The cannabis industry has been no stranger to volatility since legalization in Canada, but 2021 was surely the lowest point of the last three painful years.
After two years of restructuring, investors expected a year of recovery. Instead, a hopeful start turned into more of the same – a grinding, year-long sell-off, leaving cannabis as one of the worst-performing sectors on North American stock exchanges.
If there’s any hope for 2022, it will lie in the U.S., the largest global market for cannabis products, analysts say. There may be some movement toward federal decriminalization and legalization, but with midterm elections in November, the odds of anything major happening are slim.
“Last year was a disappointment, there’s no question about it,” says Mark Noble, executive vice president of exchange-traded fund (ETF) strategy, at Horizons ETFs Management (Canada) Inc. in Toronto. “It was disappointing across the board.”
Horizons ETFs has two cannabis ETFs. Horizons US Marijuana Index ETF HMUS-NE with about $20-million in assets under management (AUM), invests in U.S. cannabis companies. It fell by 33 per cent in the year ended Dec. 31, 2021. Horizons Marijuana Life Sciences Index ETF with $267-million in AUM, holds Canadian and U.S. companies. It declined 18 per cent in the same period.
The biggest North American cannabis ETF in the U.S. is AdvisorShares Pure US Cannabis ETF MSOS-A with US$1.1-billion in AUM. It fell 30 per cent in the year ended Dec. 31, 2021.
In comparison, the broader markets had double-digit growth. The S&P/TSX Composite Index rose 22 per cent in 2021, while the S&P 500 index gained 27 per cent.
“There was a lot of excitement in late 2020 about U.S. legalization. Maybe there was too much excitement,” says Dan Ahrens, portfolio manager at AdvisorShares Investments LLC in Dallas. He manages AdvisorShares Pure US Cannabis ETF actively.
In Canada, too many players are still chasing too few customers, with complicated regulations and restrictive marketing rules.
“There’s way too much supply relative to demand,” Mr. Noble says. “The joke is we have more pot stores than gas stations – and they’re empty.”
In the U.S., the midterm elections taking place later this year are making hopes for a federal law complicated, even though more states are passing favourable laws. Medical cannabis is legal in 37 states while 18 states now allow cannabis for recreational use. Public opinion is firmly on the side of legalization with a November Gallup Inc. poll finding 68 per cent of Americans support it.
The U.S. matters because of its size. U.S. consumers generated US$26-billion in sales of medicinal and recreational marijuana products in 2021, 80 per cent of the global total, Mr. Noble says.
The catch is that without a federal law, companies can only sell cannabis within the state in which they have a licence. They need a separate license and standalone operations in each state. As cannabis is a federally banned substance, banks cannot lend nationally, and pension and endowment funds cannot invest. Nor can the companies be listed on the New York Stock Exchange or the Nasdaq Stock Exchange.
“I’ve given up talking about politics and the timing of legalization,” Mr. Ahrens says. “It’s a fool’s game. But it’s a ‘when’ issue, not an ‘if’ issue.”
Mr. Noble believes the midterm elections mean gridlock, but Mr. Ahrens is more optimistic. He says incremental change is possible this year and sees the path forward as reform in bits and pieces until one last change opens the floodgate.
“The first domino is perhaps something like expunging records or reform on convictions,” he says.
Mr. Ahrens believes only a few large Canadian producers have a chance to get into the U.S. when this happens, including Tilray Inc. TLRY-T and Canopy Growth Corp. WEED-T. But it will be difficult because U.S. companies have the licences, established businesses, and are growing quickly. His favourite Canadian player is Village Farms Intl. VFF-T which has greenhouses in Canada and the U.S.
Mr. Ahrens says U.S. companies are leaner, more frugal, and more careful about expansion. They didn’t have easy access to investors or financing and have grown incrementally as a result.
“U.S. laws forced multi-state operators to go for smart growth, so now they have solid balance sheets, combined with terrific revenue growth,” he says. “That was absolutely not the case in Canada.”
There are a handful of good companies, but others have been “dumpster fires” of financial mismanagement, he says.
“There’s been excessive executive pay, waste, growth followed by shutting down facilities, laying off employees, and then destroying their oversupply of marijuana.”
Both Horizons US Marijuana Index ETF and AdvisorShares Pure US Cannabis ETF have the same top holdings. Trulieve Cannabis Corp. TRUL-CN , Green Thumb Industries Inc. GTII-CN , Verano Holdings Corp. VRNO-CN and Curaleaf Holdings Inc. CURA-CN all of which are profitable.
Mr. Ahrens and Mr. Noble say there’s some consolation in the fact that the pain has been priced into cannabis stocks and the next move is likely higher – although that may not be much comfort to current investors.
“With shares prices as depressed as they are, the top operators are spring-loaded,” Mr. Ahrens says.
Mr. Noble adds: “If an investor is willing to have patience, this is a very interesting entry point.”