9 Potential Cannabis Sector Growth Drivers in 2021

Access to Capital Should Continue to Expand
As we entered 2020, limited access to capital was top of mind following the vaping crisis in late 2019, an obstacle to growth that was compounded by the pandemic initially. Sale-leasebacks, primarily with Innovative Industrial Properties, were one of the important sources of funds for expansion during 2020, and debt capital became increasingly more available. Several MSOs sold equity late in the year, and the markets handled the supply well. We expect 2021 to see debt terms improve and the appetite for equity to expand. Additionally, several SPACs targeting the cannabis sector could deploy capital.

New Public Companies Are Going to List
After a long drought, companies began going public again, with a successful IPO from Hydrofarm late in the year signaling investor demand for new names. New Cannabis Ventures maintains a list of pending new issues. The Parent Company and WeedMaps, both of which are going public via transactions with SPACs, are on track to begin trading in Q1, and Verano Holdings will be listing on the CSE after completing a reverse merger. Over 4 years after the first cannabis REIT debuted, AFC Gamma, a mortgage REIT, is conducting a NASDAQ IPO. Private MSO Ascend Wellness has been rumored to be pursuing going public as well. We anticipate that there will be several more new listings in the year ahead from companies that are generating substantial revenue and profits.

The Pace of Mergers and Acquisitions Is Likely to Accelerate
Columbia Care announced the pending acquisition of private MSO Green Leaf Medical. On that same day, Ayr Strategies announced the pending acquisitions of both publicly traded Liberty Health, which will get the company into Florida, and privately held Garden State Dispensary, which will expand operations to New Jersey. As we previously discussed, we believe that the leading MSOs that have earned the confidence of investors are likely to expand within their current footprint as well as to expand into new geographies with targeted acquisitions. The three deals detailed above are consistent with our outlook, and we expect M&A to be a big story this year.

More Investors Will Embrace the Sector
One of the highlights of the sector this year was the beginning of institutional investment, which we discussed two months ago. We have seen well known funds begin to take equity stakes in several of the leading MSOs, and many investors are providing debt capital. Family office CapStone Holdings, for example, recently disclosed that it purchased $25 million of TerrAscend’s $120 million debt offering and also bought $50 million of Curaleaf’s $300 deal. These investors aren’t waiting for higher exchange listings, and it’s encouraging to see compliance departments become more comfortable with the sector.
A big challenge for retail investors has been their inability to access cannabis investments due to their listing status. In the past, Canadian LPs and just a few American ancillary companies were the only stocks trading on higher exchanges, but we are beginning to see not only more ancillary stocks but also a clever ETF that trades on NYSE ARCA that we continue to believe could dramatically expand access indirectly to American cannabis companies.

State-Legal Cannabis Should Continue to Gain Share From the Illicit Market
Medical cannabis being deemed an essential service was a game-changer for the sector last year, as it allowed the legal market to better compete with the illicit market. In addition to delivery and/or curbside pickup introductions into markets where they didn’t previously exist, progress was made on the payments front, all of which allowed effective e-commerce solutions to proliferate and the legal market to greatly improve the customer experience relative to the illicit market. Strong growth in the most mature markets, like Oregon and Colorado, compared to a year ago provided evidence of progress towards conversion to the legal market. We expect continued advancement on this front in 2021. Not only are there several new markets opening, but some states, especially California, have seen many localities that had previously not permitted retail stores reverse course. The thirst for tax revenue and economic development are tailwinds for the legal cannabis industry.

Additional States Could Legalize
Part of the reason cannabis stocks surged in Q4 was the resounding success at the ballot box in November, with voters in Arizona, Montana, New Jersey and South Dakota all approving adult-use and voters in Mississippi opting for medical cannabis. We had previously discussed that Arizona and New Jersey are particularly exciting for investors given the large presence of publicly traded MSOs, but the even bigger benefit will be a likely wave of legalization on the East Coast though the legislative process. Since November, the governors of Maryland, New York, Pennsylvania, Rhode Island and Virginia have voiced support for legalization. Beyond the East Coast, New Mexico and Wisconsin are considering legalization.

Look for Progress at the Federal Level
Any speculation regarding potential changes at the federal level this year is surely subject to the results of the Georgia runoff elections on Tuesday. We certainly aren’t in a position to predict the outcome of the Senate races, but we think it’s a win or win-big scenario most likely for the cannabis sector. We believe the status quo can yield some regulatory reforms that would be quite favorable for the industry, while the Democrats taking control of the Senate might lead to bigger changes on a shorter time-line (and likely a huge boost in the near-term to stock prices).
Cannabis reform has increasingly become a bipartisan issue. With voters in red states like Montana and South Dakota approving legalization, the pressure is building on those legislators who refuse to accept the reality of the current situation that most Americans want cannabis to be legal. We don’t expect full legalization in the very near-term and suggest that investors be aware that it could lead to some negative outcomes for existing operators, but we believe the federal government is likely to rationalize its policies no matter the outcome Tuesday.
We have spoken in the past about some of the reforms that we hope can happen, including the repeal of 280E, which weighs heavily on MSO profitability, a SAFE Banking Act, which, if improved from its prior language, could pave the way for major exchange listings, the ability of banks to make loans to the industry and the likelihood of major credit card companies permitting use, and medical research made easier to conduct. Interestingly, both the House and the Senate passed similar legislation late in the year on medical research.

The Canadian Market Should Continue to Improve
Our contrarian call is that the Canadian sector could yield some winning investments in 2021. We recently discussed that the retailers and smaller LPs are the most likely to benefit from improvement in the market. These stocks are largely ignored by investors and should appeal to value investors in our view. Our enthusiasm is grounded in the continued rollout of products beyond flower as well as the expansion of the stores, especially in Ontario, but we also are encouraged by production assets of the largest suppliers coming offline and inventory levels stabilizing at levels more in line with the demand, which has been doubling from a year ago.

Focusing Beyond North America Will Become More Important
While the largest Canadian LPs have been talking up markets outside of North America for years with the market growing more slowly than expected, things are beginning to change. Late in the year, at least two suppliers in Latin America were able to make medical cannabis sales into Germany, the first time this has happened. The global supply chain for EU-GMP products has ramped up, and this could be an area of growth in 2021. The Israeli medical cannabis market has seen stunningly strong growth as well. The number of countries that have legalized adult-use could double from two to four in 2021, with Israel and Mexico likely to join Canada and Uruguay.