Cannabis Market Update: Q1 2020 in Review

Cannabis Investing News
Cannabis Investing

The cannabis industry couldn’t escape the effects of COVID-19 in Q1. Here’s how the virus is impacting the space, plus other factors to watch.

After a rocky 2019 that saw cannabis market participants begin a critical reexamination of the space, the marijuana market is dealing with fresh challenges in the new year.

The global coronavirus outbreak is top of mind for many sectors, and cannabis is no exception — in the first quarter of 2020, both companies and investors had to determine how to effectively navigate changes created by COVID-19. They also had to start making plans for the future.

With Q1 now over, the Investing News Network (INN) reached out to cannabis experts to ask about key events during the period, with a focus on Canada and the US. Read on to learn their thoughts, plus ideas about what could be next for the developing marijuana space.

COVID-19 strengthens Canada’s online cannabis sales

While Canada’s cannabis players have faced some hiccups as they adjust to coronavirus-related restrictions, the consensus seems to be that overall the country’s marijuana industry has adapted well.

“In Canada, being deemed an ‘essential service’ has kept the cannabis industry open and operating as cultivation and production continue as the rollout (of) 2.0 products is at the early stage,” Charles Taerk, president and CEO of Faircourt Asset Management, told INN via email.

“Also positive is that dispensaries have been able to offer ease-of-use services such as click and collect and curbside pickup,” he added. Faircourt is the portfolio advisor to the Ninepoint Alternative Health Fund, which Taerk manages with Doug Waterson. The fund’s inception was in March 2017.

Online sales have also proven to be a boon for cannabis companies. Taerk noted that the Ontario Cannabis Store, the province’s only legal online retailer of recreational cannabis, has reported strong sales during the pandemic — while a typical day previously would have brought 2,000 orders, lately daily orders have been in the 8,000 range, with a recent peak day of 13,000. What’s more, over the last four weeks 30 percent of online customers were new.

Rishi Malkani, cannabis practice leader at Deloitte Canada, also highlighted Canada’s strong cannabis sales, saying that online sales in Ontario were up a whopping 600 percent in March versus February. He attributed the spike to “panic buying” related to COVID-19, saying that sales should stabilize shortly.

Coronavirus puts US legalization in spotlight

Canada’s cannabis industry appears to be weathering the COVID-19 storm fairly well, but the story has been different in the US, where the marijuana landscape is less straightforward.

Much of the focus right now is on whether the pandemic will help or hinder US legalization efforts at both the state and federal level — currently medical and recreational legality of the drug varies widely from state to state, and cannabis remains entirely illegal at the federal level.

Taerk and Malkani came down on different sides of the debate, with Taerk saying that the crisis is providing regulatory momentum. “In 28 states, cannabis has been deemed an essential service, providing further validation and legitimacy to the industry,” he explained.

“At the heart of the essential business orders is the recognition that medical cannabis programs serve patients who use cannabis as an alternative to pharmaceuticals to treat medical conditions, and a majority of adult-use consumers have self-prescribed to avoid paying high fees for medical cards.”

Taerk added that at the congressional level, it’s possible that a reduced version of the SAFE Banking Act could be included in a new COVID-19 stimulus package. The legislation, which would allow banks to offer loans and other services to cannabis businesses in states where the substance is legal, made it through the House last year, but got stuck in the Senate.

For Malkani, the future is not so bright. In his opinion, federal legalization is unlikely to be a priority for the US as it continues to respond to the coronavirus.

“This would also include banking reforms, which is a major pain point for many US cannabis companies. Further, (COVID-19) has delayed planned legalization in select states such as New York and Maine, as they deprioritize state cannabis legalization,” he explained.

Nawan Butt, portfolio manager at Purpose Investments, made a similar point, saying that activity related to federal legalization has essentially ground to a halt. Speaking via phone to INN, he pointed to Andrew Cuomo, the governor of New York, as an example, saying that while he was previously pushing for state legalization in 2020, he has now said it’s off the agenda for the year.

“That sort of gives you insight into how everything is being pushed down,” he said. “All timelines are being pushed out as far as legalization in any sort of jurisdiction is concerned. It is not top priority anymore. There are a lot more more important things going on.”

COVID-19 changes likely to persist after crisis

The question for most industries right now is what the long-term effects of the coronavirus may be, and that’s true in the cannabis market too. Overall, the experts INN spoke to agree that changes being made in reaction to COVID-19 could be adopted long term.

“The pandemic is completely changing consumer behaviors and buying patterns, driving greater demand for online shopping and new purchasing options such as same-day delivery and click and collect,” said Ashley Chiu, cannabis strategy advisor at EY Canada. With basket sizes on the rise since isolation measures began, she said companies will need to “manage and monitor sales and planning processes to align production amid this heightened demand.”

Chiu also said that cannabis retailers will have to create and maintain workplace policies to protect employees and consumers. “Part of this process is being agile to adjust to changing regulations and implement additional quality management measures as required,” she explained.

Taerk made a similar comment about same-day delivery and click and collect, saying that while they are “designed to end with the provincial re-openings, there is an opportunity to add (these services) in addition to home delivery, which further reduces demand for the illicit market.” He believes that changes in how people shop for staples will alter how consumers buy cannabis as well.

Honing in on the tax side of the cannabis business, Taerk said it’s possible that Canada and the US will move to take advantage of an industry that’s seen some success amid turmoil caused by the coronavirus.

