Cannabis stocks are getting crushed, creating financing problems for the companies that issue them. The North American Marijuana Index, which tracks leading cannabis stocks like Canopy Growth Corp. (CGC), Aurora Cannabis Inc. (ACB), Cronos Group Inc. (CRON), and Tilray Inc. (TLRY), has fallen 57% over the past year. Raising cash through the issuance of new shares at such low valuations is unappealing, but pot producers have limited alternatives, according to The Wall Street Journal.
- Cannabis stocks have lost more than half their value over past year.
- Equity financing loses its appeal at such low valuations.
- Banks are reluctant to lend as pot is still federally illegal in U.S.
- Cash crunch comes as Canadian pot sales are expected to slow.
What It Means for Investors
Most publicly traded companies raise cash through a mix of both equity financing and debt financing, and debt financing is often the cheaper option. But pot producers face a problem when it comes to debt financing that is specific to their industry. Large banks don’t want to lend to them because cannabis is still federally illegal in the U.S. Dealing with potential legal headaches is one risk banks just don’t want to take.
Another risk banks are reluctant to take is lending to companies whose ability to earn consistent profits is still in question. In a nascent industry like cannabis, most companies fall into that category. However, Green Thumb Industries is one cannabis firm that was fortunate to raise $105 million through a bond issuance in May. The company managed to convince creditors of its path to profitability, but offering a 12% coupon on the bond also helped. Since then, debt costs have risen.
The limited ability to tap debt markets means most pot producers end up issuing new shares in order to raise cash. But that’s an option that no longer looks appealing after the obliteration of market valuations over the past year. After peaking at over $17 billion in late April of this year, Canopy Growth’s market capitalization has fallen 60% to just under $7 billion.
The amount of capital being raised in the cannabis industry is falling in tandem with the drop in market values. The amount raised during the week that ended 25 October fell to just $27 million from $708 million a year ago. “The recent downturn in cannabis stocks has spilled over to the private-equity and debt markets,” Tony Cappell, co-founder of cannabis finance firm Green Ivy Capital, told the Journal.
This cash crunch comes at a vulnerable time for marijuana companies as growth in pot demand in Canada, where the drug is fully legalized, starts to slow. Analysts at Stifel have cut their sales expectations for Canada’s producers by 10% to 20% for the most recent quarter that ended in September and expect next year’s sales to be lower than previously thought, according to Barron’s. That’s likely to put even more downward pressure on cannabis stocks.
However, the analysts suggest that investors focus on companies with large hoards of cash in this currently cash-strapped environment, including Canopy Growth and Cronos Group. While other companies will struggle to raise funds, the firms sitting on piles of cash will be the ones still able to invest in an industry that has the potential to turn into a “$200 billion global opportunity.”