HIGH RE­TURNS

Cannabis investment­s could blow your mind

Financial Mail - Investors Monthly - - Front Page - Petri Redel­inghuys

Cannabis has been smoul­der­ing in the fi­nan­cial mar­kets of late. There have been some ex­cit­ing IPOs, some crazy val­u­a­tions, and some zero-to­hero, back-to-zero share-price move­ments.

Un­doubt­edly there is an op­por­tu­nity here, but get­ting your head around it is a bit more dif­fi­cult that you’d think.

Let’s get things clear. Cannabis is not just the leisure nar­cotic of choice for ston­ers. There are more than 70 medic­i­nal uses for “weed”, aside from the many ways in which it can be con­sumed for recre­ational pur­poses.

Read­ers may not re­alise that broad-minded con­sumers in the US can buy cannabis­in­fused gummy sweets and choco­lates on­line from Tar­get.

But how do in­vestors tune in to this bud­ding in­dus­try?

Prob­a­bly the best start­ing point is medic­i­nal cannabis. There are many med­i­cal ap­pli­ca­tions, such as treat­ing de­pres­sion, chronic pain, Crohn’s dis­ease, mul­ti­ple scle­ro­sis, post-trau­matic stress dis­or­der, epilepsy and trau­matic brain in­juries. Every day, more and more re­search is be­ing done into how this plant can be

used to help and heal.

The shamans and tra­di­tional heal­ers of days gone by would have said: “Your head is sore, eat this plant.”

Mod­ern medicine says: “Take this chem­i­cal.”

Now we are com­ing full circle and mod­ern doc­tors are start­ing to say: “Eat this plant.” This has some­thing to do with the grad­ual re­al­i­sa­tion by hu­man­ity that we need to change the way we in­ter­act with na­ture, among other things, in or­der to sus­tain the planet.

This data is a lit­tle old, but the med­i­cal mar­i­juana mar­ket was es­ti­mated at more than $7bn in 2016 and is fore­cast to grow at a com­pound an­nual growth rate of 36% a year through to 2024.

This would make it an $82bn mar­ket in just five years from now.

First-mover com­pa­nies are now poised to take ad­van­tage of this fast-grow­ing global mar­ket by pro­duc­ing med­i­cal­grade cannabis prod­ucts through a net­work of farms and man­u­fac­tur­ing fa­cil­i­ties.

At present the in­ter­na­tional mar­ket is not ex­actly open yet,

What is hap­pen­ing with cannabis now is fairly sim­i­lar to what tran­spired in the US in 1933 when Pro­hi­bi­tion ended and al­co­hol was once again made le­gal

but through­out Europe and Asia we are start­ing to see a move to­ward le­gal­i­sa­tion of cannabis, much like we have seen here in SA.

The process is slow and the rules are very strict. But countries the world over are start­ing to take it se­ri­ously.

For now the fo­cus — from an in­vest­ment point of view — is very much on the US and Canada.

In the US, in par­tic­u­lar, cannabis is le­gal for medic­i­nal use in 46 of the 50 states,

Canopy Growth is aggressive­ly ex­pand­ing be­cause it be­lieves that while the mar­ket is still small, there is an op­por­tu­nity now to se­cure mar­ket share

though not yet on a fed­eral level. This means that in each state a sep­a­rate com­pany, of­ten a sub­sidiary of the larger com­pany, must be reg­is­tered and it must ei­ther grow its own cannabis or pur­chase it from an­other li­censed com­pany. It must also produce the end prod­ucts it in­tends to sell within that state.

This makes it com­pli­cated and ex­pen­sive to set up a large-scale mul­ti­state busi­ness within the US, as cannabis oil ex­trac­tion and other end-prod­uct man­u­fac­tur­ing equip­ment is re­quired at each lo­ca­tion.

This is not the case in Canada. Com­pa­nies there can im­port cannabis plants and “flower” from any pro­ducer that meets the strict reg­u­la­tory re­quire­ments.

At present two com­pa­nies stand out in the medic­i­nal space — Canopy Growth and Trulieve. Canopy Growth, the first such list­ing in Canada, raised $200m in fund­ing and is lead­ing the charge in this field. It is well-funded via a $4bn in­vest­ment from Con­stel­la­tion Brands, which took a 40% stake in the com­pany.

