Advisory Intelligence: Cannabis industry survives a correction as institutional investors look on

Oct 24, 2019
Nasdaq’s Kelly Flaherty discusses cannabis stocks’ performance and their outlook for the short-to-mid-term

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In the last two years, the market for public cannabis companies has captured the imagination of many people. The clamor of retail investors and regular media coverage has created tremendous excitement around what has been dubbed as a once-in-a-generation opportunity for wealth creation.

But the last six months have shown that the sector has a long way to go until it can be considered to be mature. ‘It has been just over a year since Canada legalized cannabis and the space is very different today than it was a year ago,’ says Kelly Flaherty, senior IR Intelligence analyst at Nasdaq in Toronto. ‘In 2017 and 2018, company valuations rose across the sector. In recent months, sluggish earnings and executive shakeups have changed the perspective, and now investors are looking for some clarity on the real long-term value of the sector.’

In Nasdaq’s recently published Cannabis Pulse Report for the second quarter, it compared the performance of the Solactive North American Marijuana Index – which tracks the performance of US and Canadian cannabis stocks – to relevant US and Canadian benchmarks. The index closed Q2 16 percent lower than the previous quarter. By comparison, the S&P500 was almost four percent higher than the previous quarter, Nasdaq was 3.6 percent higher and the TSX/Nasdaq Composite was 1.7 percent higher. 

As the cannabis industry evolves, a clearer picture will begin to emerge about which companies can be trusted to consistently deliver on their financial targets and comply with existing regulations. Until then, Flaherty says, a lot of institutional investors are watching with interest, but proceeding with caution. ‘One of the things we’re seeing from investors is that they’re waiting on the sidelines and looking for the industry to address ESG factors, especially prioritizing strong governance,’ she says. ‘There’s a distinction between having a board that can help a company navigate short-term growth and one that can oversee long-term value creation. Having risk oversight at the board level can mitigate investors’ concerns about an industry that is already considered high-risk.’

Nasdaq’s Pulse Report reveals that the top three owners of cannabis stocks above the $500 mn market cap level are all index investors, while five of the top ten are growth investors. As the market caps get smaller, hedge funds begin to appear in the top ten holders’ list. Flaherty predicts that these lists could look quite different in the near-to-mid-term.

‘We’ve definitely been seeing stronger investment from growth investors over the last two quarters,’ she says. ‘I think we could see an influx of value investors, given how much the sector has pulled back. In conversation with cannabis companies, we hear that some longer-term investors are interested, but will just take time.’

Nasdaq’s report also looks at the performance of the two leading cannabis ETFs during Q2 of this year. The Horizons Marijuana Life Sciences Index ETF saw net inflows of C$22 mn in Q2, while the ETF fell almost 15 percent. The US ETFMG Alternative Harvest ETF saw net inflows of $48 mn in Q2 and the ETF fell almost 14 percent.

Flaherty points to the positive net inflows as a cause for optimism. ‘The industry is still it’s infancy and sounding the alarm after a year of legalization would be premature,’ she says. ‘We continue to see asset flows into the sector and that provides greater stability for share prices.’

For IR professionals at cannabis companies, Flaherty says that the turbulent first two quarters of 2019 may actually have provided a better story to tell. ‘A big part of what’s needed right now is transparency and openness with investors,’ Flaherty says. ‘The last two quarters provide an opportunity to explain why share prices have gone down, what realistic valuations are, and why the company can be trusted to deliver.’  

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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