It's been a rough week so far for Canadian cannabis stocks. Shares of Canopy Growth (CGC) were plunging 19.1% for the week as of the market close on Thursday, according to data from S&P Global Market Intelligence. Cronos Group (CRON -0.82%) stock was down 22%. Hexo's (HEXO) shares were sinking 27.2%. And Sundial Growers (SNDL -2.62%) and Tilray (TLRY -0.97%) were falling 18.5% and 15.8%, respectively.
What's behind these big declines? Barclays (BCS 1.75%) analyst Guarav Jain initiated coverage on three of the marijuana stocks on Thursday. He assigned underweight ratings (the equivalent of a sell recommendation) to Cronos and Tilray. He gave an equal-weight rating (equivalent to a hold) to Canopy Growth. Jain said that the prospects for Canopy, Cronos, and Tilray are limited because of the relatively small size of the Canadian legal cannabis market.
It makes sense that Cronos and Tilray would fall after the negative Barclays outlook for the stocks. But why did the others tumble also?
There's a simple explanation for Canopy Growth. Jain set a price target for the stock that's well below the range where Canopy has been trading. His equal-weight recommendation accompanied by a pessimistic price target didn't exactly thrill investors.
We don't have to think overly hard to figure out why Hexo and Sundial plunged, either. Both companies focus on the Canadian cannabis market and have the same limited growth prospects that Jain thinks Canopy, Cronos, and Tilray face.
But is Jain correct? Probably so. The big growth opportunity for cannabis is in the U.S. None of the Canadian companies can enter the U.S. marijuana market currently because of federal laws.
The major Canadian players could strike deals with U.S. multi-state operators (MSOs), as Canopy Growth has already done. However, Jain thinks that those deals help the U.S. cannabis companies a lot more than they do the Canadian companies. He's right.
Also, the valuations of these MSOs tend to be much lower than those of their Canadian counterparts. Combined with the stronger growth opportunities in the U.S. market, this makes the U.S. cannabis stocks much more attractive than Canopy, Cronos, Hexo, Sundial, or Tilray.
The obvious way that these Canadian stocks could rebound is if federal cannabis reform in the U.S. opens the door for the companies to enter the U.S. market. But that might take longer than expected even with some recent progress.
In the meantime, all five companies need to execute well in their core Canadian markets. Some of them, notably Canopy Growth and Tilray, also have opportunities in the European medical cannabis markets.