The Market Mindset Insights: Analyzing the Cannabis Market
At The Market Mindset, we’re constantly on the look out for new sectors and companies that will allow us to expand our horizons. Now, I know what you’re thinking: “hasn’t the big cannabis run already happened?” Well sure, one cannabis run has already happened, but as we’ve learned from the commodities sector, these things can be very cyclical, and another growth cycle for the cannabis industry may be on the horizon.
According to a recent market insights report from Brightfield Group, Canada’s cannabis market is expected to double over the next five years as more retail stores pop up online and regulations loosen.
Market insights predict the cannabis market will grow at a rate of roughly 10% per year over the next five years. According to Brightfield, increased sales of vape products and edibles are expected to drive the market to $8.8B. The cannabis market could be on target to follow a pattern previously laid out by states across the U.S. like Colorado that were early to jump on legalization, and enjoyed incredible early growth which was followed by a plateau for a couple of years.
The sector emerged in 2021 with high hopes for growth and expectations of federal legalization in the U.S. However, these hopes ended up falling short, meaning that the sector came into 2022 cheaper than the previous year. However, earnings and profitability continue to make sense to investors, and opportunities to expand into new markets across various U.S. states, Germany, and Israel, provide a positive outlook for growth and a potential resurgence in 2022.
Global cannabis sales in 2022 will likely reach nearly $31 billion, an increase of around 41% since 2020. The U.S. accounts for $24 billion of this forecast, and Canada accounts for $4 billion, with the international market accounting for the rest. Cannabis is consumed by more than 200 million people worldwide and medical marijuana is now legalized in 47 of 196 countries. Two of these countries include the U.S. and Canada, and 19 of the 37 legalized states also allow recreational use. Over 270 million Americans reside in states that permit the use of medical marijuana, and nearly 100 million reside in states that have also legalized recreational use.
One of the key focuses for 2022 will be the expansion of individual brands. When you look at industry examples like alcohol or tobacco, you can see the distinct advantages gained by companies with strong brands that employ intelligent and creative marketing tactics to differentiate themselves from the pack.
The Big Hitters
Let’s take a look at some of the Canadian leaders in this sector and evaluate where they stand.
In identifying the industry’s big guns, Canopy Growth immediately comes to mind. With a market cap of $2.8B and a share price of $7.10, they’re clearly the benchmark in the industry from a Canadian perspective. Unlike many competing producers, Canopy has seen their revenues continuously grow, although it’s worth noting that revenue increases have slowed from an average of 142%/per year in 2017-2019, to 56%/per year in 2020/2021. Tilray Brands is another company at the forefront of this space. With impressive revenue increases of 287% in 2020 and 208% in 2021, it sits comfortably as the second largest producer in Canada.
You can’t talk about the cannabis sector without mentioning Aurora Cannabis. One of the great success stories of the late 2017-2018 surge, Aurora entered 2017 with a share price of $22, and ended 2018 at $77.5 (climbing as high as $118, I might add). Since then, however, revenues have plateaued through 2019 and 2020, and declined by almost 9% in 2021. With a share price of $4.58 and a nearly billion-dollar market cap, Aurora could be a sleeping giant given its eight licensed production facilities and operations in 25 countries. The company recently announced that it bolstered its premium product portfolio by acquiring Thrive Cannabis for $38M. According to Aurora, this acquisition will provide an immediate boost to EBITDA.
Sundial Growers and HEXO Corp. are two other companies on the radar. With lower share prices, retail investors looking to get into this space have been attracted to companies like these due to their solid revenue numbers. The problem, however, is that both companies operated at a loss and under negative profit margins this past year.
Companies like HEXO and Sundial have diluted shareholder wealth at a rapid pace. These companies are constantly raising equity capital to support cash burn. Would one of these companies look at acquiring a smaller producer in the Canadian market to boost revenues and gain access to new markets, the same way Aurora did? This could very well be a viable option moving forward.
Looking at Germany
There’s a lot of optimism surrounding the legalization of recreational cannabis in Germany. Many companies will look to expand their offering of both CBD and THC options, while potentially increasing the manufacturing and distribution of cannabis products and accessories.
Recent studies suggest that 49% of German citizens are in favour of full legalization, a 19% increase from 2014 when that number was roughly 19%.
Not only will individual businesses benefit from legalization, the German economy is predicted to grow, the crime rate is projected to decrease, and an estimated 27,000 new jobs will be created. The German government has projected it will earn $5B Euros annually in additional tax revenue from legalization.
Companies have been starting to lay the groundwork for another potential cannabis run, and are scrambling to make sure they are ready to supply a recreational market.
Seeing as Germany is Europe’s top economy, the process will be watched closely by other EU Nations looking to potentially decriminalize or legalize in their own countries. Cannabis has already been legalized in some smaller EU nations, but a country with Germany’s size and economic power will significantly impact the future of cannabis.
What Lessons Can We Learn From The Previous Run?
It seems natural for Germany to follow Canada’s footsteps when it comes to legalization, but what lessons can the German government, cannabis producers, and investors, learn from this process?
When cannabis was legalized in Canada, there was massive demand, and this became the first hurdle to clear. There was a lack of government approved producers resulting in a shortage of supply necessary to meet the overwhelming demand in the Canadian market. It’s critical for any new jurisdictions entering this market to understand the impact of high demand, especially in the early stages.
There’s no disputing the fact that the public is focused on the dramatic development of U.S. federal legalization. You can see clearly in the chart above that as the promises of the Biden Administration regarding legalization have waned, stock prices have responded on a steep downward trajectory.
These investors may not realize that in a restrictive regulatory environment with tight access to cash, larger cannabis companies can grow faster due to a lack of competition and lower rates for growth funding. For example, SubStack highlighted that Green Thumb is borrowing at a rate of 7% while smaller cannabis companies are stuck with rates of 15% or higher. At the same time, these pubcos have the luxury of establishing barriers-to-entry for Big Pharma, Big Tobacco, Big Alcohol, and Big CPGs, who must all wait on the sidelines for the advent of federal legalization.
Importance of the Banking Act
Last month, the U.S. House of Representatives passed a bill that would enable banks to serve cannabis businesses without fear of reprisal. Although it remains unclear if the measure will pass, it could be a huge win for cannabis retailers.
At the federal level, cannabis is still illegal in the U.S. This has negatively impacted licensed producers by limiting their ability to raise capital debt. Marijuana producers are unable to establish bank accounts, meaning they can only deal in cash. The SAFE Banking Act will likely open new funding avenues for these businesses and allow them to establish long-term relationships with banking institutions.
The legal U.S. market is expected to grow $31B in 2022, and sales are expected to grow by another 28% in the same year. The SAFE Banking Act would allow cannabis companies to work with banks at a federal level, regardless of the state restrictions in place. We have seen the success of this type of relationship demonstrated during the Canadian legalization process.
Speaking of Canadian legalization… Canadian cannabis producers could see the SAFE Banking Act as an opportunity to expand their networks south of the border. If this bill becomes a law, look for Canadian producers who take advantage of their industry experience to tap into the MASSIVE American market.