“There is a chance provinces and states see the strength of tax collection during a time when virtually the entire economy was shut down,” he said. “In Canada, making curbside pickup and potentially home delivery a regular service can serve to assist the federal government’s goal of reducing the illicit market.”

In the US, Taerk said states may notice that about US$2 billion in taxes has been collected from the cannabis industry at “(a) time when state coffers are weakened due to costs related to COVID 19 response.” He believes with that in mind they may decide the space deserves more legislative support.

Taking a more global approach, Malkani said any international development plans will likely be delayed.

“For example, EU countries are prioritizing review and approval of essential medicines and medical devices over conducting EU Good Manufacturing Practice (GMP) inspections of overseas cannabis production facilities. So many cannabis companies seeking EU GMP certification will likely have to wait for longer periods and revise international expansion timelines,” he explained.

Cannabis 2.0, other factors also influencing the market

COVID-19 has been top of mind in the cannabis space this year, but that’s not to say additional factors haven’t influenced the market. Among others, Canada’s rollout of Cannabis 2.0 products, such as edibles, vapes and concentrates, has risen to the fore as a key point to note.

“This last quarter was challenging, resulting in pushbacks and slow growth as Canadian cannabis licensed producers pushed out edibles, extracts and topicals, while simultaneously navigating an immature and uncertain market,” said Chiu. Cannabis 2.0 sales originally began in the country last October.

“Managing uncertainty, coupled with rising competition, is putting more pressure on producers to maximize output in the most cost-effective and efficient ways possible. Limited access to capital and unclear regulations continue to make long-term capital allocation decisions a difficult task, forcing companies to focus on immediate efficiencies,” she added.

Malkani said that it’s still too soon to tell whether Cannabis 2.0 products will have a major impact on Canada’s cannabis industry, although initially experts thought that sales would increase substantially due to higher prices and customers interested in new product formats.

“However, the oversupply situation, poor distribution and a number of limitations placed on certain products (e.g. edibles can have no more than 10 milligrams of cannabis in Canada, and Quebec banning edible cannabis sweets such as brownies and gummies), may only result in Cannabis 2.0 having an overall tepid impact on sales,” he commented.

Expanding on Canada’s oversupply and poor distribution, Malkani said that companies in the country have focused too much on expanding domestic cultivation, pushing supply to a level estimated to be five times higher than demand. He also noted that Canadian marijuana sales have suffered due to the lack of retail operations in the key provinces of Ontario and Quebec.

“Each province had less than 25 stores as of January 2020, compared to over 400 in Alberta and 300 in BC. While both provinces have made efforts to increase retail outlets, the COVID-pandemic will likely delay this, and the lack of capital will likely further limit the ability of many retailers to setup operations. Therefore, it may take longer than expected for domestic sales to pick up,” he explained.

Finally, capital constraints are a concern that can’t be forgotten in the cannabis space. As Malkani pointed out, since mid-2019, companies have had trouble raising money due to lower valuations caused by a turn in investor sentiment. He sees COVID-19 only making it more difficult for cannabis firms to do so.

Summing up the situation, Taerk said that if anything, COVID-19 accelerated existing cannabis trends.

“This is still a capital-constrained environment. There are ‘haves’ and ‘have nots,’ meaning some companies are able to generate positive cash flow from operations, some aren’t; some have the ability to raise capital and many do not,” he said.

One bright spot for him is that companies are starting to be judged more on their own performance and less on the performance of the largest companies in the industry. He anticipates that in the next six months to a year, stronger companies will emerge with more dominant positions.

What’s the overall sentiment in cannabis right now?

2019 was a challenging year for the cannabis space, and so far it doesn’t seem like 2020 is going to let up.

“In 2019, many cannabis companies were on the upward curve of building a culture of controls, standardization, risk management, compliance and governance,” said Chiu.

“Now more than ever, they’ll need to prepare for quick changes to regulations and ensure compliance, by making sure they’re adequately equipped to maintain and sustain governance practices in the current working environment.” She also emphasized that companies will have to be disciplined about spending.

Malkani issued words of caution too, saying the sector should brace itself for more pain.

“The COVID situation has provided a bit of a distraction and even a respite (through increased sales due to panic buying), but it’s really more of a calm before the storm,” he said. “We expect to see waves of distressed company/asset sales and bankruptcies starting in the summer and continuing through 2020.”

The bright side, Malkani said, is that he sees “potentially more capable” players — such as industrial or regulated goods companies — taking on these assets; meanwhile, major cannabis companies will come out of the situation with “ample consolidation and expansion opportunities.”

Butt also offered words of hope, saying that the temperature of the sector has improved over the last month and a half or so.

“(That) has basically come from the fact that winners have separated themselves from losers. Some consolidation has happened, but essentially business models are starting to prove themselves as we get a better picture, a better idea of what operations will look like and how strong management teams are.”

In his opinion, the proof is in the number of financings seen within in the past two months, and the fact that some investors have come back into the space. “We actually think that the temperature of the industry or the sector is much better now than it was six to eight months ago,” he said.

Don’t forget to follow us @INN_Cannabis for real-time news updates!

Securities Disclosure: I, Charlotte McLeod, hold no direct investment interest in any company mentioned in this article.

Editorial Disclosure: The Investing News Network does not guarantee the accuracy or thoroughness of the information reported in the interviews it conducts. The opinions expressed in these interviews do not reflect the opinions of the Investing News Network and do not constitute investment advice. All readers are encouraged to perform their own due diligence.

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