Let’s speak about pot, but we are a finance blog right? Then it makes even more sense!
Investing in themes has been an increasingly popular investment strategy over the last few years. You may have come across investing in renewable resources, e-gaming, semiconductors, to name a few of the hot topics. While the list of interesting and high potential themes is long as your arm, there is one topic that often gets omitted - cannabis.
Once decried for it’s addictive nature, the cannabis plant is increasingly getting praised for its remarkable therapeutic applications. And if you look at the investing space, the medical use case is by far the biggest contributor to this trend, coupled with hydroponic components (i.e. everything related to growing the plant). So it’s not just about smoking it.
With the stigma coming down, the use of cannabis, be it as a leisure activity or as a useful production material, is rapidly receiving social acceptance and supportive legislation not only in the US and Canada but as well here in Europe. Cannabinoids are now already widely available to treat symptoms associated with multiple sclerosis, Parkinson, certain types of cancer and rare forms of childhood epilepsy.
But before we forget, it is important to make the difference between the known cannabinoids, THC and CBD, with the latter being derived from hemp. In short, THC is what gets you high, while CBD is mainly used for nutrition and therapeutic use.
Now back at the investing-side of things. What led to the interest in this plant from an investing perspective?
It all started in December 2012, when the US state of Washington decided to legalise small amounts of marijuana-related products for adults 21 and over. It was shortly thereafter followed by Colorado and while it was still illegal federally in the US, these two actions signalled the opening of a very attractive market. As a result large production firms started popping up between North America and Canada, the clear front runners in the sector back then, and still today.
While the sector was slowly gaining traction, the big change came when California, already one of the pioneers for the use of cannabis for medical treatment, decided to legalise recreational use of the plant in January 2018. Shortly thereafter the world’s largest producer, Canopy Growth decided to go public in May 2018, to further mainstream the word cannabis and attract investors to this new sector.
Cherry on the cake came when the US Department of Agriculture passed the so-called 2018 Farm Bill, legalizing hemp and CBD.
This marked the start of the rapid expansion of the cannabinoid industry across North America and awoke the interest of investors. In the meantime Canada followed in the steps of California.
The race to cash-in on the green rush was truly on.
While the cannabis industry created in the US alone 250,000 jobs, some companies feared less well resulting in massive layoffs and failure to meet investor expectations. On top of that, there was still a considerable grey zone in what is allowed and what is not. As a result investors started to be more prudent. Stock prices plummeted back down to 2018 levels.
Like with any new trend, the initial euphoria always gets met by heavy scepticism, after which it is important to reaffirm the sector’s use and long term prospects. And this is particularly true for the cannabis industry. Investors back in 2018 were blinded by too high return expectations, and when they saw that it turned out differently, they pulled out the money from cannabis stocks.
2020 has been a wild year for pot stocks, with COVID-19, the stimulus package and environmental issues striking the US economy, it is at first hard to see where the cannabis industry could head.
However thanks to 5 newly legalised states, the overall sales prospects through legalised medical programs and legal adult-use programs are projected to grow even faster with an annual 14% growth rate, reaching over $38b in sales by 2025.
Where is Europe standing here?
Over the past 18 months over €100m of new money has been invested in medical cannabis-focused companies across Europe, with 80% of the deals concerned Germany-based companies.
While this represents a sharp increase compared with the period before 2019, it still is miles away from the activity seen in North America, where more than $3bn was invested in the medical cannabis market through more than 450 deals in 2019.
On the back of mounting evidence of the therapeutic value of cannabis, public sentiment in Europe has followed the US example towards supporting some degree of cannabis legalisation. In the UK, support for legalisation has hit a high of 77%, while continental Europe is as well growing. In Germany about half of the population considers medical cannabis as a good alternative to traditional medicines and is likely to take medical cannabis as a treatment.
Since Germany loosened its regulations on the therapeutic use of cannabis products in March 2017, the amount of patients receiving treatment has increased from roughly 1,000 people to more than 60,000 in 2019. This still represents less than 0.1% of the population. In comparison, in the USA and in Canada, the proportion of medical cannabis patients is estimated at 1.5% to 2% of the population, which would equate a potential for two million patients in Germany.
While the demand is growing, the issue lies mainly with the supply, both for the finished products and the raw materials, i.e. the flowers.
In Germany, to obtain medical cannabis and related products you still need a prescription. However for now only very few doctors feel comfortable with this new kind of medical treatment. And the production-side, German companies still rely 100% on imports of cannabis flowers. Those are still mainly coming from the US and Canada, but lately the UK, the Netherlands and marginally Portugal started entering that market as well.
How can I invest in cannabis ETFs in Germany?
Number of holdings: 22
It seeks to provide targeted exposure to the rapidly expanding legal medical cannabis industry that is set for further growth as more countries legalise cannabis for medical use. The mainly consist of publicly listed companies conducting legal business activities in the medical cannabis, hemp and CBD industries. This means it stays away from the grower companies as mentioned earlier in the article.
It’s biggest position is GrowGeneration with 31.46% weight. The company sells hydroponic equipment (i.e. everything related to growing), soils, nutrients, and lighting fixtures in states where pot is legal. It’s stock octupled this year, making it by far one of the best performers in the sector for 2020. THis comes as little surprise given GrowGeneration is already profitable, while the majority of other pot stocks are still writing red numbers. The other large position is being held by an indirect competitor, Scotts Miracle-Gro, with a couple of important differences. Scotts manufactures and supplies lawn care products, and has expanded into the hydroponics supply space for marijuana growers with its Hawthorne Gardening subsidiary. Scotts is not a retailer, however.
But now back to the ETF, it only came out in February this year, and has so far risen 21.6%. In comparison, the S&P 500 did 14% YTD
The cannabis sector, despite it’s overheating in 2019, remains a very attractive sector with strong growth potential. However only if regulations continue to advance in favour of the plant. Recently psychedelics have gained quite some attention as well and it remains to be seen whether it could replace the hype around pot or if both can go hand-in-hand in providing new medical treatments.
In terms of products, as with most thematic investments, you will invest in very niche markets. So better be aware of the low diversification prospects. In the case of cannabis investment, the majority of money went to the big grower companies, leaving ETFs on very small fund volumes. Again this is not unusual for a niche sector, but not everyone likes to invest in small funds (i.e. if there is an issue such as the fund not performing well, then issuers can decided to close the ETF).
All in all, the cannabis market needs to continue to mature and industry metrics to solidify, in order to make a really attractive investment case. So it’s up to investors to decide when this will come and when they should enter or not the sector.