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Cannabis industry eyes U.S. federal legalization

For patient investors willing to accept risk and volatility, the pot industry is in its early days with all eyes now on the U.S.

On the second anniversary of the legalization of cannabis in Canada, the high is long gone and most of the billions invested in the industry have gone up in smoke.

Shares of the 100 or so publicly traded cannabis companies peaked in the run-up to legalization on Oct. 18, 2018 and have steadily sold off ever since. As a group, they are down between 66% and 90%, The Globe & Mail reported recently. The main problem: Too many players with too few places to sell the products and so too little revenue to go around.

But for patient investors willing to accept risk and volatility, the cannabis industry is in its early days and the global movement to legalize pot is an unstoppable force. New Zealand’s recent election included a referendum (narrowly defeated) to legalize. Australia may be next. All eyes now are on the U.S., which is the single biggest potential market. We could see quick federal cannabis legalization with Joe Biden’s election. A Donald Trump victory slows, but does not stop, the momentum.   

“The U.S. market for marijuana is already five times the size of Canada’s even though it’s only legal in 11 states,” says Mark Noble, executive vice president of ETF Strategy at Horizons ETFs Management Ltd. in Toronto. “The global cannabis market is really about the U.S. consumer. It’s about retail, adult use in the United States.”

Mark Noble is executive vice president of ETF Strategy at Horizons ETFs. Credit: Horizons ETFs

Horizons launched Canada’s first marijuana ETF in 2017, the Marijuana Life Sciences Index ETF (TSX:HMMJ). It followed the boom – doubling to $24.94 per share leading up to legalization – and then mirrored the bust, closing last week at $6.04, down 76% from the high.

The Canadian cannabis rollout was not smooth, especially in Ontario, the largest market. Soon after winning the spring provincial 2018 election, the Rob Ford Conservatives opened a lottery for the right to run stores. Some of the winners didn’t have the money or expertise to do so and so only about 40 of the 100 have opened. The pandemic was a pile on.

Phase two of legalization came last October. It allows the sale of retail products including vape pens, gummies, candies, gels and other edibles, oils, and infused drinks.

The potential of these retail products has been the industry’s target all along. Legalization was never about eliminating illegal pot sales by habitual users. It was about getting at a demographic that typically buys alcoholic beverages and might switch. This includes millennials and, as Mr. Noble says, “the soccer mom who instead of going to buy a bottle of wine on the way home, buys a vape pen for an evening with friends.”

That is why U.S. expansion is important. Canadian cannabis sales are about $2 billion a year with an expected peak of $6 billion. The U.S., with its patchwork of state legalizations, is already a US$15 billion market. It also has a much more appealing business model.

Ontario growers cannot own retail stores. In the U.S., companies can do both, a ‘seed to sale’ structure. Companies can have licenses in all 11 states where pot is legal, but without federal legalization can only sell in the state where they have a license. This means 11 separate sets of operations. Federal legalization sweeps that restriction, away allowing for enormous economies of scale.

Martha Stewart has launched a line of hemp-derived products which can be purchased on her web site, including Meyer lemon and blood orange-flavoured gummies. They are made by Canopy Growth Corp. (TSX: WEED). Cronos Group Inc. (TSX: CRON) has signed a deal with actress Kristen Bell (one of the voices in the animated film “Frozen”) for a cannabis-infused line of bath and body care products.

U.S. federal legalization would allow pot companies to have a primary listing on the New York Stock Exchange or Nasdaq. They cannot do that now because, without a federal law, it is illegal.

So, Cronos, Canopy Growth and Aphria Inc. (TSX: APHA) all have listings in New York but cannot do business there. Companies like Curaleaf Holdings Inc. and Trulieve Inc. have U.S. operations but cannot list in New York or the TSX for the same reason. The TSX decided to follow New York’s lead. The companies trade here on the Canadian Securities and NEO exchanges.

The Horizon’s ETF (HMMJ) has assets of $383 million and includes the large cannabis companies in Canada. For the six-months ending Sept. 30, the ETF was down 0.09%.

Its US Marijuana Index ETF (TSX:HMUS) holds predominantly Canadian CSE or NEO-listed companies that are U.S. multi-state operators. It is up 45.6% in the same period, though it is much smaller with just $23 million in assets.

Even with legalization, Mr. Noble says the Canadian players face an uphill climb. The multi-state operators are rapidly building marketing and distribution channels and creating branded products.   

He believes that companies including Canopy, Curaleaf, and Cronos have the best chance to move south quickly. They have cash to invest and executives with consumer marketing expertise. But each passing month makes it that much harder.

“In the early days of the internet, you knew it was going to be a transformative business,” he says. “But had you invested in America Online or Palm Pilot, which was the first mobile handheld device, you got it wrong.”

This is an edited version of article that appeared in the Internet Wealth Builder on November 2, 2020.

Adam Mayers writes about investing and personal finance. He is a contributor to the Globe & Mail’s Globe Advisor and a contributing editor to Gordon Pape's Internet Wealth Builder newsletter. Adam was Business Editor and investment columnist at The Toronto Star and is the author of six books.

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