Money Australia - August 2019

(Barré) #1

T


he answer to this question
is the same as for any
potential investment: the normal
rules of business and investing
apply – with no exceptions.
Investors need to consider
management’s track record,
business plan, competitive posi-
tioning, operating costs, supply
chain, regulatory environment
and relative valuations with
the peer group.
The difference with cannabis
is the enormous publicity it is
gaining and the investment com-
munity’s relatively low level of
understanding of the sector.
The analogy with the removal
of alcohol prohibition in the US in
1933 is resulting in over-exuber-
ance, with expectations that bil-
lions of dollars of value will be
created as the global cannabis
industry continues to be legal-
ised and expands. Sure, billions
of dollars of value will be created
but that doesn’t mean all compa-
nies will be successful.
Investors need to be aware of
the various sub-sectors, includ-
ing industrial hemp, hemp oils,
CBD-only wellness products, full
medical products (containing
THC) and the recreational area.

As with any new sector, the
first movers are usually dominat-
ed by entrepreneurs who quickly
take advantage of the new mar-
ket opportunity. Sadly, history is
repeating itself in the cannabis
sector and we have seen many
people investing indiscriminately


  • and that will only end in tears.
    So what should investors do to
    participate in what is unquestion-
    ably a new global industry?
    First, recognise that it is still
    relatively immature and has a
    much higher risk profile than
    more established sectors. That
    said, with high risk comes the
    prospect of higher returns.
    Ensure only that an appropriate
    part of your portfolio is allocated
    to cannabis and applythe
    golden rule of diversi-
    fication. Build a
    portfolio of com-
    panies that
    have sustaina-
    ble business
    plans and
    avoid any that
    are run by peo-
    ple with no rele-
    vant track record
    or with a history of
    destroying value.


HARRY
KARELIS
executive chairman,
European Cannabis Corporation

W


hen investing in stocks, it’s
easy to forget that results
aren’t a product of company
performance but company
performance relative to investor
expectations. If investors are
overly excited by an industry’s
potential, the stocks can be
overpriced. All the buzz around
cannabis is a red flag.
Cannabis companies combine
two of the worst possible indus-
tries: agriculture and retail.
Cannabis production is capital
intensive and generates little
free cash flow. Even the most
lucrative crop producers rarely
earn a return on capital of more
than a few per cent.
Today’s supply and demand
imbalanceis also likely to
beshort-lived. Adding
upthe top 10 pro-
ducers world-
wide, there are
at least 347
football fields
worth of
greenhouses
under con-
struction. That’s
roughly 2500
tonnes a year of
capacity – double total

cannabis demand in Canada, the
world’s biggest market. When
those greenhouses come online,
prices could fall materially.
Distribution and retail has its
own shortcomings – there are
only so many ways you can
differentiate a leaf. The fact that
big tobacco companies earn
high returns has little to do with
tobacco itself; it’s mainly down
to economies of scale and pow-
erful brands built over a century.
It could be decades before any
cannabis companies have built
strong enough brands to garner
real pricing power.
Some companies have tem-
porary moats thanks to their
cultivation licences or import
permits, but there aren’t explicit
caps on issuing them, so it’s
only a matter of time before
more competitors saturate the
market and crush margins.
Whatever the industry’s
eventual size, predicting long-
term profitability for cannabis is
impossible. With no money com-
ing in – and lots going out – the
companies have kept themselves
afloat largely through capital
raisings and taking on debt.
That’s a powder keg for investors.

GRAHAM
WITCOMB
senior analyst,
Intelligent Investor

YES NO


Should you buy


cannabis stocks?


THE DEBATE


WHAT YOU
NEED
TO KNOW

The global legal cannabis
market size was estimated
at US$13.8 billion in 2018,
according to Grand View
Research.
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