If any investors had been wondering how long it would take for the marijuana industry to shed its moniker as "taboo" and become a legitimate business model, wonder no longer.
Last year was a game changer in many ways for the cannabis industry. Canada became the first industrialized country to legalize adult-use weed, the U.S. Food and Drug Administration approved its first cannabis-derived drug, and President Trump signed the Farm Bill into law, legalizing hemp and hemp-based cannabidiol (CBD). Any doubts about marijuana being a valid business model were tossed out the window.
Of course, it was a generally miserable year for pot stocks, with 10 somewhat prominent companies losing at least half of their value. Perhaps the one bright spot was the surge witnessed in marijuana stocks that partook in the cannabis-infused beverage craze.
Cannabis-infused beverages were all the rage in 2018
As the name suggests, a cannabis-infused beverage aims to incorporate CBD and/or tetrahydrocannabinol (THC) into an alcoholic or nonalcoholic beverage. CBD is the nonpsychoactive cannabinoid best known for its perceived medical benefits, whereas THC is the cannabinoid that gets a user high. Alternative consumption options that don't involve smoking cannabis are gaining steam, and there's a realistic chance that infused beverages could draw in consumers who've never tried a cannabis product before.
Fueling this excitement were no shortage of brand-name deals announced last year. It began with Molson Coors Brewing (TAP -0.54%) and Quebec-based HEXO (HEXO -4.92%) forming a joint venture on Aug. 1. Molson Coors has seen its share of beer sales decline in Canada over the past decade, and its U.S. sales haven't been all that impressive, either. By partnering with HEXO, which'll likely be a top-10 producer by peak annual output, Molson Coors gets its foot in the door in a fast-growing industry, while giving HEXO the marketing leadership it needs.
Two weeks later, Corona and Modelo beer maker Constellation Brands (STZ 0.86%) announced its intent to make a $4 billion equity investment into Canopy Growth (CGC -0.12%). This actually marked Constellation's third investment in Canopy since October 2017 and, unlike the Molson-HEXO deal, was about more than just a partnership. This investment demonstrated Constellation Brands' belief that marijuana had transformed into a legitimate business model. Of course, the duo is still expected to develop and market infused beverages in the near future.
More recently, Anheuser-Busch InBev and Tilray announced a $100 million joint venture that'll see this duo researching various infused beverages and, presumably, bringing products to market sometime in 2019. Having originally bowed out of the infused-beverage craze, Anheuser-Busch believes Tilray's superior branding could be the key to a successful beverage line in Canada, and possibly beyond its borders.
The space would appear ripe for a serious wave of expansion in 2019. But looks can be deceiving.
Investors should be concerned about infused-beverage stocks in 2019
What hasn't been mentioned up to this point is that cannabis-infused beverages, regardless of whether they contain CBD or THC, aren't yet legal in Canada. When Parliament passed the Cannabis Act in June, it did so by making only dried cannabis flower, cannabis oil, and sublingual sprays legal. Other forms of consumption, such as edibles, vapes, topicals, concentrates, and infused beverages, were deemed to be far more complicated and would require further discussion. Parliament has vowed to discuss and, presumably, legalize these options in 2019, but the green flag can't be waved until lawmakers in Canada act. That puts this industry at a disadvantage during a time when domestic demand for marijuana products is exceptionally high and cannabis shortages are pervasive.
Also understand that not all brand-name beverage companies are on board with the concept. In mid-September, it was reported that Coca-Cola (KO -0.02%) was considering making an equity investment in, or partnering with, Aurora Cannabis. Coca-Cola had previously held discussions with Aphria as well that didn't end in a deal. Ultimately, Coca-Cola wound up walking away without a partnership or investment, with management suggesting that it'd rather monitor the marijuana space from the sidelines. In other words, despite plenty of sales potential, companies like Coca-Cola understand that hiccups are likely in the early going.
Another possible issue is competition. When Molson Coors-HEXO and Constellation-Canopy announced their deals, the opportunity awaiting infused beverage makers seemed huge. But now, Anheuser-Busch InBev has entered the space, Heineken is selling infused beverages in select California locations, New Age Beverages has announced a line of CBD-based beverages, and The Green Organic Dutchman is devoting about 20% of its peak production to edibles and beverages. This could be a crowded space, and that wouldn't be a good thing for margins.
Lastly, there's little guarantee that cannabis-infused beverages turn into much of a needle mover for the companies involved. According to investment banking firm Canaccord Genuity, the U.S. infused beverage market could be worth as much as $600 million by 2022. Mind you, the U.S. isn't a "legal" market for marijuana products, but it would dwarf Canada in total sales of all pot products if it were legal. Even if Canada's infused beverage potential were similar or somehow larger since it's legal, we're only talking about perhaps $1.2 billion to $1.4 billion in North American infused beverage sales by 2022, in my best estimate. That's not a lot in annual sales, especially if it's being split up between a growing number of entrants.
What's more, as noted, competition could drive down pricing which, in turn, would weigh on the margins of these beverages. That would make them not much of a needle mover for brand-name companies with billions of dollars in existing sales, while having a less-than-stellar impact on Canadian pot stocks.
In other words, cannabis-infused beverage stocks could go flat just as easily as they could succeed.
Check out the latest Molson Coors Brewing earnings call transcript.