Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation.
Executive summary: Cannabis is coming. There is a growing global tide of decriminalisation, driven by rising public support and the need for states to generate increased tax takes. The global illegal cannabis market is currently worth an estimated $150bn, implying a significant opportunity as legalisation becomes the norm. By 2020, the legal market could be worth $30bn worldwide, yet the total addressable market could be at least 10 times this size were consumers to substitute away from products such as alcohol and tobacco in favour of cannabis. Unsurprisingly, such an opportunity has created a certain sense of euphoria among some corporates and investors. There are around 60 publicly listed cannabis plays at present, almost all loss-making and many trading on elevated multiples of forecast future sales. Picking winners is, therefore, difficult. Large consumer businesses (in beverages, food, cosmetics and so on) are also getting involved, for fear of missing out if nothing else.
Many investors seem intoxicated with cannabis. Legalisation and deregulation are occurring apace. Against this background, numerous cannabis plays have listed on the stock market while many well-known large consumer food and beverage businesses seem to be trying to get in on the act. CBD – the non-psychoactive component derived from cannabis – is seemingly everywhere: in skincare products, coffee and even pet treats. However, as with almost all future trends we assess, it is important to separate hype from reality. Sure, there will be investment opportunities, but the market is still very nascent and valuation considerations are crucial.
Cannabis is an annual, flowering herb indigenous to Central Asia and the Indian subcontinent. Its use for fabric and rope dates at least to the Neolithic Age in China and Japan. Additionally, cannabis plants produce a group of chemicals called cannabinoids, which produce mental and physical effects when consumed. As a drug, it usually comes in the form of dried flower buds (marijuana), resin (hashish) or various extracts collectively known as cannabis oil. The primary psychoactive effects include a state of relaxation and also a ‘high’ (or ‘stoned’) feeling of euphoria. This latter sensation can encompass a general change in perception, heightened mood and an increase in appetite. The onset of effects is within minutes of cannabis being smoked and hours if cooked/eaten. Cannabis-induced sensations can typically endure for 2-6 hours.
Given this brief factual context, clearly there are two very distinct end-markets for cannabis: medical and recreational. The earliest written record of cannabis usage is from the Greek historian Herodotus. He refers to the Scythians “shouting for joy” after having taken cannabis steam baths in 400BC. Its popularity in a recreational context led to its use spreading from the Islamic Empire to Ancient Greece and Rome and then beyond (the Spaniards first imported it to the American continent in 1545). Its popularity also led to its eventual criminalisation, a trend initiated by the British Empire in its colonies, owing to the drug’s effects on indentured workers. These rules are only changing slowly now.
Criminalisation has, however, had little impact on consumption. Cannabis is the most commonly used illicit drug in the world, ranking in overall popularity only behind alcohol, caffeine and tobacco. The UN estimates that 192m people used cannabis at least once in 2016, equivalent to an estimated 4% of the world’s population aged between 15 and 65 having consumed the drug. Other studies (in The Lancet) suggest that over 100m Americans have tried it, and some 25m have used it within the last year. Former US President, Bill Clinton infamously ‘smoked but did not inhale.’
Given the size of the cannabis market, there is obvious interest from many stakeholders. The UN estimates that cannabis accounts for ~50% of the ~$300bn illegal narcotics market. Meanwhile, consultants BDS Analytics calculate that illegal cannabis sales in the US totalled around $50bn in 2018. For context, this is over a hundred times the size of the market for all regulator-approved cannabinoid therapeutics worldwide (equivalent to $53m in 2018, also per BDS). The recreational market is where it is at.
Legalisation is logical. It deprives organised crime of its single biggest source of income, while helping to protect (and render honest) consumers of the product. Such an approach is also popular with voters. Some 61% of Americans now believe cannabis should be legalised, double the level at the start of the decade (per Pew Research). Prominent Republicans and Democrats have both endorsed further legalisation. This is perhaps not surprising given the pressure on administrations to find new sources of revenue due to massive underfunded liabilities relating to state pensions and retiree health benefits as well as the need to service already high debt levels. Those states that have decriminalised cannabis have imposed effective sales taxes of between 20% and 47% on cannabis, with California, for example, having raised $345m of state tax revenue in 2018 from this source (per the Institute of Economic Affairs).
Cannabis is currently legal for recreational purposes in two countries (Canada and Uruguay) as well as in 8 US states. Compare this to the 41 countries (and 31 US states) where cannabis has had legal approval for medical purposes. This market, however, remains small-scale: only one drug – epidolex, manufactured by GW Pharma for the treatment of epilepsy – has currently been approved by the FDA in the US. In Germany, where medicinal cannabis was legalised in 2017, just an estimated 70,000 patients have been issued with prescriptions (per Bloomberg). Consider, by contrast, that since cannabis was legalised in Canada in October 2018, over 220 dietary supplements and around 20 veterinary products with general health claims for treating minor conditions have been approved. Data from Canada Stats Hub (an arm of the Canadian Government) show that by the end of March this year, ~C$1.5bn had been spent on cannabis since it was legalised, with just 20% of this for medicinal purposes, and the remainder for recreational reasons.
