Cannabis Market Update: Q2 2022 in Review

Cannabis market update: US stocks still have brighter future than Canadians

According to a financial advisor with a keen sense of cannabis market progress, Canadian and US cannabis operators are both struggling financially, but the reasons they're having problems are very different.

Charles Taerk, president and CEO of Faircourt Asset Management, told INN he is encouraged by the growth expectations for the total addressable market in the US and its impact on the players in that segment.

Even though most US operators are suffering from share price losses, Taerk said this downturn is not associated with fundamentals — he sees proper execution from leading firms and “pretty strong” cash flow.

“If you look at the state-by-state market, there are more states that are going to generate a billion dollars in revenue in 2022,” Taerk said.

The financial executive said the market will see more states transitioning from strictly medical to recreational programs. “The ground game in US cannabis is very strong,” he said.

On the other side of the border, several financial experts, including Taerk, have long called out the problems with the Canadian market and its operators. “We are overweight in the US cannabis names and extremely underweight in the Canadian names,” the financial expert said.

Rami El-Cheikh, strategy partner at EY-Parthenon and the firm's cannabis lead, told INN he is concerned to see Canadian leaders' domestic market share slipping despite their splashy spending.

“Market share of the biggest players in the space (continues) to decline, despite all the acquisitions, despite the large portfolio of brands that they have,” El-Cheikh said. “That's a bit alarming.”

As for this most recent financial period, Taerk pointed to some of the major issues ailing Canadian firms: poor execution from companies, a lack of cash flow, an inability to brand and an oversaturation of dispensaries.

“Increasingly what you're seeing from the Canadians is they're less focused on the Canadian market and more focused on building in Europe or looking at (getting) into the US,” said Taerk. “And those are both years away.”

One bright spot Taerk pointed to among the Canadians is smaller publicly traded and private companies that are pursuing efficient business models and stealing market share from the leading producers with unique products.

“It's not all bad in Canada,” said Taerk. “But in terms of moving the needle for the most investable companies, the largest most liquid names, we don't see significant changes on the horizon.”

Cannabis market update: Waiting game for US reform leads to frustration

Cannabis business in the US continues to find itself in a gridlock. While new states are opening up or adjusting their size with increased product availability and interest, the federal framework is severely lagging behind.

The federal government's inability to get any kind of meaningful cannabis reform across the finish line has resulted in ongoing feelings of frustration about when any changes may be arriving. While once happy to wait patiently, business operators are now exasperated and irritated at the slow pace of reform.

The leadership team of cannabis-focused finance firm CapitalNow Cannabis expects to see a rush of capital investment from institutional players once a policy such as the SAFE Banking Act — or any federal reform — opens the doors to US-based investment with no consequence.

“Once the SAFE Banking Act passes, we should see a big uptake where you can see some of the stock prices go up 40 to 60 percent,” Joshua Reynolds, president of CapitalNow Cannabis, said.

The question then becomes: When exactly will this policy make its much-anticipated arrival? The slow march of time is starting to get to the market.

“I think we're seeing a change in sentiment now that it looks like SAFE Banking isn't going fast,” Gerry Wawzonek, president and CEO of CapitalNow Cannabis, told INN.

Leonard Tannenbaum, partner and CEO of AFC Gamma (NASDAQ:AFCG), expressed his frustration at the lack of progress for cannabis reform in the US.

He believes division among Democrats is causing delays with the passing of any significant bill. “They have to do what's right for the industry and stop doing what's right for the political agendas,” Tannenbaum said.

Cannabis market update: Global economics and poor results beat up stocks

The entire global economy is facing pressures at every level, and cannabis is no different — this has led to many price downturns and valuation declines despite steady operations in the US.

“Everybody's getting punished, no matter what,” Tannenbaum said.

Rebecca Conti Koar, senior vice president of investor relations with US-based operator Ascend Wellness Holdings (CSE:AAWH.U,OTCQX:AAWH), told INN there is a very real drought of equity capital at the moment.

“A lot of the folks that (entered recently), kind of post the (Joe) Biden inauguration, they've gotten fatigued because there's no new capital entering the space,” Conti Koar said.

The investor relations expert pointed said retail investors are largely leading the charge in cannabis, whereas for a healthier market more institutions would hold a stronger position in the sector.

The fatigue Conti Koar described is playing a role in the battle of sentiment against results. “There's a severe dislocation between the fundamentals and the valuations,” she told INN.

El-Cheikh said that while entire markets around the globe are facing slowdowns, cannabis is being affected even more due to the already difficult conditions for companies.

“The entire industry is facing challenging capital markets conditions. It's not just cannabis, it's all other sectors,” El-Cheikh said. “But I think the cannabis industry is facing more challenges than others.”

The expert, who focuses on the Canadian side of the cannabis industry, said ongoing unprofitable quarters, high cash burn rates and “quite depressed” valuations have made it increasingly difficult for operators to raise capital.

For his part, Taerk emphasized to INN that he has seen disappointment from retail investors due to the lack of progress in US federal cannabis reform. Aside from that, most US operators trade on Canadian exchanges, making it hard for American investors to access them.

“If there was a change in the regulatory environment, these (US) companies would be trading at a much different cash flow,” the Ninepoint Partners executive commented. “These companies have stronger cash flows, and are executing, but are still not able to be listed in the US.”

“Equity market values are dislocated from fundamentals,” Taerk said of US operators, agreeing with the evaluation raised by Conti Koar.

Cannabis market update: What happened to the sector's M&A rush?

The cannabis industry is no stranger to explosions in consolidation. Mergers and acquisitions (M&A) have played a significant role in the emergence of the cannabis space.

While key deals have been completed in 2022, investors have seen a slowdown compared to previous years when it comes to big brand deals between major publicly traded firms.

When asked what dictates M&A in the minds of operators at the moment, El-Cheikh said there’s been a clear evolution in the mentality of companies and extended discipline when it comes to what to purchase.

“It's less about first-mover advantage,” the EY-Parthenon expert said. “It's about investing in the markets that make sense — that have legal frameworks in place, they're big enough and there's not a lot of players.”

Taerk told INN that M&A has been affected by the market conditions affecting the value of company shares.

In the short term, M&A will continue to face a dry spell since “people aren't as interested in taking shares as currency,” according to the financial advisor.

“However, that will change over the second half of the year, I think, as we get into Q3/Q4, where there are going to be some companies that want to continue, but just are not able to,” he said.

Despite the poor market conditions complicating the proliferation of M&A, Conti Koar told INN the industry is “ripe for consolidation” at the moment.

For his part, El-Cheikh said he’s witnessing a legitimate struggle for deals to take place in Canada due to the ill-suited synergies between a lot of players.

“If I'm a cannabis company with a high cash burn and my capital at this point is very limited, why would I acquire another cannabis company that also has a similar cash burn? It doesn't make any sense,” the expert told INN.

In the long term, El-Cheikh said he expects to see interest in international M&A pick up as Europe continues to open the doors for more cannabis availability.

Cannabis market update: Investor takeaway

Cannabis investments have a bright future by way of expected market growth and the ongoing opening process for new jurisdictions in the US and abroad.

However, right now both investors and companies appear to be reaching their limit when it comes to tolerating difficult market conditions. Companies will continue to pursue their business models and adjust to the new realities of the market, but the lack of progress in the US is draining momentum for the market quarter by quarter.