January saw the North American cannabis market decline for a tenth consecutive month. However, there were some moments that could point towards a turning of sentiment.
January was a strange month for the industry, with modest gains being made during the middle of the month, before being completely eroded by the end of it. For once, it was the US that performed the poorest, with the American Cannabis Operator Index down 9.4% for the month, while the Canadian Licensed Producer Index only declined by 3.1% (both managed by New Cannabis Ventures). Overall, January 2020 marked the tenth consecutive month of declining stocks, indices, and…truth be told, sentiment.
The United States
Our thesis has been and continues to be, that we believe the US offers cannabis investors far greater upside than its northern neighbours. There are many reasons to be bullish on the US cannabis industry, which include further legislative developments (SAFE Banking Act and MORE Act), more US states legalising (Illinois pulled the trigger at the start of January and pot sales have been off the charts), and a dying down of the vaping crisis (which has been proven to be exclusively the domain of the illicit market).
Indeed, the headlines in January were extremely positive, including Cresco Lab's acquisition of Origin House finally closing, Curaleaf securing $300 million in senior secured debt, and progress in the State of New York, after comments by Governor Cuomo reiterated the commitment to legalise for recreational use later this year.
News out of the US also included:
- The BIG news was the stepping down (read forced down by Gotham Green) of MedMen CEO – Adam Bierman – effective 1 February 2020. He will be replaced by current COO and CTO Ryan Lissack, who will act in an interim capacity until the board of directors can identify a permanent replacement. We at the Green Fund have been calling for this for a long time now. Naive, greedy and simply not good enough to run a company of this size, Bierman had to go. Let's only hope it's not too late to right the ship.
- Cresco Labs announced the closing of its Origin House acquisition, opening up the massively lucrative Californian market through the States largest distributor. Cresco can also now move Origin's range of Inhouse brands through its national network of retail stores.
- KushCo Holdings reported Q1 2020 earnings, with revenue plunging 26% from the previous quarter. Heavily geared towards the vaping industry (supplying a very large chunk of all US vape cartridges and other supplies), the company was hard hit by the vaping crisis. Margins remain low and we are on the sidelines on KushCo for the moment.
Canada struggled in January, albeit after also getting the year off to a good start, with a very small rally occurring in the middle of the month. However, this did not stop the rot, as the Canadian Licensed Producer Index (as managed by New Cannabis Ventures) declined by 3.1%.
Good news out of Canada included the arrival of Legalisation 2.0 form factors (thank f***). Gummy bears, edibles, extracts and vape cartridges hit the shelves at the turn of the year, with the soft chews selling out in 30 minutes on the (online) Ontario Cannabis Store.
In addition, more brick and mortar retail stores have been opening, leading recreational market numbers to slowly begin climbing. During the month, Health Canada also released the Canadian retail cannabis sales for November 2019. Sales impressively rose 5% to C$136 million in November 2019, driven by a large increase in British Columbia sales (at almost 50%).
News out of Canada also included:
- Aurora – the world's second-largest cannabis company by market cap – saw its share price tank after analysts at Piper Sandler and BOA both downgraded the stock. Their concern – the same as ours – very high leverage levels (read simply too much debt) and a goodwill-heavy balance sheet. This concern was further validated when the company announced this month that it would be selling the Exeter cultivation facility for CAD$17 million. It bought the facility for $28 million as part of its acquisition of MedReleaf in 2018.
- Supreme stock got hammered after the CEO left the company with immediate effect and a board member had to step in as interim CEO. As we always say, a C-Level executive departing with immediate effect is not a good sign. We are on the sidelines on Supreme.
- Beleaguered licensed producer HEXO announced yet another capital raise. This time 12 million shares would be sold with 6 million associated warrants. This is the third capital raise in as many months, and the future looks very dire for HEXO, especially with MediPharm Labs suing the company for payment of a contract it made with Newstrike Brands (which HEXO bought last year).
- And finally, in contrast, Organigram drove a mini-sector rally on the back of phenomenal quarterly financial results. With revenue and gross margins increasing, the stock moved over 60% in January. Although to be fair, by the end of the month, a significant portion of those gains had been returned.
What to expect moving forward
In our opinion, it doesn't matter whether companies operate in Canada or the US, as either way, they are going to have to survive the current capital crunch. The financing market is a very difficult one for cannabis companies right now, with equity capital associated with deep discounts to the current share price, and debt accompanied by very aggressive interest rates and timeframes.
We think that a stock's balance sheet has become the standard on which to start separating the good from the bad. Companies with cash in the bank and low operating costs (heavens forbid even a profit) will have far better opportunities open to them in 2020. From acquiring market share as competitors suffocate from a lack of cash, to the acquisition opportunities as cash-strapped companies look to survive.
The two standouts are Canopy Growth and Cronos. The former can thank Constellation Brands for their $5 billion ticket price for 45% of the company, and the latter Big Tobacco as Altria paid $2.6 billion for 45%. Both should have no issue surviving the current market conditions. The key for both will be execution.
In Canada, we believe Aurora and HEXO will face serious difficulties in 2020, while in the US, our concerns lie with MedMen and Acreage. We think Aphria and Green Thumb Industries do represent an opportunity for investors looking for gains in Canada and the US respectively.
This could be one of the best investing opportunities of 2020
Legislative changes are blowing through the US, and with it, an ever-increasing number of states legalising cannabis for recreational use.
With the success seen in Illinois, which legalised for adult-use on January 1 and saw products moving off the shelf at an unprecedented rate, this company is primed to take advantage of the booming US recreational market.
They have secured partnerships with the biggest cannabis companies in the US, and their portfolio is second to none.
And with the sector-wide pullback of 2019, this company is now at a bargain-basement price.
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