2019 - Another Year of Cannabis

First quarter earnings for cannabis companies could literally light a fire under the companies that have the highest prospects for growth in their industry. It may also enlighten investors to the cannabis companies that are more speculative about their future growth potential. Earnings won’t be the only factors investors need to be aware of however earnings will ultimately drive share prices, up and down.

Any new and burgeoning asset class will go through a period of extreme volatility. If you’ve put a dime into this space, and depending when and where you invested that dime, you could be sitting on a very healthy return, or feeling snuffed out like an old cigarette butt.

To quote the “Great One”, you have to be where the puck is going to be. 

Cannabis has a very long history, here is a brief primer:

  • Cannabis was first documented in China in 4000 BC for both medicine and textile f Europe and the United States, textiles, pharmaceuticals, oil, and paper were popular items produced from cannabis until the 19th century.

  • A prohibitionist trend began in the 20th century raising concern on social and some economic factors.

  • Canada banned cannabis in 1923, many other countries from about 1890 into the 1930’s also banned cannabis. In 1937, it was banned federally in the United States.

  • In Canada, the Le Dain Commission Inquiry in 1969 recommended the decriminalization of cannabis possession. The government never acted on the report.

  • In 1996 California legalized cannabis for medical purposes, in Canada it took until 2001.

  • Legalization of cannabis was one of the electoral promises made by the federal Liberal Party in 2015.

  • In Canada, Bill C-45 (the Cannabis Act) was introduced in April of 2017 laying out the guidelines for production, distribution and sales of non-medical cannabis.

  • The Government expected recreational sales by July 2018 creating a scramble by provinces. Legalization across Canada happened October 17, 2018.

Estimated Canadian recreational sales?

  • If we look to a state like Colorado where cannabis was legalized for recreational use in 2012, sales exceeded $750 million in the first quarter of 2017, up over 25% from the first quarter of 2016.

  • Canada has seven times the population of Colorado. Deloitte estimates the retail cannabis market could be worth between $4.9 and $8.7 billion dollars annually.

  • Add in all of the related industries like security, transportation, testing labs and cultivation and the figure soars to over $22 billion, with an estimated $675 million in combined federal and provincial sales taxes in the first year.

Estimated Canadian medical sales?

  • There is strong potential for cannabis to be a substitute to opioid-based painkillers. Canada has over 6 million consumers of these products.

  • About 7% of physicians, or just over 9% of physicians in Canada currently prescribe medical cannabis to patients.

  • According to Health Canada, sales of cannabis oils for medical purposes grew by more than 871% between April 2016 and March 2017.

  • Projections show that medical cannabis users could grow to 450,000 by 2024, or to a $1.2 billion market cap.

  • Canadian cannabis producers are well positioned to supply the global market. Only Canada and the Netherlands are exporters of the 29 countries in the world where cannabis is legal for medicinal purposes.

  • In the US, medical cannabis sales are projected to grow from $4.7 billion in 2016 to $13.3 billion in 2020. Recreational sales are expected to rise from $2.6 billion in 2016 to $11.2 billion by 2020.

  • The illegal cannabis industry is expected to shrink to 87% in 2016 and to 67% in 2021.

  • 250,000 new jobs are expected to be generated between 2017 and 2020.

  • Further legitimization of cannabis can be seen by eight Canadian academic institutions obtaining licenses from Health Canada to cultivate cannabis for scientific purposes.

  • August 24th, 2018, Conservative party leader Scheer clarifies he won’t re-criminalize cannabis.

There is no doubt that the cannabis industry is still in its infancy, but it should grow aggressively, assuming legitimacy of the above points.  A key factor that could change the ramp up of cannabis sales would be the removal of cannabis as a schedule one drug in the US. It is expected to happen in the next 18 to 24 months, if it happens sooner, watch out.  Other counties are in the process of legalizing also. Canada, as an exporter, could be a significant benefactor.

Many US cannabis companies are located in Canada because of the existing cannabis laws in the US; legalizing cannabis federally in the US could be material for the industry in Canada. This is an important consideration in determining what companies to own given the size of the market in the US relative to Canada.

Downside concerns: supply demand issues, crop failures, lack of licensing, failure to execute on business plans.  There are lots of potholes to lookout for as an investor.  Even with the big names like Canopy, Tilray, Aurora, Aphria and Cronos, their prices have been halved from their peaks. Reality has set in with investors that these companies now have to deliver over the coming quarters.

2019 should be another crazy ride within the cannabis sector. Using a fund manager could be the safer bet.  There are a number of funds Canadian investors can access: Ninepoint Alternative Health Fund, StoneCastle Cannabis Growth Fund and Purpose Marijuana Opportunity to name a few. Until the cannabis sector matures, I’d be careful about buying an ETF that wasn’t actively managed. The fundamentals are what is going to ultimately win the day, and having someone keep a close eye on them will be very important.