As cannabis becomes more accepted, there are also more opportunities – the addressable market is growing. Canopy Growth, a listed Canadian cannabis cultivator, describes cannabis as “a potentially disruptive ingredient,” one with “no alcohol, no calories, no hangover and a happy liver.” A recent survey showed that 72% of American consumers believe that marijuana is now safer than alcohol (per AT Kearney), and as the market evolves, consumers are increasingly viewing cannabis less as a product to be smoked, and more as something to be eaten, drunk, rubbed (as a moisturiser), taken as a pill or worn as a patch. The most favoured form of consumption is in food (especially baked goods, candy and sweets; 55% of respondents surveyed by AT Kearney chose this option), followed by dietary supplements (50%), skincare (43%) and non-alcoholic beverages (32%).
Against this background, the substitution effect that cannabis could provoke is potentially enormous. To provide some context, total beer sales in the US in 2017 were $110bn, with an additional $80bn spent on cigarettes (per Marijuana Business Daily, an industry journal). Meanwhile, Canopy Growth sees its potential global addressable market as being worth $500bn. Given that global spend is equivalent to $1tr on alcoholic beverages, $1tr on health and wellness supplements, $100bn on sleeping disorders, $90bn on pain relief, $50bn on anxiety, $50bn on animal welfare and $40bn on athletics drinks, Canopy believes that its assumptions are not unreasonable. While it seems likely that the cannabis market will grow at the expense of other, more established markets, more sober near-term assumptions about market size suggest that the US market will reach around $20bn and the global market around $30bn by 2020 (based on forecasts from consultants including BDS, Deloitte and Euromonitor).
However, there is a still a lot we do not know about cannabis, including both its harms and its benefits. The illegality of the drug means that most of the research performed on its long-term effects is hazy, so even the most informed decisions are based on incomplete information. The Chief Medical Officer for England, Dame Sally Davies, describes the legalisation of cannabis as being equivalent to “opening a Pandora’s box.” We’ve seen similar debates before, with the benefits of, say, tobacco, opioids, e-cigarettes etc. exaggerated and the risks downplayed. At the same time, the strains of cannabis consumed today are typically significantly stronger than those consumed in the past, owing to more sophisticated farming and cloning techniques. Some cannabis strains currently available contain as much as 20% THC (the main psychoactive component) compared to less than 2% 50 years ago (per 13D Research). As a result, some of the possible unintended consequences could include an increased risk of addiction, dependency, schizophrenia and psychosis. Around 30% of new cases of psychosis in London are estimated to be tied to strong cannabis, while half of first-time psychotic disorders in Amsterdam could have been avoided were potent versions of the drug not available (per The Lancet).
There are additional practical considerations that arise: which varieties to allow, who should sell it and to whom. Furthermore, setting the ‘right’ level of tax in each country – so that consumers are not tempted to turn to the black market – will vary. In other words, there is much work still to be done in terms of standardising cannabis products and developing distribution. Consumers also believe brand matters: 72% believe it to be ‘very important’ or ‘somewhat important’ when assessing the quality and safety of products derived from or infused with cannabis (per AT Kearney).
It is of no surprise then that many major businesses are seeking to establish a foothold within the cannabis industry, even if this is partly driven by a fear of potentially missing out. Within the alcohol space, AB InBev, Constellation Brands and Molson Coors have already formed partnerships with cannabis businesses (Tilray, Canopy and Hexo respectively). Diageo, Heineken and Pernod are also establishing a more active presence in the area. Turning to the food and beverage market, Coca Cola has begun to work with cannabis producer Aurora, while Kraft, Mars, Nestlé, Pepsi, Procter & Gamble and Unilever, among others, have all made positive statements regarding the cannabis opportunity. A similar picture emerges in tobacco (Altria, BAT, Imperial Brands) and cosmetics (Estée Lauder, L’Oréal). Elsewhere, in the healthcare sector, businesses such as Pfizer, Novartis and Sanofi are exploring cannabis-related drug opportunities. Despite growing interest levels, revenue from cannabis-derived products is unlikely to be a major driver for any of these companies in the near-term.
Recent months have seen many cannabis businesses list on public exchanges and some have attracted multi-billion-dollar valuations, likely partially driven by retail euphoria. Among the roughly 60 businesses listed (the largest being Canopy Growth and Aurora, capitalised respectively at C$14.5bn and C$7.7bn), nearly all are loss-making at present and many are trading on elevated multiples of forecast future sales. No player yet dominates the industry (or any sub-segment such as cultivation, equipment or logistics) and some industry consolidation seems inevitable. Picking the winners is, therefore, difficult. Numerous businesses are riding the high of the cannabis wave, but there may be well be something of a near-term comedown ahead.
Alexander Gunz, Fund Manager, Heptagon Capital
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