The question above was posed to my colleague/mentor Howard Penney and me by our Director of Research, Daryl Jones, on September 4, 2018. This was less than a month after Constellation Brands (STZ) backed Canopy Growth (CGC) with an additional $4B, bringing their stake in CGC to 38% and sending the cannabis stocks into a frenzy that peaked in October 2018.
After contemplating the thought of expanding our coverage to include cannabis for less than 24-hours, we said yes. It sent us on an adventure we never thought our careers in equity research would bring us.
We have been traveling around North America since then attending conferences, visiting management teams, and touring cultivation/production sites (it’s harder work than it sounds) trying to figure out what form this industry will take longer-term and who the winners will be. Through our travels, we have met with people we never thought we would cross paths with in an equity research role, and experienced ‘things’ we also didn’t think we would experience as part of our job!
Our initial take on the industry (and it still stands today) is that vertical integration will not work long-term, just as in any other consumer product segment, there needs to be specialization. We are starting to see company philosophies divide, some recognizing the future state, while others hanging on for dear life to the idea that farming is where the future is or can be (i.e. large scale LP’s – CGC, APHA & ACB).
Our Best Idea LONG in Canada since the beginning of our coverage is Cronos Group (CRON), we favor their asset-light approach to the industry with a keen focus on a few strategic projects, being careful not to spread their human and monetary capital too thin. We were met with great skepticism from clients on our CRON call, many using some choice (very negative) terms to describe CRON, but we stuck true to our thinking and that one has paid off to-date.
Next, we dove into the US market, coming out positive on multi-state operators (MSOs), we view their business models to be the most advantageous for the patchwork of legalization in the US (current Best Idea LONGS: CRLBF, GTBIF, ITHUF & MMNFF). Those calls in the near-term have not faired as well for us due to a number of company specific and macro headwinds for the overall industry, although we still believe these will be the winners long-term, they have a lot of proving to do.
From a macro perspective the sector has been dinged for a slew of scandals (CannTrust being the highest profile thus far), regulatory delays at the federal level (STATES and SAFE Act’s), state level delays in legalization (MA, NY and NJ to name a few), and of course, waiting for the almighty FDA ruling on how CBD can be distributed. Sounds like a lot going against the industry! Despite the struggles YTD, we are hopeful positivity will come to the surface in the latter half of 2019.
Despite the headwinds, there is hope driven by an estimated $40B illicit cannabis market (currently the legal market is about $10B, for a rough total in the US of $50B), that is ready to be harvested by legal operators. That’s the easy market, the next and harder market will be attracting new users, and that will take time. Saying and achieving this feat in the face of a well-developed black-market trade are two very different things and will take the efforts of both legal operators and governing bodies to achieve.
Most importantly the industry needs to get its act together from a consistency and product development standpoint, so every consumer has a similar experience every time. If we don’t have that, the industry will never attract new adopters who are typical beer, wine and spirits drinkers (they like consistency and fast onset) into the cannabis industry.
We will arrive at our next stop on this wild adventure come Monday, August 26th, when we’ll dive into a new space – extraction. Although not anything sexy and flashy, we believe it is a hidden gem tucked into the cannabis supply chain. Extractors will specialize in this high fixed asset-base trade and provide higher efficiency ratios than in-house operations will be able to achieve. Best idea MediPharm Labs (LABS), and LONG Bench ideas Neptune Wellness Solutions (NEPT) and Valens (VGWCF), stand out above the rest in our opinion and we look forward to taking our clients through the details on Monday.
In our chart of the day below, we are displaying the growth in cannabis sales (dry flower vs. concentrate) within the state of Illinois. As we look to 2020, Illinois will be one of the most critical new adult-use states and will have significant impacts on the financials of our Best Idea LONGS: CRLBF, GTBIF and MMNFF.
Now let me ask you, do you want to cover cannabis?
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Shayne Laidlaw
Cannabis Analyst
