Watch for these upcoming cannabis catalysts
Some investors have suggested that cannabis stocks have lost their appeal. Others believe that cannabis stocks are so overvalued that the only way from here is down.
Although this past quarter has been a very tough one for the sector, we do not believe that this will continue. Indeed, we feel that we are very close to the bottom.
Share prices have pulled right back. Revenues have been increasing and some of the valuations have really come back down to earth. We believe that we are still well within a bull market and that cannabis stocks could potentially fair very well in the latter half of the year and into the first quarter of 2020.
We also recently discussed how the cannabis industry has been consistently seasonal over the past couple of years. As per the seasonal trend, we are expecting cannabis stocks to perform far better in the second half of the year. Additionally, we believe there are significant catalysts coming in the latter half of the year that should also fuel the bull market.
It is often said that investors "buy the rumour and sell the news" and this is never truer than in the cannabis industry. So without further ado, here are some of the near term catalysts that we think will really drive certain cannabis stocks prices, and with them, cannabis markets in general.
First to Canada
Additional Ontario and Alberta stores with increasing revenue
We have long spoken about just how bad the legalisation of recreational cannabis in Canada has been. First off, legalisation was for flower and low-potency oils only, and no-one wants low-potency oils. The biggest demand is for the high-potency vape oils. It is estimated that the black market for vape pens in Canada is over $1 billion per year. $1 billion!
Then there was the lack of brick and mortar retail stores. On Day One (18th October 2018) there were very few stores open for business, with Ontario (the largest Province by population) having no stores at all. Instead, they launched with online sales only, through the Ontario Cannabis Store. It was an absolute disaster to say the least.
As of April this year, Ontario has allowed private brick and mortar retail stores. Though this wasn't much of a change, as there are currently only 25 operational stores, which is pathetic. To put this in perspective, it is estimated that Ontario could support around 1,000 stores.
In November, a moratorium was placed on the issuing of any additional retail licenses in Alberta, given the dramatic shortages in supply. The shortage was so bad that some of the stores could only remain open from Wednesday to Saturday. They simply didn't have enough stock to stay open for the entire week.
However, this is slowly changing. Not only has supply started to increase, as the largest LP's ramp up their production capacity, but Alberta has now allowed additional licenses to be issued, and Ontario is looking to open 50 new cannabis stores. More stores mean more sales, and more sales mean better numbers being reported in the quarterly earnings.
We expect the number of stores to rapidly increase as supply ramps up, and as new products and form factors are introduced to the market.
Speaking of new products…
Canada Legalisation 2.0
Canadians have been patiently waiting for October 2019 (exactly 12 months after Legalisation 1.0 of flower and low-potency oils) for the next wave of legalisation to occur.
This wave, nicknamed Legalisation 2.0, will see cannabis edibles and extracts made legal for sale. This includes form factors such as vape pens and cartridges, extracts (wax, shatter and oils, etc) as well as chocolates, beverages, and other edibles.
In mature markets like Colorado, Washington, and even California, edibles and extracts now make up nearly 60% of the market, and this is driven by people's reluctance to smoke cannabis. There is still (and always will be) a market for flower, but new age cannabis enthusiasts (of all ages) are demanding other form factors.
We believe this event will significantly propel the value of the legal market, whilst simultaneously eroding the black market, which is currently thriving thanks to the lack of legally available product types. With legalisation set to occur in October, expect products to begin hitting the shelves in December. We're expecting big revenue numbers from the Canadian retailers and associated investor enthusiasm for these results. A big catalyst is coming…
Making America Great Again
SAFE Act and Banking services
Banking has long been an issue for cannabis companies operating in the US. As it stands, cannabis is federally illegal in the US and is listed as a Schedule 1 drug (being highly addictive and harmful and having no medicinal benefits) alongside heroin and cocaine. Given its Schedule 1 status, this means that any company that deals with cannabis is deemed to be dealing with a Schedule 1 drug, and hence under Tax Rule 280E, cannot write off any business expenses against company profits.
