With the Core Consumer Price Index (CPI) signaling an annual inflation rate of 8.6%, rising costs are the talk of the town for good reason. And while some growth industries might not feel the sting of inflation very sharply due to their pricing power, unfortunately the cannabis industry is likely to face new struggles.
The challenge of inflation is happening at a time when most of the major cannabis companies aren't profitable, which exacerbates the issue. And there isn't much hope for conditions to improve very soon. Will inflation be a brutal bugbear for the marijuana industry and prevent it from growing as quickly as investors expect?
Two new inflation-related headwinds will challenge cannabis businesses
Despite what some enthusiasts would suggest, cannabis products aren't necessary for people to live their daily lives. When inflation starts to squeeze wallets, discretionary purchases like marijuana will be the first to go, whereas must-have items like prescription medications and more mundane goods like toilet paper will be just as in demand as always.
The more that wage growth lags inflation, the more pronounced this effect will be. And with President Biden predicting on June 12 that "We're gonna live with this inflation for a while," the cannabis industry is very likely to experience an inflation-driven slowdown stemming from shrinking demand for more than a quarter or two.
In addition, cannabis stocks are continuing to get demolished by the market downturn, which will make it significantly harder for companies to issue new shares to raise funds at an attractive price. For reference, the industry-tracking AdvisorShares Pure US Cannabis ETF is down by over 69.9% in the last 12 months, and the wider market is only down by around 10.4% in the same period. Inflation isn't entirely to blame for the falling prices of the last year, but the Federal Reserve's plans to control inflation are almost certainly partially responsible, which makes the affair into a double whammy that's about to accelerate.
As the Federal Reserve opts to hike interest rates to drive down inflation, businesses will see their costs of borrowing money rise precipitously. Growth-stage enterprises, like most cannabis companies, will bear the brunt of the higher costs, as they need to borrow funds to expand before they opt to become profitable.
As you can see in the chart, the cost of servicing interest isn't an idle concern, given how much money leading marijuana companies like Green Thumb Industries, Cresco Labs, and Trulieve Cannabis are borrowing.
In summary, each uptick in inflation prompts the market to expect a response from the Fed, which in turn causes the market to price in higher borrowing costs for cannabis companies, crimping their growth while simultaneously driving down their share prices. And then we come full circle, wherein lower share prices make it harder to justify issuing new shares. Those forces constitute an emerging, major headwind for the entire industry.
How bad will inflation actually be?
Despite these obstacles, the next few years will see the cannabis industry continue to grow. According to a report by Fortune Business Insights, the global market for cannabis will grow from more than $20.4 billion in 2020 to reach an estimated size of a whopping $197.7 billion by 2028. To expand by that much, it'll need to grow with a compound annual growth rate (CAGR) of at least 32% in that period, which is quite rapid but not beyond the realm of possibility.
What's more, the market could badly whiff in reaching the estimate and still multiply in size by several times over, so the future is quite bright. Plus, the sooner inflation resolves and interest rates start to decline, the sooner the young bucks will see their borrowing expenses decline, and share prices might increase as a result.
In the meantime, investors can protect themselves by preferring to invest in marijuana stocks that are both profitable and cash-rich, of which there are very few. If you're short on ideas, a diversified supplier like Scotts Miracle-Gro might be a good place to consider starting your search.
