Portfolio manager says U.S. industry is still an opportunity for investors while in Canada it's all about market share
Good cannabis investment opportunities are now largely confined to the U.S. but, across North America, the nascent industry has taken a step forward during these troubled COVID-19 times.
Nawan Butt, portfolio manager at Purpose Investments, told WP that the pandemic has helped considerably with black market displacement, with consumers forced into trusted home-delivery methods that minimize direct human contact
Around 30% last year, black market displacement has increased in 2020 with the number now around 46%. Butt said: “We've read estimates of anywhere between 50% to 70% of the black market being displaced in the first three to five years of legalization and it seems like that is very much on track.”
Cannabis has also suited the less social conditions and is viewed as a better lockdown vice, while studies by the NHS in the UK and Alpha Clean, have shown that people are using to alleviate anxiety and stress. In the U.S., the number of people being prescribed via telehealth is growing, removing the stigma associated with walking into a cannabis clinic, while the new retail stores in Ontario have also helped sales.
Almost all reporting operators have increased revenue guidance for the full year and 2021, and it’s not just the cannabis producers and retailers experiencing this growth. Ancillary companies are also experiencing similar growth of revenues.
But Butt said he looks at the Canadian and U.S. markets through different lenses. This side of the border, the analysis is based less on top-line revenue and more on the market share they are controlling.
He said: “Our thesis is that Canada will end up looking like an oligopolistic structure for a lot of these cannabis names. And this is true of the Canadian economy as a whole. When we look at banks and telecom, for example, it’s basically within five or six companies that control the whole market.”
He added: “That’s what we think will happen with cannabis as well and why market share is very important to us.”
Attractive Canadian LPS are those that can operate at the lowest cost and survive thin margins, with Butt pointing to Aphria and Village Farms as good examples. These companies, two or three years from now, will then be able to capitalize on the higher margin products, while the portfolio manager expects there to be 15 to 20 “craft growers” that have a speciality, whether that’s a flavour profile or specific identity.
The U.S., meanwhile, is a very different story. While Canada was quick to build into over capacity, the U.S. has been much slower but patient numbers have grown and legalization in multiple states – recently in Massachusetts and Illinois - has propelled how quickly revenue has come in.
“Most of their constraints are coming from the actual production and cultivation of the plant, rather than the distribution or the uptake of consumer consumers. So in the U.S., revenue growth is very important.
“More important than revenue growth is how quickly you're growing your infrastructure as a company,” Butt said. “Whereas in Canada, it's not about infrastructure growth whatsoever; that is all done so now it's all about market share consolidation.”
He added: “It’s a good time for the U.S. [investment’ opportunity] but the Canadian opportunity was something that was here a couple of years ago and has been slightly mismanaged.”
Momentum around cannabis reform in the US continues has also been boosted by the BidenSanders Unity Task Force releasing policy recommendations in July. The recommendations go beyond the minimal requirements needed for the industry to prosper; namely, the availability of banking services and tax reform.
For portfolio managers on the fence, Butt said there remains an excellent and rare opportunity to invest in an industry at its fledgling stage. It’s an industry that is more or less inevitable at this point with the U.S. – such a large market – moving towards full acceptance.
Butt added: “It’s hard to find a growth vertical out there that really offers the growth that cannabis does with the diversification that technology names don't really have to offer. Technology has been a huge growth vertical for the past 20-plus years now but that has always been very single data and correlated.
“Cannabis offer you the opportunity to get 25% growth year over year, but get it in a more diversified way. Essentially, the growth portion of any portfolio, the drawdown risks can be minimized with the introduction of cannabis.”