbers that must have impressed Simons. His fund already held more than 240,000 shares of APHA, and in Q3 increased that by 80,400. The 34% increase in the holding brings Renaissance’s investment in APHA up to US$1.4 million at current share prices.
APHA is the only of these three stocks to get a thumbs up from Zunaic. The analyst put a buy rating on the stock, along with a $7.85 price target. He notes particularly that “Aphria management is confident that cannabis sales in the May fiscal year will be 10 times August quarter levels, due to ongoing market growth and share gains.” On the strength of probably future sales, Zunaic sees a 78% upside to the stock.
Wall Street mostly agrees with Zunaic. Aphria has a Moderate Buy consensus rating, based on 6 buys and 1 sell set in the past three months. Shares are trading for $4.41 in New York, and the $8.47 average price target suggests an upside of 92%. (See Aphria stock analysis on TipRanks)
Canopy Growth (CGC)
And now we get to the world’s largest cannabis company, Ontario-based Canopy Growth. Canopy was founded in 2013 and today has a market cap of US$5.5 billion. Late last year, beer giant Constellation Brands took a 35% stake in the company, as well as a controlling vote on the board of directors. This past July, after two quarters of declining performance. Co-CEO Mark Zekulin is running Canopy until a permanent chief is found.
So, Canopy is in flux, which may explain the fiscal Q2 numbers. The company posted a C$1.08 loss per share, even though revenues rose from C$23.3 million to C$76.6 million. While a 3x increase in revenue is objectively good, the forecast had been for C$100 million. Canopy missed that mark by 23.4%. The EPS loss was even worse, a 62% negative surprise from the estimates. Shares fell more than 14% after the earnings report.
Zekulin outlined the challenges facing Canopy in a simple statement, saying, “…provinces have reduced purchases to lower inventory levels, retail store openings have fallen short of expectations, and Cannabis 2.0 products are yet to come to market.” The Q2 report reflected this in a C$32.7 million restructuring charge as well as a C$15.9 million inventory charge.
While Canopy says that the ugly Q2 was a “short-term headwind,” investors were less than impressed. CGC recorded ugly quarters in Q1 and Q4, despite receiving a $4 billion cash infusion from Constellation. The Canadian cannabis market is struggling with two related issues, oversupply of product and undersupply of distribution licenses, and Canopy, as the largest cannabis producer in the country, is perfectly positioned to take a hit from that combination.
Still, CGC is also well-positioned to gain when license bottleneck eases, and its partnership with Constellation holds promise for ‘Cannabis 2.0,’ when new products, including beverages, are legalized in Canada. This potential explains the move by Renaissance to purchase shares in CGC. Simons’ fund made Canopy its third cannabis acquisition, buying over 510,000 shares. Even after the share price drop, the holding is worth US$8 million.
In his initiation report on Canopy, Zunaic gives the stock a Hold rating and a $20.37 price target. He points out several downside risks to CGC, including low gross margins, poor medical sector performance in Canada, and legal disputes with its growers in New York state. He does recognize the underlying potential of the cannabis market, and his price target implies a 28% upside for the stock.
In his report on cannabis stock, in which he initiated coverage on the stocks in this list, Zunaic covered the Canadian cannabis market generally. His bottom line of the market was upbeat: “Positive catalysts far outweigh negative ones in the year ahead. Valuations are at two-year lows, and we deem them attractive based on the long-term opportunity.”
That potential, and the current low prices, underlay Simons’ move to expand his stock holdings in the cannabis market. It’s a simple application of the old adage, buy low and sell high.
Overall, the Street’s analysts are slightly more optimistic than Zunaic on CGC. The stock has 6 buy and 9 hold ratings, pointing to a Moderate Buy consensus. Shares are selling for $15.64, and the $27.33 average price target suggests an upside of 73%. (See Canopy stock analysis on TipRanks)