Can the cannabis industry turn growth into profits?

Thought Starters 5 minutes to read

Saxo Group

Summary:  Find out more about the current state of the marijuana industry, the trading opportunities it presents and how you can gain exposure to it with Saxo.


High growth sparks opportunities
The cannabis industry offers great growth opportunities over the next five years – but they come with great risk. 

The industry is bleeding on free cash flow generation, elevating the risks of refinancing its growth and operations. Recreational use is expected to become the main growth driver, but that comes with additional regulatory risks as cannabis was initially earmarked for medical use. The industry has also struggled in 2019 as market fundamentals have weakened, causing stocks to decline and bringing the possibility of bankruptcies sharply into view.

The key focus in 2020 will be whether the industry can show a path towards profitable growth.

All smoke and no fire?
As of January 2020, the publicly listed Cannabis industry, measured by the S&P/MX International Cannabis Index, had a combined market value $27.6bn, with the five largest companies being Canopy Growth, GW Pharmaceuticals, Cronos Group, Arena Pharmaceuticals and Aurora Cannabis. The index comprises 22 companies with a combined revenue in the last 12 months of $2.5bn – although this is largely concentrated among a few companies. 

The industry’s biggest issue is the lack of profitability amid the high growth – the index’s 12 month free cash flow shows a combined loss of $3.2bn. Consensus is expecting goodwill impairments to accelerate in Q4 as past acquisition values no longer add up with the weak market fundamentals seen in Canada during the second half. Some companies have goodwill-to-assets ratios of more than 50%, and a few more stand at around 20%, making the industry vulnerable from a balance-sheet perspective.

Bankruptcy concerns over some companies combined with large negative free cash flow means that the industry has a large, recurring refinancing issue. With the industry’s shares down 55% since September 2018, financing from traditional banks is drying up, which will leave shareholders to carry the burden of increasing the equity finance. The stock slide since also highlights the high-risk nature of the industry despite its fast growing revenues.

Recreational use to fan the flames
The cannabis industry’s historical growth rate has been high and this is expected to continue in 2020. Canada’s legal cannabis market is set to increase by 50% to around $1.7bn*, driven by more retail stores carrying marijuana products, including edibles, beverages and vaping devices. The biggest growth driver in the coming years is likely to be recreational use rather than medical use, but this will have to battle against the increased risk of consumer regulation.

Still, here at Saxo we expect growth rates to remain high for the years to come based on the projections from Bloomberg Intelligence and restructurings to accelerate the weeding out of weak companies in the industry. There will be more pain before the industry consolidates into bigger players with operational moats that can improve operating margins. Regulation has so far been a friend for the industry but over the years this could change as recreational marijuana use increases. Our view on the industry is that it will be volatile for years.

* According to Kenneth Shea, senior analyst (Food & Beverage) for Bloomberg Intelligence

Growth rolled up in volatility and risk
Since the cannabis index’s launch in September 2018 it has had annualised volatility of 45.6%, which is three times that of the S&P 500 at 15.1%. The correlation to the S&P 500 is only 0.11, showing that the industry is not driven by general macro factors but many idiosyncratic risk factors. It also highlights the appeal of Saxo’s new cannabis index futures, as the S&P 500 or any other equity index would be an inadequate hedging instrument.

The idiosyncratic risk factors facing the cannabis industry include the high debt levels of some companies and new regulations arising from an increase in recreational use. Also, goodwill impairment and very high equity valuations cause sharp declines in share prices during earnings releases, which helps to explain the high levels of volatility that make long-term investing difficult.

Trade Cannabis volatility with Saxo
To complement Saxo´s existing cannabis-related product offering, we recently launched S&P/MX International Cannabis Index Futures (SMJ). This means you can now get exposure to the major global cannabis index with a multiplier of 50. Not only will this enable you to hedge against potential losses and enhance your risk management, but more importantly it will also provide you with an efficient way to short the entire industry.

Source: Saxo Bank
You can trade a range of other cannabis-related instruments with Saxo, including equities, equity options, ETFs and single stock CFDs. By trading the latter, you´re able to go long or short, enabling you to capitalise on an individual cannabis stock’s volatility regardless of market conditions. And because you trade CFDs on leverage, your upside-potential is significantly increased – although the potential for loss is also greater. 

For reference, GW Pharmaceuticals (GWPH:xnas) makes up 13% of the total S&P/MX International Cannabis Index market cap, and you can trade it as a CFD via SaxoTraderGO with an initial margin rate of 20%.

Trading in financial instruments carries various risks. This also applies to futures and CFDs, where the total loss you may incur may exceed  the initial amount invested.
Get exposure to the cannabis industry
Open an account with Saxo to capitalise on trading opportunities in the high-growth marijuana industry.
Disclaimer

The Saxo Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-sg/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Markets or its affiliates.

Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-sg/about-us/awards.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.