Is Coronavirus Another Black Swan Event for the Cannabis Industry?

The prognosis is in…and unfortunately for investors, it's not good.

As the world continues to struggle with the COVID-19 pandemic—which has been called greatest health crisis in a century—markets across the globe have begun to spin out in response to investor panic.

Even the biggest pot stocks have proven susceptible to coronavirus fallout and market capitalizations have been shrinking at a breakneck pace.

Worse still, this is the second major downturn to hit the cannabis industry in recent months, after the arrival of the disastrous "vape crisis" in late September 2019.

Private cannabis companies who have raised capital recently and have cash on their balance sheets should be in good position to weather the storm. On the other hand, private cannabis companies who are in the process of fundraising or had plans to do so in 2020 will likely struggle to raise capital. Key Investment Partners Co-Founder, Pete Karabas

This kicked off an ongoing capital crunch which left many cannabis companies in a desperate struggle to secure funding—and keep the lights on—after a recent analysis found that many pot stocks have as little as six months of runway left.

The Global Cannabis Index has also continued to decline—after already being down more than quarter by February—and by March 2020 it had lost almost 50% of its value.

This trend can also be seen in the lukewarm response to the $90.4 million registered offering announced by Tilray (NASDAQ:TLRY) earlier this month, which prompted a 32% decline in the company's share price.

Although things seemed fine on the surface, investors were clearly rattled by the details of Tilray's offering, as the warrants' pricing revealed an 82% decline in share value since September 2019.

As a result, Tilray's valuation has now shrunk to just $317 million—after shaving off more than 80% of its net worth in the last month—which is a staggering fall from the $7.5 billion valuation achieved by the company only a year ago.

The world has been in a panic ever since the new Chinese coronavirus disease—which is now officially known as COVID-19—began stoking fears of a global pandemic in early 2020.

And things are even worse if we turn our attention to Harvest Health and Recreation (CNSX: HARV), after its $100 million non-brokered private placement was offered at 60% of the price the shares were trading at the start of September.

The underwhelming results of Harvest Health and Recreation's capital raise would prove to be a disastrous misstep, and only a few weeks later the company announced that its planned $850 million acquisition of Verano Holdings was officially called off.

This was a particularly stinging blow for the company, as the acquisition's initial announcement had generated considerable excitement thanks to its $850 million valuation.

"The acquisition is the next step in Harvest becoming the largest cannabis company in the world," Harvest CEO Steve White said at the time.

 "Our commitment to bringing these two great companies together has never been in doubt despite any delays."

However, many considered the scuttling to be an inevitable decision given the titanic shift in market conditions that has taken place since the start of 2020.

"This deal was struck in a much different time, when the market rewarded empire building over positive cash flow," Marijuana Business Daily equity analyst Mike Regan said.

"Today, companies need to focus on generating positive cash flow to survive and prove out a viable business model to investors."

Are ASX Pot Stocks on the Rebound?

However, if we turn our attention down under it's a slightly different story. Although the Australian cannabis industry has hardly been immune to the global downturn which has been hammering stock prices, there have been some positive signs from the market.  

The principal consultant for FreshLeaf Analytics, Rhys Cohen, explained that medicinal cannabis companies may even see their prescription levels rise, as people are suffering from greater stress while remaining confined to their homes.

I want our shareholders to know that we're watching the coronavirus situation very carefully, and its impact, if any, on our ability to trade, to make sure that we're implementing different management policies to ensure that our working capital is protected and that we're in as good a shape, if not better, when the fog lifts, when we come to the other end of this. We are very fiscally responsible and not afraid to make significant moves to make sure that the balance sheet health remains intact. Althea Group CEO, Josh Fegan

Cannabis growers may also see a significant boost to their market share—if they can manage to wait out the cash crunch—as the surviving cultivators will be well-positioned to cannibalise the customers of those that cannot handle the current capital-light environment. 

"The current situation with COVID-19 is highly stressful for many people and doctor referrals for these subgroups is on the rise," Cohen said.

"Some international supply chains are also facing delays as borders shut and freight routes are re-adjusted, but this is not a major issue yet."

"For those cultivators and manufacturers already operational, production volumes are mostly expected to continue as normal. Some are even expanding production to take advantage of any upcoming competitor exits."

Although this may not seem particularly encouraging, some ASX-listed pot stocks have actually managed to buck the downward trend by making small share price gains over the last month.

This can be clearly seen with the Althea Group (ASX:AGH), which saw its share price climb 17% higher to 0.24—after weeks of declining in value—following the release of an operations update detailing significant progress across the Canadian, Australian and UK markets.

