It has essentially become a fact that cannabis stocks are among the riskiest investments due to the illicit nature of the industry in many countries. Investors seemingly agreed, with the AdvisorShares Pure U.S. Cannabis ETF (MSOS -5.43%) dropping by 58% in the last 12 months.
Headwinds like low selling prices, rising interest rates, and regulatory hang-ups have become stronger recently -- and there's a trio of new risks that investors should know about. Let's explore each of them so that you can appreciate what might weigh the marijuana industry down even further in the medium term.
1. Labor shortages, strikes, and other workforce issues
After a two-week strike at Green Thumb Industries's (GTBIF -3.12%) Chicago dispensaries in late April, it is undeniable that the cannabis industry is not immune from labor issues affecting the rest of the U.S. economy. Ultimately, Green Thumb agreed to pay wage increases in the ballpark of 50% to get the strike to end. If the workers' victory is any indication, the labor force in other companies could command similar changes to compensation, causing costs to rise. And in the context of an ongoing multi-year labor shortage in the cannabis industry, that's a big risk. Furthermore, some cannabis companies have laid off employees as a cost-cutting measure, which directly challenges striking as a labor tactic at the risk of lowering morale.
Empowered workers are also more likely to push back against potentially unsafe working conditions in certain marijuana growing or manufacturing operations, which have become more noticeable as the industry scales up. It's not clear which operators will be the most vulnerable, but if you read about safety complaints or incidents about a company you're thinking of buying, remember that it could lead to all sorts of issues down the line.
2. Diseases affecting cannabis plants are surging
It's easy to forget that the marijuana industry is inherently agricultural. Without a safe growing environment to nurture cannabis plants, creating the products consumers want is difficult. And, much to the chagrin of cultivators everywhere, the game looks like it will get harder thanks to a pair of cannabis plant diseases, both of which constitute new risks for investors.
In particular, black root rot fungus is spreading in aeroponic commercial cannabis cultivation facilities in North America. It threatens to destroy harvests and render manufacturing equipment unusable due to the potential for contamination. While the fungus was recently confirmed to be circulating at faster-than-anticipated rates in Canadian cannabis farms, plant science researchers have known that it's affecting at least some facilities in the U.S. too. One hemp producer reported in 2019 that they had lost 30% of their crops to the fungus. One can imagine the potentially disastrous economic impacts to Canadian growers like Tilray Brands and SNDL if they were to report that nearly a third of their plants had died.
Then there's the threat of the hop latent viroid, another pest organism that transmits from plant to plant in hydroponic growing. The disease was first spotted in California in 2019, and as of 2023, the extent of its spread is unknown, but researchers think it's significant. While the viroid doesn't kill marijuana plants outright, it does tend to hobble their growth, and it especially tends to reduce their output of economically valuable cannabinoids like cannabidiol (CBD), in some cases by as much as 40%.
Any company focusing on growing marijuana in a hydroponic environment to isolate cannabinoids is especially vulnerable. However, since that's a process that most public cannabis businesses do at scale anyway to make edibles, vapes, and distillates, pretty much every player is exposed to more risk now.
3. Retail footprints are becoming unsustainably saturated in growth markets
One of the hallmarks of an oversaturated cannabis market is the glut of marijuana retail locations.
For example, in Massachusetts, it's common to see billboards announcing the opening of a new dispensary. In 2022, over 70 dispensaries opened in the state, with more slated to open soon. With the addition of three stores in Boston near my home, there will be twice as many cannabis retail locations as liquor and wine stores within a mile radius. And while that concentration of stores may prove sustainable, at a glance, it looks far too saturated relative to the area's population and level of demand.
Per the state government's data, there are a total of 17 businesses with a full license to sell adult-use cannabis, 149 provisionally granted licenses, and at least 59 licenses in progress toward full status, not to mention 40 more licenses that are in the earliest stages of the process and which are not yet approved to open a location. And Massachusetts' situation is hardly unique; anywhere that legalized cannabis over the last few years will be in the same boat if they aren't already, thanks to the industry's recent grab-market-share-at-all-costs mentality.
In other words, even more dispensaries will be opening soon, just as U.S. producers are complaining about how there's too much inexpensive marijuana for sale due to overproduction. The risk for investors is that overextending with retail footprints will eventually hurt earnings, as high overhead costs and low average selling prices are not a good mix, especially if consumers are flocking to buy weed from their new local stores. The opposite situation, with so many stores that there isn't much traffic to any single one, may also become a major issue, especially for companies like Curaleaf that are concentrated in saturated markets like MA.
