Cannabis has always been relatively easy to grow, for a cash
crop. The plant is native to the Himalayas, from the Asian steppes around
Mongolia to the border of Afghanistan.
It grows on all four continents. In the wild, it will grow
at high altitudes, in cold, dry climates or in hot, humid island fields. It
grows in soils both thin and fertile.
The oldest written record of cannabis harks back to its use
as a surgical anaesthetic in China in 4000BC, while the Vikings and medieval
Germans used it as a painkiller for everything from toothache to childbirth.
It was several hundred years ago, 1753 to be exact, when the
famous Swedish botanist Carl Linneaus became the first man to classify cannabis
sativa in terms of modern taxonomy. But people have been using the plant in all
its forms for over 12,000 years.
The ease with which it can be grown means that when
industrial production comes into play, massive oversupply becomes an issue.
It’s not yet clear that there is a huge and growing market for adult use.
Estimates for the compound annual growth rate (CAGR) for the industry between
now and 2025 vary from around 12% to 17%.
One liquidity analysis report by weed investment bank Ello Capital — staffed by former JP Morgan execs — found that Canadian cannabis producers have on average just six months’ worth of cash, compared to US companies that have 14 months of operating capital.
“Market expectations have been tempered and stock prices
have compressed, with significant concentration and focus on liquidity concerns
in the industry,” they wrote. This is a far cry from the speculative boom
that grew up around weed stocks as regulations fell away two years ago.
All 20 companies surveyed by Ello have seen their share
prices fall by more than 45% from their all-time highs.
The big picture
Aurora Cannabis (NYSE:ACB; TSE:ACB) is a useful
cipher for the market at large. The Canadian producer has seen its cash burn
increase and reserves shrink with heavy operating losses.
Investors are concerned it could run out of money entirely.
It was a popular punt with speculators in the early days of
the industry, when Canada legalised recreational cannabis use in 2018.
And sovereign wealth funds including South Korea and the
Swiss central bank have recently upped their stakes.
More recently, things have not been shaping up well.
Shares of the Edmonton company have fallen by 94% on the
Toronto Stock Exchange over the last 12 months, from $140 in May 2019 to trade
at less than $9 today.
Weak Q2 results, before the coronavirus hit, saw Aurora’s
revenue fall 26% and it reported a loss of more than $80.2 million, more than
double the $39.7 million loss from Q1.
After seven years in the role, CEO Terry Booth stepped down
in February 2020 while this disastrous set of results worked their way through
the market. The company also shed 500 jobs amid a larger cost-cutting exercise.
March filings reported by Bloomberg show that Booth sold off more than
two-thirds of his stake in Aurora.
Then came news of the plans to make a 1-for-12 reverse stock
split. The New York Stock Exchange had threatened to delist Aurora because its
stock had fallen so heavily, trading below $1 for more than 30 days in a row.
Aurora then diluted shareholders again with another placing.
The Aurora story took another turn with better than expected
Q3 results. Prices surged 53% on 19 May on volume 1,000% higher than its
average, with 102 million shares changing hands. And yet while revenues were at
the top end of estimates Aurora still reported steep losses.
The upswing pulled up the rest of the weed market, with
Ottawa’s Hexo (NYSE:HEXO) adding 50% and the cannabis ETF THCX rising
Brokers are heavily split on the company’s potential.
Ladenburgh Thalmann said “We think ACB can become a solid cash-flow
generator simply from the Canadian operations.”
But Jeffries, a much larger brokerage house, downgraded
Aurora to ‘underperform’ following the Q3 reveal, saying a re-rating was “neither
sustainable nor justified.
Analyst Owen Bennett wrote in a client note: “We think
near-term sales and gross margin headwinds are not fully appreciated.”
Aurora’s long-awaited $40 million all-share takeover of
Reliva, a CBD manufacturer, failed to quell the broker’s fears for the future.
Bennett added: “There is still no permanent CEO to lead
this CBD push, the CBD space is experiencing significant headwinds currently
there is further dilution at a questionable multiple.”
But the growth of the CBD space is undeniable. Reliva sells
products like gummies, CBD water, chews and gels in 20,000 locations across the
CBD is the non-psychoactive compound in cannabis. Few
long-term peer-reviewed studies exist, but anecdotally it is quite widely used
by athletes to treat inflammation injuries and is often touted as a cure-all
for pain management. The US NFL has recently relaxed its policy on players who
test positive for THC, the psychoactive compound in cannabis that produces a
high, while former players continue to lobby for CBD’s legal use in the game.
The 2018 Farm Bill, signed into law by President Donald
Trump, effectively legalised the use of industrial hemp in the US. But it did
not quite remove all obstacles to the wide-scale sale of CBD products. The Food
and Drug Administration still has an issue with the way CBD products are
marketed to the public with unproven claims of therapeutic benefit.
And this regulatory uncertainty hit another weed producer
recently: Cronos Group. It told investors in a recent conference call
that it had put back the launch of a CBD brand because of regulatory
Cronos bought upscale CBD startup Lord Jones for a whopping
$300 million in 2019. It was widely noted at the time that the takeover price
was at least 100 times the junior company’s previous year revenue of $2 million
to $4 million.
Bigger = Better?
Canopy (TSE:WEED), by far the largest weed producer
by market cap, also cut 500 jobs in May, closing two grow centres as it
reported slower than expected sales. This defies earlier interest from beer,
wine and spirits giant Constellation Group, which since 2017 has totalled
around $4 billion in investments.
When depressive moves like this are being made, and the
market still sells off, it’s a potential sign that there’s long-term value to
Brokers in general are fairly downbeat on the short-term.
Production is again the issue. Referencing Canopy, Jeffries analysts Owen
Bennet and Ryan Tomkins wrote recently:
“It has been clear that [the company’s] vast production
space has been far in excess of what’s currently necessary.” Canopy’s annual
capacity is two and half times larger than the 200,000kg total sales, they
added in a client note.
Exchange traded funds have proven a popular method of
exposure to the sector. But investors have not had a happy time here, either.
The world’s largest weed ETF is ETFMG Alternative Harvest
(NYSEARCA:MJ), whose top weighting is in Nasdaq-listed British biopharma group GW
(NASDAQ:GWPH). Meanwhile, Cronos Group (TSE:CRON) — down 75% from
its 2019 all-time high — Corbus, Canopy and Tilray round out the
The losses across the cannabis industry are pretty stark. The
Alternative Harvest ETF’s net assets have dropped from $673 million to $506.3 million
since the start of 2020. The ETF has witnessed three-year losses of 22.74% and
is down a crushing 64.48% in the last 12 months.
The second largest weed ETF, Canada’s Horizons Medical
Marijuana Life Sciences, fell by 33% last year.
However, there is one bright spot to note, and it points to
growth away from generalised adult use and towards pharmaceuticals.
Recent Q1 2020 results from GW Pharmaceuticals show
that it sold far more of its cannabis-derived epilepsy drug Epidiolex than
Q1 net sales of the drug reached $116.1 million, and there
are commercial launches in France, Spain and Italy on track for later this
Net losses were slashed from $50 million last quarter to $8
million this time around, while revenues hit $120.6 million, up from $36
million in the same quarter last year.
While clinical programs have been delayed to the second half
of the year because of the Covid-19 restrictions, there are several significant
trials in the pipeline.
We already know that pharma firms will become systemically
important between now and 2030. If I were thinking of a cannabis play, GWPH
would be at the top of my list.