Investors reacted positively to the news that Althea was on track to achieve its highest ever revenue in March, thanks to strong patient uptake and a significant increase in revenue from recurring prescriptions.

The company has also ramped up production to meet increasing demand from the UK market—along with completing construction on its Peak Processing Facility in Canada—which is expected to generate considerable additional revenue once the manufacture of cannabis edibles officially commences.

The CEO of Althea Group, Josh Fegan, explained that the company intends to deliver on its responsibilities to both shareholders and patients—regardless of the current market conditions—and with no debt, $1.8 million in inventory, and $15 million cash on hand, they are certainly well equipped to do so.  

"Althea is extremely healthy with $15.5 million dollars in the bank, and solid cash flow now amongst all the businesses. We're nearing breaking even in profitability for the Australian business in isolation, which is a real positive. The supply chain is unaffected by Coronavirus. That's the most important point," Fegan said.

"Right now, you've got some mixed messages by the government about what you can leave your house for, and social distancing, and this and that. You also have clinicians and clinics that are hyper-sensitive to potential coronavirus patients and making sure that they're screened and directed to the right places.

"Once we get some clarity from the Government, people will know which framework we're looking at, and we will all be on the same page from there."

Auscann Group Holdings (ASX:AC8) is another pot stock that has recently begun to rally—despite shedding almost 50% of its value in recent months—following the announcement that its hard-shell cannabinoid capsules range has now become commercially available.

The company will begin distributing the capsule range to pharmacies and healthcare providers immediately, while also kicking off its first independent clinical trial to assess the medication's medicinal benefits.  

The news was welcomed by Auscann shareholders, causing the share price to climb by 19% to 0.20 a share, although the company has admitted that its timeline may need to be adjusted due to unforeseen complications from the COVID-19 pandemic.

"We are extremely pleased to have reached this milestone and that our capsules are now available for prescription," Auscann CEO Ido Kanyon said.   

"The capsules have been tested in a lab setting and demonstrated to be reliable, stable and deliver a consistent controlled dose of the formulations. We are now excited to commence the clinical evaluation of the capsules to demonstrate the product's benefits for patients."

"These results will build the clinical evidence supporting the unique benefits of AusCann's capsules, whilst enhancing the medical acceptance of cannabinoid-based medicines for patients in Australia."

Consumers Catch Panic-Buying Fever

Although the COVID-19 outbreak has put considerable downward pressure on almost every segment of the economy, one area of the cannabis industry that's thriving is the retail sector.

Dispensary customers across North America have been ramping up the frequency and volume of their cannabis purchases over the last month, as panic-buying sets in and consumers begin stockpiling supplies for the coronavirus lockdown period.

As investors face uncertainty associated with the spread of COVID-19, they are less likely to invest in early stage cannabis companies. This will enable investors with dedicated pools of cannabis capital to drive more favourable terms and valuations since their capital is in higher demand. Key Investment Partners Co-Founder, Pete Karabas

In fact, over the past week legal cannabis purchases throughout the US increased by an average of 30%— which was confirmed by sales data taken from Washington, California, Colorado, Oregon, Alaska and Nevada—according to a recently published report from BDS Analytics.

However, some states even managed to outperform this number, such as in Florida, where medicinal marijuana sales in by almost 40%, accounting for approximately 2,274 pounds of raw cannabis biomass sold.

Adult use cannabis sales in California spiked by 56% during this period, while the sale of edibles enjoyed an impressive 107% increase.

Reports from the Ontario Cannabis Store show that the hoarder mentality is also alive and well in the Great White North, as Canadian consumers managed to make almost 3,000 purchase orders in a single day, representing an 80% increase when compared to an "average Sunday". 

If this seems surprising, it's important to remember that cannabis retail—like cigarettes and alcohol—is expected to remain largely insulated from the COVID-19 pandemic, as "vice industries" typically remain shielded from market downturns.

"Compared to other asset classes we expect the cannabis industry to be relatively recession resilient (especially considering the pent-up demand in the black market, which is estimated at nearly 10x the legal market)," Key Investment Partners co-founder Pete Karabas said.

"Since the COVID-19 outbreak we have seen an uptick in cannabis sales, particularly delivery sales, as people use cannabis to cope with mounting anxiety around the pandemic and create a stockpile of products out of fear that dispensaries will run out."

"While cannabis has never been legal during a US recession, we can look at alcohol as an example to understand how vice industries perform in recessionary environments – research has shown that although consumers tend to spend less in total dollars on alcohol and other vices during a recession, the quantity tends to increase as people buy more of less-expensive products."

