In the few short years since cannabis companies first floated on stock exchanges around the world, they have developed a reputation for being volatile and high risk.
At the start, stocks exploded in value, peaking around the start of 2018. Then the hype started to fizzle, but industry experts said 2019 was the year cannabis was supposed to take off again.
However, it seems most cannabis stocks in the mature market of Canada – where the drug was legalised for medical purposes in 2001 and for recreational use a year ago – have lost at least half their value over the past year.
Compared to January, stock market data shows multi-billion-dollar companies such as Canopy Growth Corp (NYSE: CGC, TSE: WEED) and Cronos Group (TSE: CRON) have dropped by more than 50%, with Tilray (NASDAQ: TLRY) plummeting by a whopping $6.7 billion, or 74%.
Medical cannabis industry expert Dr Sud Agarwal spoke with Small Caps about the reasons behind Canada’s struggling cannabis stocks and whether Australia could be heading in the same direction.
Dr Agarwal is an internationally-recognised key opinion leader in the industry who is the chief executive officer and co-founder of Australia’s largest medicinal cannabis distribution and research company, Cannvalate.
He also serves on Impression Healthcare (ASX: IHL)’s board as a non-executive director and chief medical officer.
Oversupply in Canada
The latest crowdsourced data released by Statistics Canada has shown the average price per gram of cannabis in the third quarter (June to September) fell 6.4% to C$7.37/g (A$8.29). This is the first time the price has dropped since the country legalised the drug.
According to Dr Agarwal, this is the first “alarm bell”, reinforced by Health Canada forecasting the market heading into oversupply by the end of 2019.
“Up until now, because demand has been escalating with the recreational legalisation and export opportunities, the price per gram was always going up,” he said.
Mistrust of cultivators
In addition, Health Canada recently suspended the licence of one of Canada’s top cannabis growers, CannTrust, after it was found conducting unlicensed cultivation and providing inaccurate information to the federal regulator.
Shares in the company, which was once worth more than $1 billion, were shot down with CannTrust now being valued at around $257 million.
According to Dr Agarwal, the distrust generated by the incident had a rattling effect on the rest of the market.
“That was the first time anybody started questioning cultivators, who say they’re allegedly producing a pharmaceutical grade product but are actually not adhering to pharmaceutical quality standards,” he said.
Investors shift from upstream to downstream
Dr Agarwal said one of the reasons behind cannabis stocks’ struggling performance is investor sentiment moving away from companies exposed to cultivation.
The cannabis industry is split into upstream, midstream and downstream markets.
The upstream market is comprised of companies involved in plant cultivation, specifically growers, landowners, those who build facilities, or provide equipment or software related to cultivation.
The midstream market are the value-adding services such as manufacturers, extractors and packaging companies.
Downstream is any company considered “patient-touching” such as clinics, doctor networks and researchers.
“A general trend in the public equity markets has been the redeployment of cannabis investment capital from upstream businesses to downstream businesses, particularly those with established revenue, intellectual property, diversified income streams and other non-plant-touching businesses,” Dr Agarwal explained.
“This is an industry-wide trend towards quality, defendable intellectual property and businesses with strong recurrent revenues and line-of-sight profitability.”
He said in addition to Canada reaching an oversupply, there is now the emergence of other cannabis-growing countries including Colombia, Lesotho and Thailand – low-cost developing world nations that countries like Canada and Australia would find difficult to compete with.
“This is where several forces have aligned to create significant downward negative pressure – obviously, not good news for cultivators,” Dr Agarwal said.
Is Australia following?
However, Dr Agarwal said this may not necessarily be due to this shift from upstream to downstream, noting that Australia does not yet have a net surplus or oversupply of cultivation.
“The reason I think most of the Australian values have dropped is partly because of a market pivot to more sophisticated plays, recognising that cultivation is likely to be done by lower cost countries overseas and we’re going to be an import country rather than a grower,” he said.
“Secondly, because we’ve got so much regulation here and the cost to get anything done is so expensive, I think … it will never become cost-effective to grow locally in Australia and use our product to turn into a final product here.”
Dr Agarwal also said the tangible markers of value in the industry have changed.
“Two years ago, if we had this conversation, the tangible markers of value were having a licence and having the patch of land where you would grow it. If you had that, you would float and you’d probably be given a market value of anywhere up to $200 million,” he said.
However, he said today the barriers to getting an ODC [Office of Drug Control] licence are much lower and of the multiple licence holders, “a large number aren’t deriving any commercial benefit”.
“There’s many licence holders now, there are many more in the pipeline and the ODC is processing these applications more efficiently. We’re expecting the number of cultivation and manufacturing licence holders to go up and up and up, even before the end of this year.”
Dr Agarwal said this would only exert further negative pressure on the commercial value of licence holders as they increase in number.
He said “you would be a brave person to launch a cultivation stock in the next few months”, adding that Australian companies should focus on value-adding offerings that a developing world country may not be able to imitate, such as high-level GMP finished pharmaceutical goods manufacture, sophisticated research or patented intellectual property development”.
US gears up to knock over competition
According to Dr Agarwal, another factor to be aware of is that the US hasn’t fully joined the global cultivation race since cannabis is only legalised in selected states and exporting is still prohibited as it is federally controlled.
But when the US federal government does legalise cannabis, potentially even in the next 18 months, he said there could be an “tsunami of high quality, well-branded, sophisticated US-made products flooding the global market that will make it very hard for start-up companies in other developed countries to compete.”
“They’ve had a tremendous advantage – California legalised [medicinal cannabis] in 1996 and recreational cannabis in 2016, so they’ve had many years of practice with product development, consumer testing and business strategy.
“Americans are very good at creating global consumer-focused brands and … they’ve generally got excellent cultivation skills and know how to scale businesses multi-nationally,” Dr Agarwal added.