Less than two weeks ago, with marijuana stock Tilray (TLRY +0.00%) closing in on $70 a share, I questioned whether the company's stock could continue its incredible run. Apparently, the answer was "yes."
Last Thursday, Sept. 13, Tilray hit yet another intraday high, with its stock rising to a peak of $127.27. Not only did this catapult Tilray's valuation to north of $11 billion, but the commensurate 14% intraday decline in Canopy Growth Corp.'s stock also made it the new largest pot stock in the world. Since pricing its public offering at $17 on July 18, Tilray has risen by more than 600%, through Thursday's closing price of $119.76.
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Four reasons Tilray has blazed higher
What the heck is driving Tilray's stock higher, you ask? It appears to be a combination of factors, rather than just one thing.
First, there's growing speculation that Tilray could be next to find a strategic tobacco, alcohol, or big pharma partner. Investors might be overlooking the fact that Tilray already has a big pharma partner in Novartis. Earlier this year, Novartis' generic drug subsidiary Sandoz and Tilray partnered in an effort to get Tilray's products in pharmacies and hospitals throughout Canada. As the now-largest marijuana stock, more partnership opportunities would seem logical.
Second, with ample cash on hand, Tilray is expected to become one of the country's largest growers. The company's S-1 prospectus filed with the Securities and Exchange Commission in June suggested that it would complete 912,000 square feet of combined growing and processing space in 2018. Most of this (a little over 850,000 square feet) will be devoted to growing. But now that Tilray is flush with cash from its initial public offering, it has the land capacity to quadruple its grow space. Should it choose to do so, it could lift itself to perhaps the nation's No. 3 grower by peak production.
Third, investors are excited about Tilray's international expansion opportunities. It's no secret that while Canada is legalizing recreational weed, exports to foreign countries where medical pot is legal could dwarf domestic adult-use weed sales. Plus, medical marijuana, which is what Tilray specializes in, should be a higher margin focus than recreational marijuana, given the willingness of medical patients to purchase cannabis oils rather than highly commoditized dried flower. On Thursday, Tilray's stock popped after announcing the receipt of regulatory permits to ship both dried flower and cannabis oils to Germany.
Lastly, don't overlook the simple power of momentum. Tilray is a relatively new stock (it hasn't even been trading publicly for two months), and as such is still under the lockup period when insiders are barred from selling. Much like cryptocurrencies during the fourth quarter of 2017, investors simply don't want to miss out on this monstrous run higher.
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Opinion: Without question, Tilray is grossly overvalued
However, a 600% move higher in less than a two-month period, especially for an industry that hasn't even hit the starting line yet, is likely unsustainable. That makes Tilray grossly overvalued at north of an $11 billion market cap.
In the company's most recent quarterly results, it recorded a 95% year-over-year increase in revenue, but produced just $9.74 million in total sales. Extrapolated out, that's $39 million in annual sales commanding an $11.2 billion valuation.
What makes even less sense is that Tilray will be aggressively putting its cash and operating cash flow to work in the coming quarters to expand its capacity, build its brands, and lay the foundation for growth in foreign markets. This won't be cheap, which means Tilray is expected to lose money until perhaps 2020 or 2021. Sure, investors have been willing to give juggernauts like Amazon and Netflix a pass on profitability as they reinvest in their businesses, but there are no guarantees that Tilray can command the same competitive advantages in marijuana that Amazon or Netflix do in their respective fields.
And, as noted, Tilray isn't anywhere near a top producer at the moment. Both Aurora Cannabis and Canopy Growth are liable to top 500,000 kilograms of annual peak production, while Tilray's current trajectory places it around 75,000 kilograms to 80,000 kilograms a year, without any further expansion, by my estimate.
All signs would point to Tilray's stock losing steam and heading lower at some point in the not-so-distant future.
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Don't short Tilray or buy put options on this stock
But just because Tilray appears overvalued doesn't mean you should be daring and short shares of the stock or buy put options.
Short-selling, which allows an investor to profit from a move lower in a stock, involves borrowing stock through your brokerage from someone who owns it. Unlike purchasing a stock, where your downside loss is limited to 100% and your upside is unlimited, the reverse is true with short-selling. It means your losses could exceed your initial investment. Had investors short-sold Tilray on Aug. 28, after doubling in the previous two weeks of trading, they'd currently owe their brokerage money after losing all of their initial investment.
But there's more to worry about than just Tilray's volatility and seemingly endless upside of late. In order to borrow stock from your brokerage, you'll need to pay an annual interest rate on what you borrow. Generally, this rate is reasonably low, unless you're dealing with a high-profile or hard-to-borrow stock, which perfectly describes the recently public Tilray. According to financial analytics firm S3 Partners, even if you are able to short Tilray's stock through your brokerage, you could pay as much as 370% in annual interest to do so. In my 20 years of investing, I've never seen a borrowing rate for short-selling this high.
The company's option contracts aren't any better. I decided to peruse some of the October put contracts, which are due to expire in roughly five weeks' time. And, needless to say, they are laughably priced. The Oct. 19, 2018, puts with a $115 strike price closed on Sept. 13 at $36. Let me remind you, Tilray's stock closed at $119.76. These puts have $36 of time premium built in, plus the need for the stock to fall $4.76 just to hit the strike. Buying now would mean the need, without time premium, for a nearly $41 share price decline just to make good on your investment, in terms of intrinsic value. That's insane.
As overvalued as Tilray appears, there isn't a very good way to bet against it. My suggestion would simply be to keep your nose clean with this kingpin pot stock for a while.
