In Q2, the cannabis investment story continued to face challenges due to COVID-19, but the outbreak has also created opportunities.
As the effects of the novel coronavirus continue to spread across countries and industries, the cannabis market is facing its own set of challenges.
Following a difficult first quarter, in Q2 cannabis names have seen continued impacts from the pandemic, which is affecting the entire global economy. However, there have also been positive signs thanks to the pantry-stocking activity seen among consumers.
As multi-state operators in the US captivate the market’s attention with their results, some of the industry’s largest players in Canada are beginning to experience consolidation as companies previously interested in expansion cut back and focus on essential output.
Overall, investors have faced ups and downs with cannabis in 2020, and the Investing News Network’s (INN) cannabis market update covers some of the most relevant elements from Q2.
Cannabis market update: COVID-19’s business impact
Prior to the COVID-19 outbreak, the Canadian cannabis sector was facing increasing pressure after failing to deliver on the lofty results expected before and after recreational legalization in Canada.
This year, the economic downturn attached to the virus has only added to the strain on the industry. One of the primary concerns for cannabis public names throughout North America has been the amount of investment capital available during the pandemic and moving beyond it.
Despite those concerns, there is optimism among some market watchers who believe valuations in cannabis are becoming more measured. Experts also agree that capital from institutional investors is ready to be deployed as soon as the US eases up on its cannabis regulations.
Similarly, on the cannabis stage outside North America — particularly in Australia — there’s been encouraging commentary about the availability of capital for cannabis operations.
Aside from its effects on capital, various analysts have highlighted the way COVID-19 lockdowns in Canada and the US have led to higher recreational product sales.
In a monthly commentary note, the managers of the Ninepoint Alternative Health Fund, which has exposure to a number of cannabis stocks, describe the pantry-stocking effect as an event seen “through the lockdown and post lockdown.”
The fund is managed by Charles Taerk, president and CEO of Faircourt Asset Management, and Douglas Waterson, CFO and portfolio manager with Faircourt.
The uptick in recreational product sales is important for Canadian cannabis producers as oversupply is an accepted ailment for the industry at large. And even with higher sales, this oversupply looks set to continue as inventories in the country reach new highs.
“The lockdown has played into a strength for cannabis,” Taerk and Waterson wrote in their note to investors for the month of June.
Cannabis market update: All eyes on the US politics
When it comes to the cannabis stock universe, it’s become clear for industry observers that the growth opportunity has moved largely to the US market.
With an upcoming presidential election, investors are evaluating all the possibilities for how any kind of cannabis reform could fit into the bigger picture.
While it remains to be seen what kind of heft the cannabis legalization conversation will carry between US President Donald Trump and presumptive Democratic presidential nominee Joe Biden, some forms of cannabis reform are moving ahead in the political system.
For example, the much-anticipated SAFE Banking Act has now been attached to the HEROES Act, a new piece of Democratic-led policy. The SAFE Banking Act seeks to offer banking protections to cannabis businesses in legal states despite the federal illegality of the drug.
The new HEROES Act is primarily designed as a stimulus bill geared at balancing the effects of the coronavirus, and it made its way through the House of Representatives in May. However, it remains at the Republican-controlled Senate for the moment.
The managers of both the Ninepoint Alternative Health Fund and the Purpose Marijuana Opportunities Fund (NEO:MJJ) have highlighted how significant it would be for US banking limitations to be lifted.
During the Q2 period, the managers of the Ninepoint Alternative Health Fund consistently praised the performance of Trulieve Cannabis (CSE:TRUL,OTCQX:TCNNF) and Green Thumb Industries (CSE:GTII,OTCQX:GTBIF).
In a note to investors, the fund managers at Purpose Investments highlighted the following states as areas of growth for patient numbers related to cannabis figures:
- New Jersey
- New York
Cannabis market update: Future M&A projections
The high number of cannabis stocks has been a topic of note for awhile now, and discussion around cannabis company sizes has been growing as well.
Investors are starting to see the effects of mergers and acquisitions (M&A) as a consolidation tactic, as well as the troubling acceleration of bankruptcies and struggling roadmaps for some of the less-prepared names in the cannabis market thanks to financial pressures from the coronavirus.
“As the industry matures over the near term, much more M&A is expected,” Jefferies analyst Owen Bennett wrote in a note to clients issued in June.
The biggest Canadian companies — including, but not limited to, Canopy Growth (NYSE:CGC,TSX:WEED), Aphria (NASDAQ:APHA,TSX:APHA), Aurora Cannabis (NYSE:ACB,TSX:ACB), HEXO (NYSE:HEXO,TSX:HEXO), Tilray (NASDAQ:TLRY) and Sundial Growers (NASDAQ:SNDL) — have all cut back on staff and operations to save on costs.
However, one expert thinks consolidation for Canadians firms is becoming more and more about actual company operations and less about the whole sector shrinking by way of M&A activity.
“I think most consolidation has come in the way of minimizing footprints for a lot of these companies, rather than just the straight out bankruptcy, and I think it comes from that entrepreneurial spirit that’s still very much embedded within the management teams on some of these companies that know that they’re only a stone’s throw away from profitability,” Nawan Butt, portfolio manager with Purpose Investments, told INN.
Butt, alongside Greg Taylor, chief investment officer at Purpose Investments, serves as the fund manager for the publicly traded Purpose Marijuana Opportunities Fund.
In their May commentary note to investors, the Purpose Investments experts opined that the downsizing and layoffs seen among Canadian cannabis companies will ultimately help the industry get to a more appropriate size and valuation.
“A significant consolidation is currently underway in Canada with a handful of bankruptcies already accounted for and many licensed producers (LPs) running on fumes,” Butt and Taylor said in their commentary note for the month of July.
Butt told INN he sees the consolidation trend evolving beyond companies acquiring each other or joining forces in order to survive.
“In previous months, LPs have used COVID-19 as an excuse to downsize production and implement ‘temporary’ layoffs,” he said. “We, however, view this as a rightsizing for the industry and ultimately a net positive as production moves down towards actual industry demand.”
He envisions consolidation dominating the conversation into the second half of 2020 and beyond.
“Those that should have consolidated, those that should have been shut down by now, have been given this last lifeline by the industry, a last little bit of money to keep on going to see if they can prove themselves,” he told INN. This time extension Butt refered to is approximately six to 12 months.
Cannabis market update: Investor takeaway
Cannabis investments have morphed from an exciting up-and-coming proposition into a more grown-up industry trying to re-establish its footing and adjust to the scrutiny of investors.
During his talk at the Prohibition Partners LIVE online event, Alan Brochstein, analyst and industry commentator with 420 Investor and New Cannabis Ventures, confirmed that the cannabis investment story has moved beyond excessive and overly complicated stories.
Instead, investors are rewarding more direct approaches into the larger cannabis industry, according to the analyst. That approach may be paving the way for the new wave of investment for cannabis as part of the remainder for 2020.
Don’t forget to follow us @INN_Cannabis for real-time updates!
Securities Disclosure: I, Bryan Mc Govern, 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.