The new year is likely to kick off with a wave of bankruptcies and consolidations as struggling pot companies run out of cash. But, for those that survive long enough, bipartisan support for U.S. legalization could jump-start a turnaround heading into the November election.
Several factors conspired to make 2019 a rough year for pot stocks. Following legalization in Canada, stocks began the year at valuations that even some in the industry said were too high. Then reality hit as Canada’s and California's slow and painful retail roll-out made companies’ optimistic forecasts impossible to achieve.
A serious regulatory breach at CannTrust Holdings Inc. and a vaping-related health crisis in the U.S. added to concerns about the sector’s prospects.
“Cannabis is just a little baby, it’s barely able to sit up yet or roll over,” said Paul Rosen, managing director of BreakWater Venture Capital and a co-founder of the company that became Cronos Group Inc. “The takeaway of the last six months is that building a new industry from scratch is hard and you’re going to have some skid-outs, you’re going to have some blood spilled. It’s natural.”
“Some of these companies don’t have a future,” Rosen said. “I won’t name names but I think we’re going to see in Canada and to some degree in the States full-blown, wipe-out failures.”
Consolidation is also likely, but not necessarily to the benefit of the companies being acquired, said Troy Dayton, CEO of cannabis investment and research firm Arcview Group.
“You’re going to have opportunities for distressed-asset deals,” Dayton said. “We’re going to start seeing a lot of roll-up strategies, collecting companies for pennies on the dollar.”
Expect the volatility to continue in the first half of 2020 with some clear winners beginning to emerge by the second half, according to Brendan Kennedy, chief executive officer of Tilray Inc.
The biggest catalyst to watch will be U.S. politics. Seven to nine Republican states including Idaho, Wyoming, North Dakota and Missouri are likely to hold referendums on legalization during the 2020 election and most of them will vote in favor, Kennedy predicted.
“That means there will be a Wednesday morning in November when 14 to 18 Republican senators wake up representing a state that has legalized medical cannabis or cannabis in some form, and they’ll go to work that day with that frame of mind,” he said. “That’s the beginning of the end” for federal prohibition.
The Secure and Fair Enforcement Banking Act, which would pave the way for financial institutions to do business with cannabis companies, could also boost stocks if it passes, Rosen said.
It would signal to investors that “the water is warm enough but there’s still meat on the bone in that we don’t have legal cannabis yet,” he said. “It would be in my opinion the perfect time for risk-on money but not reckless money to come in.”
In Canada, the introduction of more retail outlets and new form factors like edibles, beverages and vapes should eventually boost companies’ sales and margins and put them on a faster path to profitability, but analysts believe it could be several months before the benefits are reflected in earnings reports.
One thing is certain: whatever 2020 holds, pot stocks will continue to be volatile.
“I’m an inveterate bull and I do think 2020 is going to be comeback year,” Rosen said. “But as long as we’re an industry that doesn’t have dozens of years of earnings and we’re still making forecasts about events not fully realized, we’re going to be subject to potential volatility.”