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The Coronavirus Is Causing Big Problems for the Cannabis Industry

By David Jagielski - Updated Mar 13, 2020 at 2:22PM

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Supply-chain disruptions are making things even more challenging for pot stocks.

The coronavirus has put many investors on edge as of late, with the markets recording some of their biggest losses in decades. There's a lot of fear out there related to the virus and COVID-19, the illness it causes. Stocks are plummeting, with the S&P 500 down more than 20% year-to-date as of Friday afternoon. The Horizons Marijuana Life Sciences ETF (HMLSF 1.28%), however, has dropped by more than 40% over the same period. And the problem isn't just that investors are ditching pot stocks for safer investments -- the coronavirus is causing some serious issues for the industry that could affect the performance of many companies in 2020.

Vape components primarily come from China

China is responsible for more than 90% of the components that make up vaporizers for the cannabis industry. And while some factories are up and running in China, they're certainly not at full capacity. That creates a problem for companies banking on vape products for growth. Cronos Group (CRON 2.49%), for example, sees vaping products as a key part of its strategy. Last year, the company announced it was opening a start-of-the-art facility in Israel to help it create next-generation vaporizers.

The problem, however, is that if the components are coming from China, such a facility may end up sitting idle, incurring costs without any potential revenue to make up for them. And the longer Chinese factories aren't operating at full capacity producing vaporizer components, the more significant an effect there will be for cannabis companies, including Cronos. Because cash isn't plentiful in the industry, many vape manufacturers don't have the luxury of making large, significant bulk orders of vape components to secure a great deal of supply and avoid running into a shortage.

Vape pen.

Image source: Getty Images.

The vulnerability puts many cannabis companies at the mercy of these Chinese factories, as the alternatives are few and far between. And even if the factories are back up and running in a few weeks or months, they'll likely be backlogged with orders, which will slow the process even further. In addition, the lead time for companies manufacturing vaporizers needs to be taken into account as well. Receiving the components will represent the start of the process -- in reality, it could take a lot longer for companies to resume, and complete, production runs after that. Unfortunately, this all adds up to what could be a very lengthy delay in the production of vaporizers and vaping equipment.

Packaging presents another issue

Another area of concern for cannabis companies is in packaging. China produces low-cost packaging for many industries, including cannabis. Although companies can source packaging from other parts of the world, the coronavirus has reached dozens of countries, making it very difficult to avoid at this point. And changing suppliers is not something that companies take on lightly, as that too could take considerable time.

If customers source packaging from China -- or any other part of the world where there's a coronavirus outbreak -- there will be questions about safety. Andrew Kline, the director of public policy for the National Cannabis Industry Association, points out there are many questions companies in all industries should be asking with respect to manufacturing processes: "Are they wearing masks? Are people sneezing on the things they're putting together? Are they testing employees for the virus? What actions are they taking? It's a real issue that's not just going to affect cannabis."

What does this mean for investors?

In the case of Cronos, the company has a strong investor in Altria Group (MO 1.10%) that can help it during these challenging times by offering guidance and financial support for what may be a lengthy slowdown for many industries. And with close to 1.5 billion Canadian dollars in cash and cash equivalents on its books as of Sept. 30, Cronos is in a much stronger position than many of its peers.

But that doesn't mean these supply-chain issues won't negatively affect the company's financial results and weigh down the share price even further. The pot stock is already down more than 30% so far in 2020, and investors may see it as more of a risk than other cannabis companies because of its exposure to vaping. More than 2,800 people in the U.S. have suffered lung injuries as a result of vaping, meaning it's a segment of the industry that's already been a concern for investors. Adding supply-chain problems into the mix will only exacerbate those issues.

Many cannabis stocks, including Cronos, are trading near their 52-week lows as a result of the stock market's struggles. And while it may be tempting to buy at these levels, investors should take a careful look at a company's fundamentals and cash to assess how strong it is -- and how likely it is to withstand the headwinds the coronavirus has caused. While Cronos may be in good shape, the same cannot be said for many of its peers that don't have the benefit of having a big investor like Altria to help offer support.

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Stocks Mentioned

Cronos Group Stock Quote
Cronos Group
CRON
$3.08 (2.49%) $0.07
Altria Group, Inc. Stock Quote
Altria Group, Inc.
MO
$41.62 (1.10%) $0.46
Horizons Marijuana Life Sciences Index ETF Stock Quote
Horizons Marijuana Life Sciences Index ETF
HMLSF
$2.85 (1.28%) $0.04

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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