December 3, 2019

Uncovering the Truth Behind The Global Cannabis Industry Slump

5min read

With stocks in the cannabis industry climbing to record highs at the end of last year, 2019 was supposed to be the most prosperous year yet for the cannabis industry. Adult-use cannabis had become legal in Canada and medical legislation was creeping across the globe, driving press coverage and investor confidence to all-new heights. However, 12 months later, shares in major cannabis stocks have reached a nine-month low, and no imminent legislative decisions or major industry deals look capable of reversing the crash in the short-term. As we approach the close of the year, we examine whether the industry faces a burst bubble or a market correction

Cannabis stocks are struggling. Stock prices in major companies such as Cronos Group (CRON) and Canopy Growth (CGC) have fallen by more than 70% and 65% respectively since their highs earlier in 2019, and are down around 30% over the year-to-date.

cannabis industry decline

(Source: The Marijuana Index)

As stock prices continue to fall, some are comparing the cannabis market to the burst of the dot-com bubble in the 1990s. During the height of the bubble, high valuations, given to a wave of new internet-based companies, could not be supported by financial performance, leading to the loss of billions and the folding of numerous companies.

The cannabis industry has not defaulted. The top cannabis stocks are still trading at a higher value than their initial price but declining stock values and lower-than-expected profits have many concerned about the direction of the market.

What is behind the market slump?

At an international level, the complex regulatory regime surrounding the legality of cannabis is limiting patient access to medical cannabis. Promising programmes in Ireland, the UK and France have not led to a significant number of regular patients or prescriptions. Additionally, cannabis remains prohibited at a federal level within the United States, inhibiting the most prosperous single market in the world. Inherently, this prevents the market from reaching its full potential.

But the strict regulations on cannabis use dissuade much of the investment community — by making large institutions more reluctant to invest in cannabis businesses. As a result, the capital supporting the industry tends to stem from individual retail investors, who invested money on the back of the media hype surrounding the cannabis industry or family offices, who have been quick to provide startup funds to drive the industry forward. These investors tend to be less patient to wait through periods of market downturn to see a return on their investment and might choose to sell off their stock before an institutional investor would. If large institutions were to start investing more freely in cannabis stocks, this could potentially change significantly change the trajectory of cannabis stocks.

It is also worth noting that this pattern of media hype, large valuations, huge investor expectations, and an inevitable downturn is not specific to the cannabis industry. Highly-popular tech startups such as Uber (UBER), Lyft (LYFT), and Slack (WORK), faced comparable experiences when they initially went public. Similarly, the cannabis industry has fallen foul of its own hype as recreational legalisation in Canada (and select parts of the US) has not been enough to generate the type of profits that investors expected.

Further adding to the equation are falling cannabis prices in North America, which are dampening the potential margins for cannabis retailers, and political instability, which looks set to impose tariffs on a number of Chinese-made goods needed in the domestic cannabis industry.

Most recently, a statement from the US Food and Drug Administration caused North American cannabis stocks to fall lower still. The federal agency declared that it “cannot conclude that CBD is generally recognised as safe” for use in food. The agency also revealed that it had issued 15 warning letters to companies for illegally selling CBD products that violated the nation’s Federal Food, Drugs, and Cosmetic Act, and published a revised consumer update advising that “CBD can cause liver injury” and “can affect the metabolism of other drugs, causing serious side effects”.

Slump or Correction?

There is an argument to be made that the market slump could ultimately be a good thing for the global cannabis industry.

The industry is suffering layoffs and losses. MedMen, one of the first American cannabis companies to become publicly traded, has announced that it will be laying off 190 employees, which follows big layoffs at Hexo (200) in October and CannTrust (180) in September.

However, there is an argument to be made that the market slump could ultimately be a good thing for the global cannabis industry.

The market slump is a stark reminder that cannabis is just as susceptible to boom and bust market forces as any other industry. The industry is entirely dependent on the regulation and legislation that underpins it and without any clear timeline from international policymakers, market growth is increasingly hard to predict.

By the same reasoning, expected earnings were always going to be inaccurate. In fact, industry-insiders have been envisaging a dip in the market since valuations began to peak.

The market will continue to expand, albeit at a more measured pace, as more and more countries continue to legalise cannabis. In 2019, 40 countries have legalised medical cannabis with numerous more expected to legalise in the next 12 months. State governments are establishing education and access programmes and research institutes are conducting studies on the efficacy of cannabis as a medical product, which will only increase patient access in the long-term.

countries where medical cannabis is legal

Although there is room for improvement, the Canadian recreational programme has proved to be a commercial success and opened a debate around the international regulation of cannabis with Luxembourg, the Netherlands and New Zealand all considering new federal programmes for adult-use.

countries where recreational cannabis is legal

Cannabis stocks have not yet hit the bottom and further disappointing Q4 results will ensure a few more difficult months for cannabis companies, but the market fundamentals remain intact. An infrastructure is being built from the ground up and regulations, access-programmes and education schemes are still being fine-tuned. The industry will hit an upturn again, but firms will need to harness the learnings of the market slump to prosper in the phase of the international cannabis market.

Prohibition Partners’ consultancy team advises clients on licensing, regulation and market entry strategy across the globe. For more information, contact info@prohibitionpartners.com.

Uncovering the Truth Behind The Global Cannabis Industry Slump

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