Should Cannabis Investors Start Sweating?

Down more than 70% in the last 12 months, the brutal decline of the industry tracking AdvisorShares Pure US Cannabis ETF (MSOS -0.78%) is an undeniable sign that cannabis stocks are in huge trouble. Leading companies like Tilray Brands (TLRY -4.05%), Trulieve Cannabisand Cresco Labs reported a contraction in quarterly profits compared to a year ago, and their struggles to become and remain profitable are as pronounced as ever.

If you’re a cannabis investor and the above doesn’t bother you, you probably should, as there are several factors such as market saturation that lead to declines in both top lines and share prices.

However, all is not lost and in fact there are several opportunities to make bank with a timely purchase of the right competitors, provided you can sleep at night while taking on significant risk. Let’s discuss what’s happening with cannabis right now and we’ll get to how to take advantage of the situation a little later.

Earnings reports bring grim news

Cannabis investors should really start sweating, especially if they have invested primarily in US-based marijuana businesses.

In short, the U.S. marijuana industry is following the same trajectory as the Canadian one over the past few years, in which companies like Tilray, Canopy growthand Dawn Cannabis voraciously expanded most elements of their operations to absorb the newly legal weed market, resulting in a surge in revenue. Eventually, output from cultivation and manufacturing increased to the point of exceeding demand, at which point unwary investors received a nasty shock as losses mounted thanks to excessive overhead costs.

This forced some drastic production cuts to reduce the cash burn rate. At the same time, an oversupply of cannabis has caused prices per gram to crash, just as some like Canopy have been trying to improve their product lines to squeeze more money out of each gram sold.

Check out this chart of these three Canadian players:

TLRY Revenue Data (Quarterly) from YCharts

Notice how all three companies increase quarterly revenue for a short period of time, then eventually level off before pulling back in the last few quarters?

Now look at this other figure, which includes US-based multi-state operators (MSOs) Trulieve, Cresco Labs and Green Thumb Industries:

GTBIF Revenue Chart (Quarterly).

GTBIF Revenue Data (Quarterly) from YCharts

As you can see, the situation in the US cannabis market is now almost the same as it has been in Canada for the past few years. And while the prices of these US cultivator stocks peaked in early 2021 during the meme stock craze, they mostly continued to grow on their top line at a decent clip for the rest of the year, though their stock prices continued to fall.

Flat growth in 2022 has offered a small respite for shareholders, but the real problem is that the contraction is only just beginning with gusto – and most companies have failed to become consistently profitable when higher average selling prices for cannabis would have made the task a little easier.

What’s more, smaller competitors are showing signs of distress, and some may go public, which would signal to investors that more trouble is ahead for the larger businesses. For example, Innovative industrial properties (IIPR -0.82%) buys and leases acreage to grow marijuana, and recently had trouble collecting rent from no less than three of its tenants.

In short, this is a very risky time to start a new position in marijuana stocks, as the next year or so will simultaneously see more revenue headwinds, a fierce marketing and branding battle for market share, stagnant or declining stock prices, and perhaps other problems too such as labor shortages.

Legislative changes may be a wild card

There are several advantages that shareholders and prospective investors should appreciate. First, the fact that the US cannabis market is currently saturated does not diminish its prospects for future growth. The industry will eventually right-size to the level of demand, and it is reasonable to expect the level of demand to continue to grow over time.

So if one of your holdings is in the red, there is still some hope for recovery if you are willing to wait long enough without selling. It may even be advisable to load up on stocks of your preferred companies in the meantime, provided you can tolerate their value falling for some time after purchase.

The second good lining is that marijuana legalization could eventually happen at the federal level, which would massively expand the size of the market overnight. Even in the absence of federal legalization, in the next election cycle more states could choose to legalize themselves, which would also provide a boost.

But legalization isn’t the only legislation that could push the entire industry to come together; bills that make it easier for cannabis companies to access traditional financial institutions and sources of capital would also be catalysts if passed.

So if you’re sweating about the future of your investments, take heart that a recovery may be around the corner, although a more reasonable outlook is to assume that the industry will take a year or two to recover.

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