What goes up must come down, right? Well, not if you're invested in the marijuana industry. Since the year began, the Horizons Marijuana Life Sciences ETF, which holds around four dozen pot stocks in various weightings, has risen by 63%, through March 5. Since April 2017, when this cannabis-focused exchanged-traded fund debuted, it's up nearly 110%.
It's no secret that investors and Wall Street are expecting big things from the legal pot industry. Cowen Group has aggressively called for $75 billion in global sales by 2030, with investment bank Jefferies projecting the industry could one day hit $130 billion in annual sales. But not every stock or every marijuana trend is necessarily going to be a success.
As I peruse the cannabis industry, I see three trends for 2019 that look to be overhyped. Should one or more of these trends fall flat, a period of reckoning could await pot stock investors.
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1. CBD beverages
I'm not sure there's been a trend more overhyped since last summer than the expectation that cannabidiol (CBD)-based beverages were going to take off. CBD is the nonpsychoactive cannabinoid best known for its perceived medical benefits.
The hype really began when Molson Coors Brewing (TAP -0.75%) announced a 57.5%-42.5% joint venture with Quebec-based cannabis grower HEXO (HEXO) on Aug. 1. Till this point, HEXO was a relative no-name that had snagged a huge supply deal with its home province, but was otherwise off the radar. Meanwhile, Molson Coors had seen years of declining North American alcohol sales, as well as a precipitous loss of beer market share in Canada. The duo will be researching and developing a line of cannabis-infused nonalcoholic beverages under the Truss brand, with an expected launch during the fourth quarter of 2019.
Soon after Molson Coors and HEXO tied up, we witnessed a major equity investment from Modelo and Corona beer maker Constellation Brands into Canopy Growth (CGC -0.66%), and in December saw Tilray and Anheuser-Busch InBev form a $100 million joint venture for infused beverage research and development.
Here's the problem: Infused beverages aren't yet legal in Canada. Regulatory agency Health Canada has outlined plans to legalize new consumption options by no later than the one-year anniversary of when recreational weed went on sale (Oct. 17), meaning by then we could see a slew of competitors champing at the bit to nab their piece of the pie.
Aside from just Molson Coors, Constellation Brands, and AB InBev, The Green Organic Dutchman is devoting about 20% of its peak annual output to edibles and infused beverages, and Heineken has been testing infused beverages in select California locations. The market for CBD beverages is going to be far more cramped than investors realize, and it simply may not be the needle mover that Wall Street and investors are expecting.
Check out the latest earnings call transcript for Canopy Growth and other companies we cover.
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2. Industrywide consolidation
A second trend that's received a lot of hype over the past year is that of industry consolidation.
As with any rapidly growing industry, there are often far too many companies that want in. Wall Street and investors have been expecting buyouts and mergers throughout all facets of the supply chain, and they're counting on this consolidation to create value and reduce expenditures via cost synergies and less competition. But what if industry consolidation doesn't go as planned?
With the exception of Aurora Cannabis (ACB -2.96%) in the grow industry, which appears hell-bent on buying everything within arm's reach, and the vertically integrated dispensary model, we haven't seen much in the way of buyouts or mergers. And what we have seen, thus far, is enough to make fundamentally focused investors cringe.
There's no doubt that Aurora's acquisitions have played a key role, along with its organic projects and partnerships, in pushing it to the projected No. 1 spot in peak annual production. Yours truly expects Aurora Cannabis to yield 700,000 kilos a year by 2021 or 2022, which may give it close to 20% market share, based on production.
However, the company has grossly overpaid for its acquisitions, as evidenced by the growing amount of goodwill it's carrying around on its balance sheet. While we'd certainly expect some goodwill following a buyout, 63% of the company's total assets (more than $3 billion Canadian) were tied up in goodwill at the end of its fiscal second quarter. In other words, Aurora Cannabis will need to make up billions of dollars via cost synergies and other growth avenues to justify its acquisitions, otherwise very large future writedowns may await.
It may be early, but there's plenty of hype and little substance surrounding merger and acquisition activity in the marijuana industry.
Image source: Getty Images.
3. Profitability
Last, but not least, Wall Street and investors have been hyping the presumed imminent inflection point that'll see marijuana stocks turn from consistent money-losers to moneymakers.
According to a report issued by Arcview Market Research and BDS Analytics, global weed sales are expected to grow by 38% in 2019 to $16.9 billion. That's a lot of money, and the thesis is that it'll help push quite a few companies into the black. For instance, Cowen Group recently initiated coverage on Aurora Cannabis with an outperform rating, proclaiming it'll be the first top-tier grower to generate positive EBITDA (earnings before interest, taxes, depreciation, and amortization).
But there's a lot that the path to profits narrative leaves out.
For starters, it ignores the Canadian weed supply shortage that pretty everyone saw coming prior to legalization, other than Canadian regulators. With many growers still in the process of expanding capacity, and regulatory agency Health Canada buried by a backlog of cultivation license and sales permit applications, there's no quick fix for Canada's supply problems. In fact, some Wall Street firms wound up reducing Canopy Growth's revenue estimate in its most recent quarter by approximately 40% as a result of cannabis shortages.
It also assumes that no other hiccups will be encountered, which is unlikely. Costs to build up recreational and medical cannabis brands, market those brands, push into international markets, and potentially make acquisitions, are all reasons losses should be the expectation in 2019, and perhaps even 2020. As a reminder, Canopy Growth has lost more than CA$402 million on an operating basis over the past nine months of fiscal 2019 -- and it's a supposed industry leader.
Long story short, profitability in the marijuana industry looks to be overhyped for the time being.
