THCX Cannabis Investment Conference Insight

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THCX Cannabis Investment Conference Insight

By DataTrek Co-Founder Jessica Rabe

I had the privilege of speaking in the THCX Cannabis Investment Forum at the New York Stock Exchange yesterday. It was the first cannabis investment conference ever held at the NYSE, so it was somewhat of a historic event. Big thank you to THCX and Matt Markiewicz, Managing Director of Innovation Shares, for inviting me to participate.

Given that my panel was called “Getting Tactical with Cannabis”, we thought it would be useful for me to share some of my responses to both questions from the moderator and audience of +70 institutional investors. Here they are:

Question #1: Given that you speak to a lot of global macro investors, how do you view cannabis ETFs’ overall role in a portfolio?

Answer:

  • If you look at the stocks that have worked over the last 10 years, they are big disruptive tech companies with a common theme. They have broad platforms with adjacencies that have allowed them to grow and scale past their initial stage. For example, Amazon started selling books online and moved on to numerous other consumer goods and verticals. Google is not just a search platform anymore, but a systematically important and data-driven advertising company. Lastly, Microsoft is now as much cloud computing as it is basic enterprise offerings like email.
  • The legal marijuana industry fits this paradigm, as it also creates a new platform with many applications from consumer products to medicine and others. It already has a large user base/total addressable market in the US. Scientists only recently decoded the cannabis genome, so researchers have just scratched the surface on all the use cases of the plant. And it targets the now largest US generation – millennials – that will shape consumer preferences and spending for decades.
  • The upshot: it’s important to hold disruptors in your portfolio, not just the disrupted in the S&P 500, for example. That’s why liquor companies have been early movers when it comes to investing in cannabis companies as a means to diversify their product offerings. They understand that legal marijuana is a disruptive industry with substitution effects that have already started changing consumer preferences and interests, which will play out for years to come.

Question #2: What do you recommend to clients when it comes to investing in public marijuana stocks?

Answer:

  • In order to invest in this space, you need to believe that marijuana will be legalized nationally in the US within the next 5 years. The current patchwork regulatory framework makes it very difficult to grow and scale.
  • This is our baseline assumption. In late August, we conducted a survey on the legal marijuana industry and received over 270 responses from institutional investors. Ninety percent said they believed marijuana would be nationally legal in the US within 10 years and 50% said it would happen within 5 years. We agree, but you also have to be in this camp in order to be bullish on the industry.
  • Additionally, you have to be able to withstand high volatility in these names. Public marijuana stocks are much choppier than your average S&P 500 company, so they require a stronger investor tolerance for volatility. That’s why we recommend investing in a marijuana-based ETF in order get exposure to a basket of these names. Otherwise, if you can hold on for the long run, one advantage that public marijuana stocks have is that they can grow in market cap as the drug is still federally illegal and eventually be bought out by a larger company once it is legalized nationally.

Question #3: Is there a spot in the value chain that currently provides a better investment opportunity: upstream, midstream or downstream?

Answer:

  • We often hear investors using this construct to group marijuana stocks within the value chain. Upstream refers to producers, downstream includes retailers and midstream applies to ancillary businesses.
  • Our marijuana survey of over 270 institutional investors in late August mostly said they think midstream companies offer the best long-term opportunity. We agree: this way, you don’t incur the capital risk of growers or retail risk of dispensaries. But you still get exposure to the enablers of the industry’s growth. Therefore, if you have access to private equity deals, we’d favor ancillary businesses, such as packaging, extraction or testing lab companies.
  • For those interested in public stocks, this year has shown how difficult it is to pick winning from losing marijuana companies. That’s also why we recommend investing in a cannabis-based ETF, both for lower volatility and broader exposure to the industry.

Question #4: What do you think about marijuana stock’s valuations?

Answer:

  • Most major public cannabis companies operate at a loss as they have been in investment mode. Thinking about valuations here comes down to seeing an adequate ramp in revenues and investment to reach the return on equity they need to meet.
  • We liken marijuana stocks to that of emerging or disruptive tech. For example, people invested in Uber and Lyft this year because they believe in the long-term potential of their business models. Marijuana companies at least have the benefit of selling a consumer good rather than a discretionary ride, and they do not need to roll out new technologies to become profitable.
  • Ultimately, investors will need to be patient and play the long game. Public marijuana companies need time as they are building out an entirely new industry while also trying to navigate ever-changing regulations and scale as incremental legalization unfolds somewhat slow and unpredictably.

Question #5: Why have marijuana stocks traded so poorly this year?

Answer:

  • It’s important to remember that any disruptive industry creating a new platform has its fits and starts. Even Amazon has taken 20 years to get to where it is today. Public marijuana stocks have had a rough year but that’s to be expected as the industry needs more legalization and a more homogenous regulatory framework.
  • More specifically, 2019 was the perfect storm for this space: a split Congress caused slow regulatory progress, high expectations for populous states like New York and New Jersey to legalize retail marijuana through their state legislatures failed, and the vaping crisis hurt the reputation of popular and high margin products. And of course, high tax rates continue to make it difficult for the legal marijuana industry to compete with the black market.

Looking ahead to 2020, there are a few catalysts that could help bolster public marijuana stocks. Canadian dispensaries are finally allowed to start selling higher margin products, such as edibles and vapes. Recreational sales went live in Michigan earlier this month and will also start in Illinois on January 1st. And there should be enthusiasm heading into the 2020 presidential elections. Certain states like New Jersey will put recreational cannabis legalization up for a vote on the ballot, and a potential big win for Democrats in the White House and Congress could lead to faster national legalization.

Our overall message that caught our audience’s attention most: if you don’t think marijuana will be federally legal within 5 years, this is not the group to own for you.