Cannabis investments could blow your mind
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