Hops on the bandwagon: brewers eye pot of gold in cannabis
As the weed increasingly gets the green light in law, the dynamics of 'investing in sin' have changed
Alcohol producers are right to be worried about moves to legalise marijuana in North America.
Even permitting cannabis use for medical purposes has been shown to have a significant effect on sales of beer and spirits. That’s why recent reports that a suite of major brewers, including UK-listed Diageo, are in talks about investment in the fledgling cannabis industry makes business sense.
And, with many headwinds still facing the highly regulated tobacco sector, it looks like investing in “sin” is in the throes of a major structural shift. Diageo is reportedly in talks with at least three Canadian cannabis producers ahead of full legalisation in the country on October 17.
Anheuser-Busch InBev, Pernod Ricard, Molson Coors and even Coca-Cola are believed to be trying to find a way into the fledgling drinkable-cannabis market. They will follow in the footsteps of first-mover Constellation Brands, the US group behind Corona beer, which announced a couple of weeks ago it was increasing its investment in Canadian medicinal cannabis producer Canopy to 38% in a $4bn deal. It initially took a 9.9% stake last October.Dutch brewer Heineken has already launched a product in California, Hi-Fi Hops, through its craft brewer Lagunitas. It is available at a number of cannabis dispensaries in California for $8 a can.
These moves appear wise. A study by the University of Connecticut and Georgia State University has shown that in US counties where medicinal cannabis use had been made legal, there was a 15% drop in alcohol sales. The research directly linked the two findings.
This mirrors research by Wall Street analysts, with CFRA Research finding that alcohol sales fell 13% in states with medical marijuana.
“Alcohol overlaps significantly with cannabis, whereas something like tobacco doesn’t,” the report said. That’s why the Canadian experiment, as the first G20 country to fully legalise pot, will be closely watched.The potential market is huge. Forecasts vary because of the difficulties in assessing current consumption of the prohibited drug, but RBC Capital Markets estimates that legal sales of cannabis in the US could hit $47bn in 10 years, implying a compounded annual growth rate of 17%.
Of course, the sale of cannabis remains federally prohibited in the US, but individual states such as California and Alaska have passed legislation for recreational sales. In total, nine US states have legalised its use recreationally and 29 plus the District of Columbia for medicinal applications.
The biggest risk in the US is from Capitol Hill, which could clamp down on individual state actions. However, currently, it appears that this is unlikely. US banks have been reticent in providing funding to the industry because of this federal uncertainty. Should a compromise be struck in Washington, there is also a substantial opportunity for banks and insurers to enter the industry.The moves by global brewing companies have reignited investor interest in the sector. ETFMG “Alternative Harvest” fund, which trades under the symbol MJ, has been the best-performing exchange-traded fund (ETF) offered by the provider over the past month. It is the only listed ETF in the US that targets investment in the marijuana space and it had fallen significantly this year on sector overvaluation fears, but M&A activity and the interest of brewing giants has sent it soaring yet again. MJ is up more than 20% over the past 30 days.
It is undoubtedly true that the sector’s valuation is high. For example, the third-largest cannabis company in the world, medicinal supplier Tilray, posted its quarterly results this week. These showed it sold less than $10m of cannabis, despite a market capitalisation of almost $6bn. Canopy made C$26m of quarterly marijuana sales, compared with its market value of C$14bn. Both companies reported a loss.One thing the cannabis bulls see in their favour is potential tax revenues. The first full year of legal marijuana sales in Nevada exceeded expectations by 40%. Taxable pot sales hit $529.9m, raising nearly $70m in tax revenue, including $27.5m for schools. This fledgling industry has great potential for investors and also offers alcohol companies a way to boost flagging sales.
But any investment can only be regarded as highly speculative. With a lot of froth in the sector, perhaps the best way to play this trend is through the brewers themselves.
• Garry White is chief investment commentator at wealth manager Charles Stanley.
– © The Daily Telegraph