The prospects of Canadian cannabis firms cashing in on the lucrative U.S. market are fading.
The big money in the Canadian pot business has always been eventual massive exports to the U.S. and Canadian-owned pot operations in America.
But investors are learning that the U.S. market might not be the bonanza that industry hype has long made it out to be.
And that full access to the American market will take much longer than expected.
Shares in the biggest Canadian cannabis firms have fallen sharply from their peak prices last winter.
That earlier investor enthusiasm was driven by reports of strong sales growth in the U.S. market.
The bulls also anticipated U.S. legislation this year that would for the first time make commercial cannabis legal at the federal level.
Alas, both of those factors turn out to be examples of the false hope that has underpinned this industry for years.
On closer inspection, the U.S. revenue growth in cannabis is underwhelming. And so is the surprisingly restrictive U.S. draft legislation that would legalize pot federally, unveiled on Capitol Hill last week.
Meanwhile, as Canadian firms wait to enter a fully legal American market, their U.S.-based rivals are becoming more formidable and deeply entrenched, operating in the states that have legalized recreational or medicinal pot or both.
Investors need to take a closer look at the U.S. market’s key characteristics.
To start, fewer than half of the 50 states have legalized cannabis for adult use.
You could look at that as potential for upside growth, but it will be a long time coming.
Cannabis is intensely political, and state decisions on pot legalization are subject to political partisanship and lobbying by anti-pot groups.
The latter’s objections run the gamut from pot as a gateway drug to cocaine (a canard that just won’t die) to stoned operators of heavy equipment.
So far, and likely for a long time to come, the U.S. cannabis market is regional.
The air went out of the latest bubble in Canadian pot stocks when investors realized that the seemingly impressive 46 per cent growth in U.S. cannabis sales last year was concentrated in a handful of mature markets.
Those include Colorado, Oregon, California and other U.S. states where pot has been legal for the longest periods.
And in California, America’s biggest pot market, sales were up just 21 per cent last year, half the U.S. national average.
In most industries, that kind of double-digit growth would be impressive. It does not, however, justify the sky-high stock-market valuations of the biggest Canadian pot companies.
Come to that, the U.S. cannabis market is forecast to merely double in size over the next five years, to $41 billion (U.S.). That forecast, by a bullish cannabis consultancy, amounts to 27 per cent growth per year.
That’s not enough to support the scores of publicly traded North American pot companies, a great many of them listed on Canadian exchanges.
That sum, five years out, is roughly equal to annual U.S. craft beer sales.
And it’s shy of the $46.9 billion (U.S.) in revenues of beer giant Anheuser-Busch InBev in 2020 alone. And 2020 was a bad year for AB, whose Bud sales tanked with the pandemic closure of sports and concert venues and neighbourhood bars.
The cannabis sector just isn’t that big, nor is pot destined to become more than a niche product.
Meanwhile, the black market that pot legalization is meant to displace continues to thrive. In the U.S., it remains a $100-billion (U.S.) business, far eclipsing the size of the legal trade, despite years of inroads by commercial cannabis firms.
Pot-stock bulls point excitedly to Colorado, where market penetration is highest, with about 48 per cent of Coloradans imbibing.
“Close to 50 per cent market penetration is really compelling,” Kelly Nielsen of the cannabis sales data platform BDSA told Forbes, “as alcohol penetration is around 60 per cent.”
The supposed affinity between cannabis and beverage alcohol explains the booze sector’s investments in selected pot firms, notably Constellation Brands Inc.’s controlling stake in Canada’s Canopy Growth Corp.
But benchmarking against alcohol makes little sense, given the gradual decades-long decline in alcohol consumption. And pot, when consumed as it usually is by smoking it, faces further limits to growth due to anti-smoking restrictions widespread in North America.
As this space has argued earlier, the number of pot firms will shrink drastically, with only a few of the biggest firms surviving. Even they will be vulnerable to takeover by giant, long-established beverage and tobacco companies with vastly larger distribution systems.
It is difficult, for instance, to think of Canopy Growth as a viable long-term business.
Despite being one of the Canadian industry’s two giants, along with Tilray Inc., the Ontario-based Canopy has seen its revenue growth slow to what passes for a crawl in what is supposed to be a fast-growth industry.
Canopy’s revenue growth last year was just 37 per cent, half the previous year’s growth rate, and less than one-fifth its sales growth in 2019.
Two years after replacing a growth-obsessed Bruce Linton as CEO, Canopy continues to post mounting losses. The firm’s loss in fiscal 2021 of $1.7 billion was a 31 per cent increase over the previous year. Canopy’s losses have increased in each of the past four years, for a total of $3.8 billion, a sum that exceeds its total revenues during that period.
Even at its current share price of $24.73, down 63 per cent from its peak in February, Canopy stock remains overvalued.
The same applies at Tilray, which hopes to capitalize on increased market share after its recent merger with rival Aphria Inc.
But the Leamington, Ont.-based Tilray more than quadrupled its losses in 2020, despite more than doubling its revenues. Its share value has fallen 31 per cent from its February peak.
Meanwhile, the U.S. draft legislation to legalize cannabis federally, unveiled July 14, is stillborn.
Public-health lobbyists oppose it for its lack of a cap on marijuana potency. Some Democratic U.S. senators are tying it to legislation that would release prisoners whose crime was marijuana possession. And the union representing about 10,000 cannabis workers is demanding a bill that provides better pay and workplace protections for its members.
In other words, it will be a long time before a semblance of this legislation gains passage, and Canadian pot firms finally have the full U.S. market access on which their business plans have always been based.
For now, the global investors that once swooned over Canada’s legalized pot firms have shifted their attention — and money — to fast-growing U.S. firms like Curaleaf Holdings Inc. The Massachusetts firm’s sales now top those of Canopy, once the world’s biggest publicly traded pot company.
Today’s cannabis stock-market darlings are the big U.S. multi-state operators like Curaleaf, Green Thumb Industries Inc., Cresco Labs Inc. and Trulieve Cannabis Corp.
Even those stocks are vulnerable to the sector’s notorious volatility.
It remains the case that the best investment in cannabis is to buy the weed itself and enjoy it with your friends.