Much ado has been made about the Tilray (NASDAQ:TLRY) merger with Aphria (NASDAQ:APHA). Indeed, this merger will result in the combined entity being the largest cannabis producer in the world. Investors piled into TLRY stock aggressively since the merger was announced Dec. 16.
How aggressively?
Shares of TLRY stock increased from the $9 level at the beginning of the year to as high as $67 per share in early February. That’s a seven-bagger in the matter of a few weeks.
However, a month later, shares are down nearly 70% from these highs. This comes as investors continue to re-evaluate the strength of companies in the cannabis sector.
It appears investors are gauging the relative strength of individual cannabis stocks to a degree I haven’t seen in the past. Typically, these stocks trade in high correlation to each other. However, in recent weeks, this high correlation has broken down.
Here’s why I think this is the case.
Growth Stocks Aren’t Doing Well
To start, the fact that both TLRY stock and APHA stock are underperforming in recent weeks shouldn’t be news to investors. Broadly, risk-off sentiment appears to be taking hold in the stock market. Investors appear to be rotating out of high-growth stocks in sectors like cannabis toward safer, highly cyclical value sectors that have been beaten up as a result of the pandemic.
Why?
Rising bond yields are one key reason for this. Inflation expectations have picked up. Cannabis stocks are among the most highly priced growth stocks on the market today. Indeed, the rotation we’re seeing from growth to value sectors could continue for some time in a rising interest rate environment.
I think investors need to be keenly aware of the downside risks TLRY stock and other highly volatile securities have today. I think it can be easy to ignore what this volatility represents when everything’s going up. Indeed, when risk-on sentiment is taking growth sectors higher, in many cases by double-digit margins daily, it’s easy to forget what the downside potential of these stocks could look like.
As many have said, stocks go up in an escalator, and down in an elevator. For stocks that go up in an elevator, a similar (potentially worse) parabolic move to the downside can occur.
U.S. Legalization a Big Deal for TLRY Stock
I think the high degree of speculation around U.S. cannabis legalization has a lot to do with Tilray’s performance of late.
Again, I’d redirect readers’ attention to U.S. cannabis players like Curaleaf (OTC:CURLF) right now. Cannabis companies like Curaleaf with vertically integrated business models based in the U.S. are likely to outperform international peers like Tilray or Aphria.
That’s not to say Tilray can’t or won’t grow in the U.S in the near term. Both Tilray and Aphria have made steps toward growing their non-THC products in the U.S.
For example, Tilray owns Manitoba Harvest, a provider of hemp products with sales in the U.S. Aphria bought U.S.-based SweetWater Brewing for $300 million prior to the merger, which could help the combined entity in tackling the CBD-infused beverage market in the U.S.
That said, companies like Curaleaf have a massive head start right now on Tilray. Additionally, growing organically or via acquisition in the U.S. market will take time and be extremely costly right now. Companies like Tilray are playing catch-up with some pretty formidable competitors.
Conclusion
Right now, TLRY stock is one I wouldn’t touch given the aforementioned headwinds this stock is facing. I think there are far too many higher-quality U.S.-based cannabis companies to choose from right now.
Additionally, I think the cannabis sector is likely to suffer from a broad-based sell-off in growth stocks that is likely only beginning. Long-term investors seeking growth opportunities may be best-suited waiting until the dust settles.
Yes, the new Tilray (post-merger) is an exciting opportunity for long-term investors. However, the hype surrounding this stock appears to be larger than the company’s actual potential right now. Until this company becomes a viable player in the U.S. market, I’m going to remain on the sidelines.
On the date of publication, Chris MacDonald did not have (either directly or indirectly) any positions in the securities mentioned in this article.