The biggest surprises for cannabis investors in 2021

There are still three weeks left in 2021, but it's pretty clear that after starting the year with so much price momentum and strong fundamentals, cannabis stocks are likely to end the year lower. The New Cannabis Ventures Global Cannabis Stock Index, which is down 20.7% year-to-date, is well on its way to seeing three declines over the past five years:

At the beginning of the year, we identified nine potential factors for the big rally to continue into the fourth quarter of last year, many of which have occurred, including expanded access to capital, multiple company IPOs, increased pace in mergers and acquisitions, one Expansion of the share of institutional and private investors and legalization in other countries. At the same time, our predictions for some federal reforms, market share gains in the illegal market, further legalization outside of North America, and improvements in the Canadian market have not come true.

As for the positive results, the most important one has been increased access to capital. Borrowed capital has become available to cannabis operators at lower cost and with longer terms, and the pool of available sale-leaseback capital has also increased. This expanded access to capital has resulted in companies having to spend less equity as they build their capacities ahead of legalization and scaling in existing states.

Two of the top-selling MSOs, Ascend Wellness and Verano Holdings, went public this year, but big news was the addition of many side businesses. Indeed, the expansion of the by-products segment prompted New Cannabis Ventures to launch the Ancillary Cannabis Index in the spring. In support of expanded access to capital, two mortgage REITs, AFC Gamma and Chicago Atlantic, went public on NASDAQ, and NewLake Capital, which conducts sale-leaseback transactions, also went public.

Mergers and acquisitions have been huge in both Canada and the US, and market consolidation is likely to continue to drive growth. Two publicly traded Florida operators were bought, Liberty Health and Bluma Wellness, and Trulieve bought one of its top-selling MSOs, Harvest. At TerrAscend, the takeover of GAGE ​​Cannabis is pending. The list of private company acquisitions is also quite long as all of the major MSOs have been quite active. GW Pharma was acquired and there was massive consolidation in Canada, including the acquisition of Supreme Cannabis by Canopy Growth and several acquisitions by HEXO Corp including Redecan, 48North and Zenabis. Valens and IM Cannabis also bought smaller listed LPs. Sundial has bought retailer Inner Spirit and is on the verge of acquiring Alcanna, which controls retailer Nova Cannabis. There was also consolidation in the CBD space as High Tide, Valens and Village Farms made acquisitions. The Canadian LPs also continued to invest in the U.S., acquiring non-equity interests, including options Canopy Growth acquired for Wana Brands and Cronos Group for a minority stake in PharmaCann, as well as convertible bonds and warrants for MedMen, acquired by Tilray.

The investor base has broadened this year. As early as the beginning of the year, when the MSOs raised capital by selling shares, many of them reported an increase in institutional participation. As the year progressed, institutional investors continued to invest in Green Thumb Industries, it was publicly announced, and participated in private placements for small caps such as Dutchie. Institutional investors are increasingly discovering how to invest in this area, even if there are many barriers to doing so. Perhaps an even more important factor was the growth of the AdvisorShares Pure US Cannabis ETF, which we highlighted in our outlook. In 2021, the number of shares in the ETF grew 627%, and its net worth now stands at over $ 1.1 billion. The ETF has given more investors access to direct cannabis operators.

Our assessment that the elections in November 2020 would serve as a catalyst for legalization in other countries has come true. In 2021 Connecticut, New Mexico, New York and Virginia voted to legalize adult cannabis, a move that will fuel the growth of the industry for many years to come.

As for reforms at the federal level, this year has been disappointing. Control of the Senate was not known when we gave our outlook, but we argued at the time that even if the Democrats won both Georgia elections, full legalization was unlikely anytime soon. Instead, we hoped some reforms could take place, but the Democrats failed to pick the low hanging fruit as they pursued a flawed strategy in trying to put in place all-encompassing legislation that was dead when they arrived.

In 2020, the legal cannabis market was able to steal shares from the illegal market as the pandemic paved the way for online ordering and roadside pickup or delivery. We expected further growth in 2021, but it's not clear if that was the case. The slowdown in growth in most markets, particularly Western markets, some of which have seen year-over-year declines in recent months, suggests that these gains were temporary to some extent.

