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Why the Coronavirus Is Bad News for Pot Stocks

By Sean Williams - Feb 11, 2020 at 7:51AM

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The North American cannabis industry is more reliant on China than you probably realize.

Last year was a wake-up call for marijuana stock investors. For years, pot stocks had ascended to the heavens on promises of strong demand, rapid growth, and an expected quick push into the profit column. This vision looked especially feasible given Canada's legalization of recreational weed, support for legalization among the public throughout the United States, and the tens of billions of dollars in sales conducted annually on the black market.

But when the curtain closed on 2019, it turned out to be the worst year on record for cannabis stocks, with many losing at least half of their value over the final nine months of the year. In Canada, supply shortages and bottlenecks reared their head, while high tax rates in select U.S. states (ahem, California) made it impossible for legal players to compete with black-market pricing.

Following such a miserable year, the expectation has been that 2020 will be a rebound year for pot stocks. However, certain circumstances might prevent that from happening.

Two surgeons examining a chest X-ray.

Image source: Getty Images.

The novel coronavirus is bordering on a pandemic

As you may already be aware, a novel form of coronavirus -- a virus that typically affects mammals and birds but has recently been found in humans and is capable of causing respiratory distress -- has been garnering a lot of headlines. This novel coronavirus, known simply as 2019-nCoV, originated in Wuhan, within China's Hubei province, but has spread to 25 countries, with 37,558 confirmed cases worldwide, as of Feb. 9, 2020. Within China, 812 people have died, with another 6,188 cases considered "severe," according to the World Health Organization. 

With fear growing that 2019-nCoV could become a pandemic, aggressive measures are being taken within China, and in various entry ports globally, to halt the spread of this virus. Some of these measures include shutting down businesses and/or quarantining large swaths of people. Since China is the second-largest economy by gross domestic product, there's almost no question at this point that its growth rate will be adversely impacted, at least in the short term.

However, this isn't just a China story. A number of industries lean on Chinese manufacturing and supply chains because of their relatively low labor costs and ability to mass-produce potentially commoditized products. One of those surprising industries that could be in big trouble as a result of 2019-nCoV is the marijuana space.

Potted cannabis plants growing under special lights.

Image source: Getty Images.

Direct and ancillary cannabis stocks could suffer because of the novel coronavirus

Both direct and ancillary players within the pot industry could be adversely impacted.

For example, direct players, such as growers, purchase everything from lighting systems to HVAC systems from China. After contending with potentially higher price points for these products in 2019, which was a result of the trade war between China and the U.S., 2020 could be marked by shortages of LED light bulbs or the materials used to make efficient HVAC systems. Considering the supply problems in Canada, this may not be all that noticeable. But for vertically integrated U.S. pot growers, this could be worrisome.

However, the most pain, at least in the short term, could be felt by ancillary pot stocks that don't come into contact with the cannabis plant, but are nevertheless imperative to the industry's operation.

Utilizing the example above, Cree (WOLF -1.28%) is a lighting-solutions company that manufactures LED bulbs for enterprises and individuals. Although the cannabis industry still leans on high-pressure sodium (HPS) bulbs (because crop yields are predictable with HPS lighting), LED bulbs are becoming more popular given that they last longer, use less electricity, and produce far less heat than HPS bulbs. The problem is that Cree relies heavily on its Chinese manufacturing facility to produce these efficient LED bulbs. If virus-related work stoppages continue, an LED shortage could ensue for Cree.

A bearded man with sunglasses exhaling vape smoke while outside.

Image source: Getty Images.

Ancillary player KushCo Holdings (KSHB) may also feel the sting of 2019-nCoV's proliferation. KushCo currently generates most of its revenue from selling vaporizers, but it also offers packaging and branding solutions, as well as sells hydrocarbon gases used in the production of cannabis oils. The thing is, KushCo sources its vaporizers from China, as well as some of its packaging materials. Depending on where in China KushCo imports its products, it could see a serious shortage of vaporizer products and accessories later this year.

A lack of vaporizers could also work its way back up the supply chain back to direct pot stocks, such as Cronos Group (CRON -0.83%). As you may know, tobacco giant Altria Group is a major investor in Cronos Group and expected to aid Cronos in its launch, branding, and marketing of vape products in Canada. Derivative pot products, such as vapes, first began hitting dispensary shelves in mid-December, and they offer much juicier margin potential than traditional dried cannabis. However, if vaporizer sales are stymied by supply/manufacturing issues tied to 2019-nCoV, then one of the biggest perceived moneymakers of the derivatives movement could stall.

While I believe caution is certainly merited given the early stage manufacturing disruption we've witnessed throughout parts of China, it's also worth noting that previous health scares, such as Severe Acute Respiratory Syndrome (SARS), Middle East Respiratory Syndrome (MERS), the avian flu, and Ebola, wound up doing far less economic damage than anticipated, and had a relatively short-term impact on the stock market. In short, marijuana stock investors should expect an adverse impact from 2019-nCoV, but history suggests this impact will be fairly short-lived. That's something to keep in mind as 2019-nCoV's impact is felt throughout the cannabis industry.

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Stocks Mentioned

Wolfspeed, Inc. Stock Quote
Wolfspeed, Inc.
WOLF
$64.56 (-1.28%) $0.84
Cronos Group Stock Quote
Cronos Group
CRON
$3.00 (-0.83%) $0.03
Kush Bottles, Inc. Stock Quote
Kush Bottles, Inc.
KSHB

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