Why We Feel Cannabis Producer Tilray Is Currently Overvalued

Cannabis company Tilray Inc.’s (NASDAQ: TLRY) stock has soared since its debut on NASDAQ, increasing a scarcely believable 200%. The euphoria surrounding the legalization of recreational marijuana in Canada, the potential of tie-ups with alcohol giants for producing cannabis-infused drinks, and inking a supply agreement with Nova Scotia Liquor Corporation are a few of the factors responsible for the mammoth rise in the share price. The pot company also posted its second quarter results on August 28, wherein it beat consensus expectations on revenue, which rose 95%, but missed on earnings, with losses widening to $12.8 million versus $2.4 million in Q2 2017. With recreational marijuana use legalized in Canada, effective October 2018, along with medical cannabis usage allowed in a number of international markets, this market is expected to boom. Keeping this in mind, many pot companies are scrambling to expand their capacity, including Tilray. However, given the substantial rise in its share price, we feel its current bull run is unsustainable.

We currently estimate a price of $43 for Tilray Inc using a 2019 P/E multiple of 20. We have created an interactive dashboard analysis on Our Outlook For Tilray Inc. In FY 2019 to estimate Tilray Inc.’s Valuation based on its expected revenues for FY 2019. If you disagree with our forecast, you can make changes to these variables to arrive at your own price estimate for the stock.

We have arrived at a $43 price estimate for Tilray Inc. based on revenue projections of $160.8 million for 2019, a P/S multiple of 20, and a share count of 75 million. The market price stood at $60 as of August 29, 2018, implying our price estimate is lower by 25%.

The P/S multiple in this industry has been considerably high, given the tremendous growth expected in the coming years. Moreover, with the addition of recreational marijuana use and increasing international opportunities, the revenues for companies like TLRY should grow immensely from FY 2019 onward. The legalization of recreational marijuana has also lured alcoholic beverage companies such as Constellation Brands (NYSE: STZ), Molson Coors Brewing Co (NYSE:TAP), Diageo (NYSE:DEO), and Heineken, who are looking to launch cannabis-infused beverages.

Besides growth in the overall medical cannabis market, there are a number of other factors that should result in a rise in both the revenue drivers – grams sold and average price per gram, as well as growth in the sales of accessories.

1. Capacity Expansion: Tilray intends to use much of the capital raised through its IPO on building out its capacity to meet the significant increase in demand anticipated. Once the planned additional facilities are completed, the company believes that its total production space across all facilities worldwide will total a mammoth 912,000 square feet by the end of 2018. Moreover, the maximum potential development would be 3.8 million square feet, leaving plenty of room to increase production.

2. Expansion Into International Markets: Although cannabis is still heavily regulated, medical use is now authorized at the national or federal level in 28 countries. Moreover, more than 24 of these countries have passed significant reforms to their cannabis use laws to broaden the scope of permitted use since 2015. TLRY’s products have been made available internationally in Argentina, Australia, Chile, Croatia, Cyprus, the Czech Republic, Germany, New Zealand, South Africa, and the United Kingdom. The company is also reported to be the first to legally export medical cannabis from North America to Africa, Australia, Europe, and South America.

3. Partnership With Novartis: Tilray has signed a collaboration agreement with Sandoz Canada, a division of Novartis, to market its non-combustible products. The two companies will together develop new cannabis products, with Sandoz co-branding them for prescription by licensed healthcare professionals. This may help Tilray in producing new products, while helping reduce the R&D costs, as a result of the co-development agreement.

4. Supply Agreements: The company has entered into a definitive agreement to supply Shoppers Drug Mart, the largest pharmacy chain in Canada, with its cannabis products. TLRY has also signed a binding letter of intent to be a preferred supplier of cannabis products to Pharmasave, one of the largest independent pharmacy chains in Canada. The pot company has also negotiated agreements to supply seven provinces and territories with cannabis products. This includes an agreement to supply Quebec’s Société des alcools du Quebec with initially up to 5,000 kilograms of cannabis products per year for three years. TLRY will also provide the Yukon Liquor Corporation with up to 900 kilograms of cannabis products over three years.

5. Cannabis Edibles Market Opportunity: The company expects its High Park Processing Facility to be licensed and operational during the third quarter of 2018. Tilray intends to produce a range of products at this facility once permitted under regulations, including edibles, beverages, capsules, vaporizer oils, tinctures, sprays, topicals, pre-rolls, and dried flower products. While it is currently not legal in Canada, Health Canada did set a one year deadline for forming the regulations. The appeal of the edibles market is expected to increase at a fast pace once legalized, given its growth in the U.S.  For example, in Colorado, the share of edibles and concentrates went up from 11% and 13% at the beginning of 2014 to 15% and 29% by the end of 2017. Furthermore, in California and Oregon, their combined share exceeds 35%.

6. Potential Tie-Up With Alcoholic Beverage Company: The market for beer has been declining in the U.S., and liquor companies could be looking to offset this drag on their revenues by introducing cannabis-infused drinks. Consequently, a number of liquor companies have or are planning an entry in this space, including Constellation Brands (NYSE: STZ), Molson Coors Brewing Co (NYSE:TAP), Diageo (NYSE:DEO), and Heineken. There appears to be a correlation between the decline in liquor sales and marijuana use in some cases. According to a joint study conducted by three universities, it was found that counties located in U.S. states where medical marijuana has been legalized registered a 15% drop in monthly alcohol sales. While Constellation Brands has stated that marijuana-based beverages won’t be introduced in the U.S. until the federal law is changed, it is possible that legislative changes could be imminent, potentially expanding the market for cannabis.

As a result of the above factors, and consequently a growth in the revenue metrics, we expect the sales to increase to roughly $160.8 million in FY 2019.

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