Whether you’re interested in the sector for its recent returns, long-term prospects or just because you support legalization from a social perspective, cannabis is one of the most intriguing investment opportunities on the block right now. But as with any emerging market, this sector comes with its caveats, especially in the near term as demand and pricing issues shake out. Here’s what you need to know about some of the ins and outs of cannabis investing:
In the Weeds
Legal access to marijuana for medical purposes has been permitted in Canada for some time, but recreational cannabis is set to become legal on Oct. 17, 2018, thanks to the passing of the federal Cannabis Act in June which created the framework for the production, distribution, sale and possession of marijuana across Canada.
Each province and territory is responsible for developing, implementing, maintaining and enforcing systems to oversee distribution and sale — things like where cannabis can be bought and the legal age to purchase it. Details are still being ironed out in some jurisdictions — Ontario, for example, only recently set out what the retail model will look like.
At the moment, investors can not only access cannabis investments through the larger, listed producers like Canopy Growth Corporation, Aurora Cannabis and Aphria, as well as a number of ETFs and mutual funds, but also via the ‘ancillary’ side of things (companies outside of the scope of actually growing and selling marijuana — such as packaging or the accessories market.)
Even the beverage sector is involved — Molson Coors, for example, recently announced a joint venture to create non-alcoholic cannabis infused beverages, while alcohol company Constellation Brands has taken an ownership stake in Canopy.
Indeed, the cannabis investment universe has been growing exponentially, explains Mark Noble, senior vice-president and head of sales strategy at Horizons ETFs — expanding from around a dozen names when Horizons launched its first marijuana-focused ETF in April 2017, to nearly 40 now (companies with market capitalizations of at least CAD $75 million and an average monthly trading volume of 250,000.) At the same time, Noble says he expects consolidation in the sector at some point, which will also provide an investment opportunity.
In terms of returns, one-year performance is in the double and triple-digits for several cannabis stocks and funds, although the sector has seen a pullback year-to-date. Still, a recent survey from Horizons ETFs noted that nearly 60 per cent of advisors are bullish on marijuana stocks, expecting the sector to deliver positive returns in Q3. For most listed cannabis producers and cultivators, analysts’ consensus recommendations remain at either ‘outperform’ or ‘buy,’ according to Reuters.
There are a number of factors driving the excitement, says Noble, including impending legalization of recreational use, and the fact that it’s a brand-new sector.
“When you talk to a lot of investors, they really feel like they’re investing in Seagrams or another alcohol company at the end of prohibition in the late 1920’s,” he says.
Another positive for the space, explains Darryl Brown, a Toronto-based CFA and independent financial advisor, is that cannabis appears to have the characteristics of both a growth and defensive sector.
Barring any major legislative changes, he says, its growth is largely independent from an economic cycle, with strong generational and popular support, and developments on the medicinal side in the context of an aging population also appear positive.
In terms of demand, Noble says there is some indication that longstanding recreational users will not represent the main growth market for legalized cannabis. In California, for example, he says, there has been some suggestion that the largest growth market is women 35-50, who have sought to try out these products now that there are fewer social and legal ramifications.
“We don’t know how big that market could be, but that’s something that obviously has some of these marijuana providers excited,” he adds.
While legalization is driving a lot of enthusiasm for the sector, cannabis is going to be a heavily regulated industry in Canada, which will have both positive and negative effects. This and pricing are among the top risks on the investment side, says Brown.
In the short-term, he says, “there’s a little bit of volatility as people try and decide what is a fair price to pay for this individual company or this sector in general, so trying to gauge that is very, very difficult.”
As Noble notes, valuations in the sector are “extremely high,” with many investors betting on the fact that some companies will be able to dramatically increase their earnings and revenue on the recreational side.
“There’s obviously a little bit of buyer beware in that a lot of these stocks right now, their valuations are taking into account the fact that there is this recreational opportunity which will definitely increase their revenues, but the question is – by how much and how much of that is already priced into the stocks?” he says.
A lot of unknowns still exist with respect to the recreational market in terms of the demographic of buyers, how much will be bought and which companies actually manage to sell to this market, which brings a certain amount of risk.
“Not every marijuana producer is going to be able to take advantage of this — there’s going to be some winners and there will definitely be some losers as well,” says Noble.
Ultimately, the cannabis sector boasts a lot of positive characteristics, but carries risk like any industry, says Brown. There can be a place for it in the context of a diversified global portfolio, especially, he says, when looking at it over a longer timeframe — years and decades.