We expected Israel and Mexico to legalize adult use this year, but that didn't happen. It is encouraging that both countries could still do this. Of course, Germany also seems to be moving in this direction. We had indicated that in 2021 it would be more important to focus beyond North America, but it's not clear if that was the case as these international markets continue to be slow to develop. At the same time, the largest publicly traded cannabis company, Curaleaf, has shifted its focus to Europe and made a $ 286 million acquisition.

The Canadian market grew in 2021, but year-to-date growth was slower than expected at 55% through October. The largest LPs have also lost market share in the highly fragmented market. Further inventory and manufacturing write-downs were made during the year, but the market remains under pressure on pricing. In addition, derivative products still make up a smaller part of the market than we expected. Flowers and pre-rolls account for more than 72% of total retail sales in Canada, up from around 74% a year ago, according to Hifyre.

In our annual outlook last year, our crystal ball failed to show five key events, a mix of positives and negatives, that we believe were very important to cannabis investors:

New Jersey is delayed

Voters in New Jersey voted to approve adult cannabis last November, and the state was expected to roll out its program by the middle of the year. We still don't have a date, and this delay has been very detrimental to the various MSOs operating in the state's medical market. The delay is an indication that implementation in the cannabis area is generally taking longer than expected.

Trulieve acquires Harvest

While we anticipated many mergers and acquisitions this year, we were very surprised by this given the overlap in Florida and Pennsylvania. Harvest was able to keep all of its Florida dispensaries and cultivation, but was forced to dispose of its license (it received $ 50 million for sale to Planet 13). Pennsylvania did not enforce divestments. This transaction suggests that the industry may consolidate faster than expected over time as regulators become more accommodating.

Price drop in California

The drop in prices in California was probably the biggest surprise of the year and caused significant damage not only to the operators but also to the ancillary operations. The cannabis-only operators in this state were among the worst-performing stocks this year, and many of the largest small caps are heavily reliant on this market. WM Technologies, for example, had to write off $ 2 million (5% of sales and 20% of Adjusted EBITDA) in receivables from California operators in the third quarter. Most MSOs have little exposure in this state, so this factor did not have as much of an impact on the sector as a whole.

Republican federal legalization laws

We've long argued that cannabis legalization and reform is a bipartisan issue, but we didn't expect a new Republican MP would propose federal law to legalize it. We feel that the Nancy Mace States Reform Act takes a much more practical approach to federal legalization than the Democratic proposals (lower taxes, less FDA interference), and we are encouraged to have a dialogue about the best taxation and regulation could begin at the federal level.

How low the MSO ratings would get

There was a mix of positives and negatives in 2021, but given the performance of many MSOs, one might assume that a major problem is about to occur; B. lower revenues or tough crackdowns by the federal government. Of course, neither is the case. As prices fell while predictions rose, valuations of the largest MSOs have fallen. A year ago we discussed the GTI deadline rating as an indicator of the very favorable rating of the large MSO group. At the time, the stock was trading at 6.5 times its expected revenue for 2021 and 18.8 times its expected adjusted EBITDA. Although the company is delivering on forecasts and has excess cash on its balance sheet, it trades at 4.4 times its expected 2022 revenue and 12 times its expected Adjusted EBITDA. GTI seems very cheap, but most of its competitors are rated even lower by these standards. We detailed how cheap the MSOs seem in our premium subscription service 420 Investor last week.

The cannabis industry is still young and predicting its future remains a difficult process. 2021 was largely in line with our expectations as the industry continued to make significant strides. Still, the price trend was terrible. We look forward to expressing our expectations for 2022 in a few weeks' time, but remain optimistic that the strong growth and maturation of the industry will continue into the coming year.

The Valens Company continues to provide bespoke manufacturing, cannabis processing, formulation, product development and testing services to a select group of Canadian LPs and brands, but also has its own brands and capabilities after multiple acquisitions that helped make it one leading platform for cannabis consumables, including Citizen Stash, Verse Cannabis, and LYF Food Technologies, and Green Roads, which has also allowed the company to enter the US as it continues to develop its focus and global reach.

After being listed on NASDAQ last week, shareholders can now benefit from better access to liquidity, increased corporate exposure and a broader investor base.