Head of Equity Strategy
Summary: The cannabis industry has been growing at a rapid pace the past five years as more and more US states have legalized recreational use of cannabis and in some US states narrow medical use is also legalized. However, Canada is also a big and growing market with a better legal framework and Europe is still long behind North America offering a potential third major market in the future. Key to future growth will be legalization on the US federal level and more scientific proof of health benefits from cannabis oil and related drugs. But despite of all the various obstacles the industry has grown revenue by 37% over the past year highlighting the great potential.
Today we are launching our 18th equity theme basket, and this will be the final one before the holiday season kicks in. Later this year we will roll out new theme baskets that will focus on green metals (used in the green transformation), payments, robotics and automation, medical technology as much more.
Next growth period to be driven by medical use and federal legalization
As the table below shows, the cannabis theme basket is the second-best performing theme basket this year after our crypto and blockchain basket up 45%. The drivers behind the performance are continued legalization in more US states, a Democratic majority owned US Congress which increased the probability of federal legalization of cannabis, and finally continuous high revenue growth numbers from several key industry players. One of the recent legislations moves have come from US House Judiciary Chair Jerry Nadler reintroducing the social justice focused cannabis legalization bill, also known as the MORE Act.
According to some estimates the US market for cannabis will reach $18.4bn in 2021 and then grow to $24bn in 2025 with medical use overtaking recreational use as the key growth driver. But key to the medical use as a driver is scientific proof that can convince the FDA of the effectiveness of THC and CBD (read a description of THC and CBD here). Other key growth drivers over time are easier access to financing which is expected as regulation eases and potentially a full-blown legalization on the US federal level. Economics of scale is important in this industry and therefore mergers and acquisitions will be an important driver of shareholder returns in the coming years. Europe is a small market relative to Canada and the US, so there is a considerable upside potential for the industry in Europe. This recent Deloitte industry report is a good read on the different drivers.
Some of the companies in our basket are on reduce-only in our trading systems meaning that they cannot be bought but only sold. IM Cannabis is not available on the platform because we do not have a price feed for the Canada Securities Exchange which is an alternative exchange to Toronto. Why are some of the major companies in the industry listed on a small alternative exchange? The TMX Group, behind the Toronto Stock Exchange, has imposed regulation preventing companies with US cannabis business or assets to list on the main exchange in Canada because cannabis is still illegal in the US on a federal level. As a result, many US business in the cannabis industry has listed on Canada Securities Exchange. But Curaleaf’s Executive Chair Boris Jordan has said recently that they expect US cannabis companies to be able to uplist to major US exchanges if the US Congress passes a cannabis banking reform legislation. If the industry gets these legislations through US Congress it will open for institutional ownership and easier financing, which could create a boom in cannabis stocks.
The table shows the companies that have been included in the cannabis basket. We could only find 20 companies with good direct exposure to this theme and a sufficient market value. The 20 companies are combined valued at $51bn which is a very small investment theme, but that means that the potential is also likely that much greater. The median revenue growth the past 12 months has been 37% and EBITDA is also improving in the industry. Sell-side analysts covering the companies have an average price target that is 26% above the current market price.
| Name | Mkt Cap (USD mn.) | Sales growth (%) | EBITDA growth (%) | Diff to PT (%) | 5yr return |
| Curaleaf Holdings Inc (*) | 9,642 | 180.0 | 492.8 | 61.7 | 1,639.0 |
| Canopy Growth Corp | 8,653 | 37.1 | 27.3 | 22.6 | 881.0 |
| Tilray Inc | 7,290 | 5.3 | 42.2 | 6.4 | NA |
| Green Thumb Industries Inc (*) | 7,190 | 122.7 | 393.2 | 42.9 | 102.1 |
| Innovative Industrial Properties Inc | 4,785 | 135.1 | 7,066.8 | 9.4 | NA |
| Cronos Group Inc | 2,956 | 74.4 | -12.2 | -6.6 | 5,332.4 |
| WM Technology Inc | 2,364 | NA | NA | NA | NA |
| Sundial Growers Inc | 1,907 | -19.7 | NA | -33.9 | NA |
| Aurora Cannabis Inc | 1,572 | -12.1 | -55.3 | -12.9 | 112.3 |
| Turning Point Brands Inc | 877 | 16.9 | 175.1 | 38.7 | 370.7 |
| Organigram Holdings Inc | 769 | -19.0 | -512.3 | 20.2 | 220.4 |
| HEXO Corp | 736 | 62.4 | 71.8 | 25.6 | 252.8 |
| Charlottes Web Holdings Inc | 604 | 0.7 | -105.0 | 46.8 | NA |
| Valens Co Inc/The | 423 | -18.3 | NA | 55.4 | NA |
| High Tide Inc | 362 | NA | NA | 93.8 | NA |
| AFC Gamma Inc | 350 | NA | NA | 25.1 | NA |
| IM Cannabis Corp (*) | 282 | NA | -6,129.5 | 81.9 | NA |
| RIV Capital Inc | 282 | NA | NA | 26.3 | NA |
| Agrify Corp | 263 | 195.7 | -296.3 | 62.2 | NA |
| Clever Leaves Holdings Inc | 242 | 54.7 | 23.9 | NA | NA |
| Aggregate / median | 51,548 | 37.1 | 25.6 | 25.9 | 311.7 |
Source: Bloomberg and Saxo Group
* These stocks are either on reduce only or not available on the trading systems due to lacking price feed
As the chart below shows, the long-term performance of the cannabis basket has been good, but as with all our baskets the performance has strong survivorship bias because we create the basket today and calculate performance backwards in time. We do this, because regulation requires us to show 5-year historical performance on securities or indices of financial instruments. The historical performance is not an indicator of future performance. What is notably is the strong performance since the lows during the pandemic likely highlighting the growth of retail investors which are the dominant source of demand for cannabis stocks.
Key risks
The biggest risks when investing in cannabis stocks are the low liquidity and high volatility in many of the stocks driven by the low ownership ratio by institutional investors. The long-term growth outlook is dependent on a US federal legalization of cannabis for both recreational and medical use, but also legal adoption in international markets such as Europe. The industry is competitive and many of the companies have not yet reached profitability which increases the bankruptcy risks overall in the industry. News stories related to overdoses of misuse for either recreational and medical use could drive negative public relations stories and scrutiny by politicians. The medical use as a key driver hinges on sound scientific proofs of health benefits from cannabis oil and related drugs, which is still uncertain at this point.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