Global Supply Chain set for "Corona Hangover"

Unfortunately, a lack of capital flows isn't the only problem that the cannabis industry is currently facing, as the global supply chain may also be about to take a big hit.

The reason for this is that many cannabis companies rely heavily on hardware that is produced in China, due to its cheap labour costs and capacity to mass manufacture commercial products.

It could be a very difficult year for hardware companies trying to maintain a steady supply of inventory. Cloudious9 CEO, Richard Huang

As a result, cannabis cultivators can expect to face higher costs for lighting systems and heating, ventilation, and air conditioning (HVAC) technology once the "Corona Hangover" sets in. And the situation is even more dire when it comes to ancillary pot stocks such as KushCo Holdings (OTC:KSHB), which sources its entire supply of vaporizers from China.

This could eventually lead to a product shortage later this year—which would spell disaster for KushCo—as the company currently derives the majority of its revenue from vaporizer sales.

Exacerbating the issue further is the timing of the Shenzhen shutdown, which came shortly before the Chinese New Year celebrations began on 25 January. By this point most cannabis companies had already entered shutdown and the majority did not resume work again until February 17.

This might not seem like long, but the three-week gap in production may provoke a chain reaction which leads to the "perfect storm for supply-chain derailment".

"I am aware of major delays for R&D projects due to the lack of workers returning from Chinese New Year due to the back-to-back nature [with the] coronavirus," Offstage Holdings CEO and co-founder Danny Davis said.  

"While work has resumed in major areas like Shenzhen, the backlog due to the virus is causing extended timelines and lower factory output efficiency due to continued labour shortages."

Another important factor to consider is the potential disruption that could take place in the global hemp and hemp-derived CBD markets.

China is still the largest hemp growing nation in the world—despite the fact that all marijuana products are illegal within its borders—and is currently responsible for a fifth of global hemp production.

As a result, any reduction in output will likely exert a negative effect on the availability of hemp worldwide, although at this point the extent of the damage is still unclear. 

Batten Down the Hatches

On the other hand, there are some potential positive outcomes that could emerge from the global COVID-19 pandemic, such as the increased likelihood of cannabis legalization during the direct aftermath.

Some experts believe that an indirect consequence of the coronavirus outbreak—aside from the attendant economic slowdown—will be a greater receptiveness to the introduction of legal adult-use cannabis from both federal state governments.

Although many lawmakers are still hesitant about pulling the trigger on recreational legalization, their priorities may shift in a post-coronavirus economy, as government budgets shrink in response to greatly decreased tax revenue.

Legislators who were previously "on the fence" when it comes to cannabis may even end up pushing for its introduction as a way of shoring up unemployment numbers—since the cannabis industry is still the number one job creator in the US—while also providing a sorely needed boost to the economy.

However, until market conditions improve, cannabis companies will be forced to hunker down and wait out a rocky couple of quarters.

And unfortunately, pot stocks with a high cash burn and a weak balance sheet may soon find themselves dead in the water, making them into an easy acquisition target for their competitors.

Once the COVID-19 infection rate begins to decline—and investment capital become less scarce—the market will likely begin to rally. But until then, the industry will have to rely on a survival-of-slickest mentality where cash is king, despite the fact that global cannabis sales remain high.

As a result, panic-driven investors can be forgiven for fleeing the market in droves, even though this approach typically tends to backfire. Historically, the greatest gains have always been made following a market downturn, and investors with the capital to initiate or grow a position—while taking advantage of rock-bottom prices—will be able to reap tremendous rewards over the long term.

Depending on your perspective, the coronavirus-induced economic downturn could either be an asset destroyer or a once-in-a-lifetime investment opportunity. The only question you need to consider is: are you looking at a black swan or a green one?

This pot stock could reach new heights in 2020 due to Coronavirus

The COVID-19 pandemic is showing no signs of slowing down, and as global markets enter meltdown many cannabis companies are feeling the effects of capital crunch.

While the market crash will continue for some time, it represents a golden opportunity for investors who are capable of riding out the volatility until share prices rally.

Luckily, one pot stock has developed antimicrobial drug that can already treat two superbugs while limiting their ability to develop antibiotic resistance.

Investors can also start picking up shares at rock bottom prices, as global investor sentiment continues to dampen thanks to COVID-19.

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Hugo Gray
Hugo Gray

Hugo Gray is a Melbourne-based journalist with a body of work that covers a diverse range of topics, including immigration law, sex technology, and now the rapidly expanding cannabis industry.

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