Can the cannabis industry turn growth into profits?

Recreational use to fan the flames
The cannabis industry’s historical growth rate has been high and this is expected to continue in 2020. Canada’s legal cannabis market is set to increase by 50% to around $1.7bn*, driven by more retail stores carrying marijuana products, including edibles, beverages and vaping devices. The biggest growth driver in the coming years is likely to be recreational use rather than medical use, but this will have to battle against the increased risk of consumer regulation.

Still, here at Saxo we expect growth rates to remain high for the years to come based on the projections from Bloomberg Intelligence and restructurings to accelerate the weeding out of weak companies in the industry. There will be more pain before the industry consolidates into bigger players with operational moats that can improve operating margins. Regulation has so far been a friend for the industry but over the years this could change as recreational marijuana use increases. Our view on the industry is that it will be volatile for years.

* According to Kenneth Shea, senior analyst (Food & Beverage) for Bloomberg Intelligence

Growth rolled up in volatility and risk
Since the cannabis index’s launch in September 2018 it has had annualised volatility of 45.6%, which is three times that of the S&P 500 at 15.1%. The correlation to the S&P 500 is only 0.11, showing that the industry is not driven by general macro factors but many idiosyncratic risk factors. It also highlights the appeal of Saxo’s new cannabis index futures, as the S&P 500 or any other equity index would be an inadequate hedging instrument.

The idiosyncratic risk factors facing the cannabis industry include the high debt levels of some companies and new regulations arising from an increase in recreational use. Also, goodwill impairment and very high equity valuations cause sharp declines in share prices during earnings releases, which helps to explain the high levels of volatility that make long-term investing difficult.

Trade Cannabis volatility with Saxo
To complement Saxo´s existing cannabis-related product offering, we recently launched S&P/MX International Cannabis Index Futures (SMJ). This means you can now get exposure to the major global cannabis index with a multiplier of 50. Not only will this enable you to hedge against potential losses and enhance your risk management, but more importantly it will also provide you with an efficient way to short the entire industry.