This puts the cannabis companies at a massive financial disadvantage compared to other US companies, given the extremely high levels of tax they have to pay as a result of Rule 280E.
In addition, Federal Banks won't deal with cannabis companies, given the federal illegality of the drug. This makes general banking even more difficult for cannabis companies, as they struggle to get basic financial products (loans, debt facilities, etc) and also cannot take credit card payments, as all of the major card companies refuse to have anything to do with it.
The SAFE Act is a bipartisan bill working its way through Congress that would address the aforementioned issues. It is actually to the benefit of the regulated banking sector, as its introduction would move cannabis businesses out of the financial grey area and into the regulated black and white. Given cannabis companies have to deal in so much cash, it inevitably leads to difficulty in revenue tracking and associated taxation leakages.
Make no mistake, if this bill should pass, it would have a significant impact on the industry, and we would expect the market to react very favourably, as it's another step in making the industry less risky for investors. This, in turn, could drive capital into the market, further fuelling price rises.
The Mega-Deals being passed
In the latter stages of 2018 and the first half of 2019, there was a flurry of US mega-deals that sent the markets into a frenzy. MedMen's purchase of PharmaCann for $680 million, followed by Harvest Health's purchase of Verano for $850 million kicked off the consolidation spree, which was followed by Cresco Lab's purchase of Origin House for $1.1 billion and CuraLeaf's acquisition of Cura Partners for the same amount.
Shares in the acquirers skyrocketed and the market got very frothy for a while. However, investor enthusiasm has since dwindled, given the lengthy delay in the deals actually closing. The primary reason for the delay has been the Department of Justice's Antitrust Division carefully considering the deals. Although there is always the chance that they block the sales, we think this is highly unlikely given that all of the deals have been delayed and no individual acquisition have has been singled out.
When these deals eventually do pass, we expect the market to gain back the initial enthusiasm as these MSO's start reporting massive consolidated revenues. Look for this towards the back end of the year.
More States are jumping on the bandwagon
Right now, 33 US states have legalised cannabis for medicinal use and 11 for recreational use. The latest Gallup poll suggests that over 67% of the US population wants cannabis legalised at the federal level. To put this in perspective, only 62% of Americans are in favour of gay marriage.
Canaccord Genuity is also optimistic about the level that marijuana retail sales in the US could climb to. In a recent report, they suggested that retail sales could reach $22 billion by 2022. This estimate is based on the fact that America will see over $12 billion in retail revenue in 2019, and from there, sales could grow by 20% each year.
This growth is being driven by the ever-increasing number of states that are legalising cannabis for either medicinal or recreational use, or in the case of the latest state, Illinois – both.
"With a population of almost 13 million, we believe the Illinois market could quickly become one of the largest in the country."
– Canaccord Genuity
Illinois becomes the 11th US State to legalise for recreational use. We expect that more states will follow suit later in the year and into early 2020. The East Coast, in particular, should see movement in New Jersey and New York (which could be one of the largest markets in the US). These state-driven catalysts make for great prime time news, which in turn drives retail investment enthusiasm. Expect share price movement from the MSO's best placed to take advantage of new states (like Green Thumb and MedMen in Illinois).
We continue to believe that we are in the middle of a bull market. As you can see from the chart below, the cannabis industry has been steadily increasing for the past couple of years and we expect this trend to continue for the coming 5 to 10 years.
There are many estimates being thrown around about the potential size of the US cannabis market in the coming years. From Canaccord's $22 billion by 2022 to Cowen and Co's $75 billion by 2030, the numbers are vast and disparate. However, most analysts agree on one thing – that the industry will continue to grow at 20-30%, year on year, for at least the next decade.
We believe that the coming months will be much better for investors as the seasonal buying frenzy (hopefully) kicks in. Add to that the sparks from potentially game-changing legislative changes, a mega-deal or two gaining approval, and Canada's edibles and extracts market kicking off, and we could have a roaring fire driving the industry onwards and upwards into 2020.
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