Al­ready a num­ber of cannabis-based epilepsy drugs have been ap­proved by the Fed­eral Drug Ad­min­is­tra­tion in the US, with more in stage 3 tri­als and hun­dreds of patents reg­is­tered.

Canopy Growth is aggressive­ly ex­pand­ing be­cause it be­lieves that while the mar­ket is still small, there is an op­por­tu­nity now to se­cure mar­ket share.

It is also aware of the dis­rup­tive po­ten­tial that hemp pro­duc­tion could have on the cot­ton in­dus­try when it comes to mak­ing cloth­ing and ma­te­rial at con­sid­er­ably lower costs.

In ad­di­tion, it is in­volved in the recre­ational mar­ket and the ac­ces­sories mar­ket. Canopy Growth also boasts a pres­ence in a vast num­ber of lo­ca­tions, with reg­u­la­tory ap­provals in Ger­many to farm, produce and sell cannabis. It has strate­gic part­ner­ships in five Euro­pean countries, Aus­tralia, Le­sotho and five South Amer­i­can countries in­clud­ing Brazil and Peru.

The first-mover ad­van­tage is pal­pa­ble.

There is a small is­sue which, in truth, is still a prob­lem for pretty much every listed com­pany op­er­at­ing in the space at the mo­ment. There is no profit yet.

For the three months ended De­cem­ber 2018, Canopy Growth made a loss of $0.38 a share. Much of this loss can be at­trib­uted to the con­stant ex­pan­sion by the busi­ness and the investment­s it is mak­ing to se­cure its po­si­tion in the mar­ket. I be­lieve that as the mar­ket ex­pands and Canopy Growth’s foot­print in­creases it will be­come a true force to be reck­oned with. For those who want to buy shares, Canopy is listed on both the New York and Toronto stock ex­changes.

Trulieve is a much smaller com­pany. Listed on the Toronto Stock Ex­change and op­er­at­ing only in the US states of Florida and Cal­i­for­nia, has it a net­work of 28 dis­pen­saries as well as an abil­ity to grow “flower” in its own fa­cil­ity.

It is one of the few cannabis com­pa­nies ac­tu­ally mak­ing a profit at this stage.

Be­tween 2017 and 2018 rev­enue grew by 172% while earn­ings be­fore in­ter­est, tax, de­pre­ci­a­tion and amor­ti­sa­tion rose 591%. Nat­u­rally, Trulieve is also on the ex­pan­sion and ac­qui­si­tion path, though the fact that the com­pany is al­ready mak­ing healthy prof­its of $15m with 58% mar­gins cer­tainly makes it one of the more at­trac­tive cannabis com­pa­nies for in­vestors.

Fur­ther­more, con­sid­er­ing the ex­plo­sive growth of the sec­tor and rapid growth of rev­enues, Trulieve looks well­po­si­tioned to be­come a cash cow quite soon.

Turn­ing our at­ten­tion to the recre­ational mar­ket — which will prob­a­bly turn out to be sig­nif­i­cantly big­ger than the medic­i­nal mar­ket over time — there are even more ex­cit­ing prospects.

To­tal sales of recre­ational cannabis in the US and Canada are ex­pected to be a com­bined $172bn be­tween 2018 and 2025 — of which $136bn is ex­pected to be in the US alone. Not only that, the US is ac­tu­ally only the fourth-largest mar­ket by con­sump­tion, though the most ac­ces­si­ble at this stage due to le­gal­ity is­sues in Africa and Asia.

The le­gal­ity of recre­ational

Buy­ing shares in these com­pa­nies now will not be a de­ci­sion based on cur­rent fi­nan­cial per­for­mance, but rather on po­ten­tial fu­ture per­for­mance

cannabis is not yet on par with that of medic­i­nal cannabis, though as time is prov­ing, the pace at which it is be­ing le­galised around the world is in­creas­ing.

This is where it gets re­ally in­ter­est­ing. Peo­ple have been putting mar­i­juana into food and sweets for­ever. But now it is ac­tu­ally le­gal to man­u­fac­ture and sell these ed­i­bles.

