2021 could be the year cannabis valuations return to their former glory, after the ongoing COVID-19 market turmoil might have shown investors where the bottom of the market is.
Global and North American cannabis indices have recovered after hitting all-time lows in April.
Mike Curtis, director of North America-focused cannabis investor MMJ (ASX:MMJ), says this isn’t just a dead cat bounce — the idea that “even a dead cat will bounce if it falls from a great height” — but evidence of a lot of quiet work within the industry to get set for the next round of growth.
But more than that, he says companies like MMJ which have used this period to invest and prepare for a recovery led by industry fundamentals, are set to grow hard and fast.
The world cannabis industry is led by Canadian majors and closely followed by US companies.
After some event-driven peaks in 2018 and 2019 — legalisation of hemp in the US and legalisation of recreational cannabis in Canada being two major events — the trend for stock valuations has mostly been down, according to New Cannabis Ventures.
Canada legalised medical marijuana in 2001, but it was the initial legalisation of adult use cannabis in October 2018 that got the world’s attention.
Across Canada people invested in growing facilities, farm-to-pharma and farm-to-retail operations, and put enormous amounts of money into making and selling dried flower.
In May 2018, Canadian producer Canopy Growth became the first marijuana company to list on the New York Stock Exchange. Its share price doubled within six months to $US52.03 ($84.17).
In October 2019, the market was widened to include edibles and vapes, exposing a structural flaw in the industry.
“Licensed producers over-invested heavily in facilities to grow cannabis, but not in making the high-value products that will appeal to a greater number of people,” Curtis says.
“In the last six months of 2019, expectations had been building around retail earnings, namely that they were going to justify the huge capital expenditure these companies had made and the investment they’d asked for to pay for them.”
But in January those expectations were dashed because although some reported triple digit growth, few were nearing profitability.
Canopy Growth is now trading at $US14.46.
Now the cannabis bubble may have burst, market stresses are laying the groundwork for a strong recovery in 2021.
MMJ has been taking advantage of the slump to invest in a range of businesses across the industry but focusing on extraction — the section of the sector that is catering to demand for edibles and vapes.
“Now we’re in the fun times when we can figure out who the winners will be,” Curtis says.
He is picking the bigger licensed producers such as Canopy and Aphria to survive, and even those with debt burdens like Aurora Cannabis are taking the necessary steps to become profitable.
Companies that can’t be immediately profitable and don’t have capital on hand now are unlikely to do well.
“If you look at the sector from a historical perspective, the year after a bubble has burst tends to be mildly positive — that’s 2020 — and the oversupply and over capitalisation is being integrated,” Curtis says.
“The year after is when an industry kicks and the businesses that survive become highly profitable.”
Curtis expects 2021 to be the breakout year for Canadian cannabis and MMJ is positioning itself to be able to deploy its cash to take full advantage of that boom.