Poised for Secular Growth
August 27, 2020
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From our perspective, the next leg of the secular bull market in the cannabis sector has begun. Since mid-March, cannabis stocks have rebounded 80% from the record low, yet they remain down 24% so far for the year 2020 and 86% since early 2018. With U.S. cannabis revenue of $13 billion in 2019, sales of legal adult-use and medical marijuana in the United States have now topped spending on sleep aids, hard seltzer and toothpaste combined. Total marijuana sales now exceed the National Basketball Association’s average annual U.S. revenue and could reach over $30 billion by 2024, surpassing Americans’ annual spending on craft beer.
Given the shift that cannabis companies have made towards operating fundamentals in the past year, coupled with rising sales and good prospects for the upcoming legislative changes, we believe now is an ideal time for investors to consider allocating exposure to publicly traded cannabis companies. This may be the most attractive entry point we have seen in a long-term investment opportunity since the crash of the dot-com bubble in the 2000s, which set the stage for an explosion of operations-focused tech companies that came to dominate the global economy in the following decade.
-Teneo Capital Management
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Legal Cannabis Remains A Strong Investment in COVID-Ravaged Economy |
Despite the American and global economies being rocked by the coronavirus pandemic and the ensuing economic downturn, the fundamentals of the top U.S. cannabis companies are strengthening across the board. We continue to see revenue increases in the industry despite the pandemic, with multiple states across the country reporting record cannabis sales. We here at Teneo Capital Management remain bullish on our long-term thesis that the cannabis industry’s growth and maturity will coincide with regulatory catalysts that will drive increases in revenue and profitability, and ultimately capital appreciation for our clients. For investors looking for a relatively safe investment during what could be a prolonged recession, cannabis stocks may be one of the smarter plays in the market today. |
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Online Advancements Herald Next Chapter In Cannabis Profitability |
A recent industry driver, online technology has broadened customer access and greatly increased demand for legal cannabis. Having granted cannabis businesses with essential status, many states have allowed for curbside pick-up or delivery, which was not available in many markets previously, and we believe that these measures are likely to be made permanent. Moreover, new modes of delivery have enabled companies to implement online ordering—a massive advantage over the illicit market—as consumers are now able to purchase cannabis products in the same manner as many other consumer products online. This has been enabled by several new payment processing options that facilitate electronic payment rather than cash, furthering the case for legal market advantage. |
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Expanding Access to Capital and Legalization Promise MSO Growth |
As we move into this next phase of development, we believe that many of the U.S. cannabis multi-state operators (MSOs) are well positioned, considering how well they are already executing with the many existing obstacles they face, including onerous tax treatment, limited access to capital, and being relegated to junior Canadian stock exchanges. Despite these impediments, the leading MSOs are breaking through the $100 million quarterly revenue milestone and operating at or near profitability. Moreover, only 11 of 50 U.S. states have legalized cannabis for adult-use, and cannabis remains a Schedule I controlled substance at the federal level, leaving significant room for growth and expansion as normalization progresses.
To be clear, not all MSOs are created equal. The differences are becoming apparent, with several MSOs being able to raise debt capital and execute sale/leasebacks, allowing them to fund growth without dilution. We expect that those companies with access to capital and the ability to generate cash flow from operations will gain share (and we are tracking several private MSOs that share these characteristics as well). Many U.S. operators, particularly those with a strong focus on operating fundamentals, have already started to see their valuations rebound off the lows from late 2019 and early 2020. However, these companies should still have significant room to grow as we anticipate the passage of adult-use legalization in New Jersey and Arizona this November, which could propel legalization in neighboring states of New York, Pennsylvania, Connecticut and New Mexico soon after.
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SAFE Banking Act Promises Access to Banking and Investment Capital |
It is not yet clear how things will play out, but with federal reform on the horizon, there is the potential for a huge boost in the valuations of American publicly traded cannabis companies. Primarily, the SAFE Banking Act would provide access to banking for cannabis businesses in the U.S. and would immediately reduce their cost of capital. Further, this legislation could allow the major U.S. stock exchanges to view listing MSOs as riskless to them legally, which would dramatically expand the cannabis sector investor base, particularly among institutional money managers. The SAFE Banking Act already passed the House of Representatives as a standalone bill in 2019, and again as part of the HEROES Act, the latest attempt at a Covid-19-relief package in the House, and could be included in other pending legislation, such as the Bank Secrecy Act-Anti-Money Laundering (BSA/AML) bill that is expected to pass prior to the November elections. In essence, with multiple shots on goal, efforts are underway to ensure that support for cannabis businesses is rising and poised to inject new life, protections, and capital into this growing industry. |
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