This is cre­at­ing an en­tirely new mar­ket as many peo­ple re­frain from us­ing cannabis recre­ation­ally be­cause they do not want to smoke it. Con­sumers may be more likely to con­sume cannabis in the form of a gummy sweet, a brownie, a choco­late or in a cold brew cof­fee.

The point is that the re­moval of il­le­gal­ity is open­ing cannabis to a new mar­ket of peo­ple who never con­sid­ered it be­fore. Its ad­vo­cates say it can be likened to hav­ing a glass of wine or a beer when you get home from work.

Of course there are many reg­u­la­tions to com­ply with. Po­tency is one of them.

Once again, in the US at least, the is­sue of not be­ing able to cross state lines with cannabis makes it dif­fi­cult to have one cen­tral pro­duc­tion fa­cil­ity or farm. So any ex­pan­sion needs to be in the form of stand­alone busi­nesses grow­ing and pro­duc­ing ed­i­bles in each state.

This has not stopped non­listed Wana Brands from gen­er­at­ing $14.5m in rev­enue in 2017. Wana Brands is prob­a­bly the best success story in this par­tic­u­lar sub­sec­tor (cannabis ed­i­bles), though sadly is not a pub­lic com­pany.

Dixie Brands, on the other hand, is a pub­lic com­pany which spe­cialises in mak­ing ed­i­bles and dis­trib­utes more than 30 prod­ucts through 443 shops in five US states.

Dixie Brands has yet to make a profit, but so far the stock has traded well.

Buy­ing shares in these com­pa­nies now will not be a de­ci­sion based on cur­rent fi­nan­cial per­for­mance, but rather on po­ten­tial fu­ture per­for­mance. Dixie Brands is en­gaged in the de­vel­op­ment and man­u­fac­ture of cannabis-in­fused sweets, choco­lates and drinks.

Given the strict reg­u­la­tions around the po­tency of these prod­ucts, they can be used for ei­ther recre­ational or medic­i­nal pur­poses, mak­ing them rather ver­sa­tile.

A slightly smaller ver­sion is a com­pany called Plus Prod­ucts, which makes gummy sweets that are avail­able in Cal­i­for­nia.

Dixie Brands and Plus Prod­ucts are listed on the Toronto Stock Ex­change.

I think the ed­i­bles mar­ket might be over­looked at this stage and that there is a mas­sive op­por­tu­nity for early-bird in­vestors.

The big­ger pic­ture is that in­vestors have to re­alise that what is hap­pen­ing with cannabis now is fairly sim­i­lar to what tran­spired in the US in 1933 when Pro­hi­bi­tion ended and al­co­hol was once again made le­gal.

In the be­gin­ning hun­dreds of com­pa­nies sprouted and com­peted for mar­ket share, much like the more than 50 op­tions avail­able to in­vestors right now in the form of listed cannabis com­pa­nies. Over time, con­sol­i­da­tion took place in the in­dus­try and titans emerged.

There were many losers along the way. Some com­pa­nies were ac­quired by larger ones, others sim­ply went out of busi­ness.

To­day we have an ad­van­tage that was not avail­able to in­vestors in the 1930s — ex­change traded funds (ETFs).

A few ETFs track the cannabis in­dus­try in the US, and this is prob­a­bly the eas­i­est and best op­tion to get ex­po­sure to the world of weed.

One such ETF is the Hori­zons Mar­i­juana Life Sci­ences In­dex ETF (listed on the Toronto Stock Ex­change). This tracks the North Amer­i­can mar­i­juana in­dex, which con­sists of 46 cannabis stocks. In­vest­ing in this ETF re­moves the risk of mak­ing poor stock picks. It en­sures that if, 20 years down the line, there is sig­nif­i­cant con­sol­i­da­tion in the in­dus­try you will still be in­vested in the in­dus­try as a whole.

Pic­ture: 123RF — LUKERUK

Pic­ture: 123RF — ELENA SCH­WEITZER

Pic­ture: 123RF — ROX­ANA GON­ZA­LEZ LEYVA

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