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Five weeks ago, just before what served as the lowest mid-point for the New Cannabis Ventures Global Cannabis Stock Index and just after the American Cannabis Operators Index hit what also turned out to be an mid-low , we suggested that three underperforming stocks signaled an upcoming problem or offered a potential investment opportunity. Since then, these three stocks, all leveraged for developments expected by cannabis operators as new states go online, have generally performed poorly, with two falling by more than 18%. After this drop and with the Global Cannabis Stock Index and the American Cannabis Operators index being respectively at the lows of 2021 and down 4.5% and 20.9% since the start of the year, it is easy to conclude that there are problems ahead, but we think this is the wrong conclusion.
2021, the year of the big round trip for the cannabis industry, has been frustrating for investors, with massive gains at the start of the year wiped out on the balance. Many have discussed the disconnect between price action and valuations and fundamentals. While trying to call the end of the slowdown from the parabolic peak in February is a difficult task, we expect strong fundamentals to eventually pull prices up.
Since last November, we have reported a risk of a slowdown in cannabis sales due to increased demand following the onset of the pandemic. Recent data has certainly shown a slowdown. The earnings season starts in just over a week, and the third quarter will be the toughest comparison. In the summer of 2020, consumers had excess time and disposable income, and these factors, among others, led to very strong consumption trends. The good news is that comparisons will get easier for the fourth quarter and beyond.
The growth of the industry is not limited to same-store sales. It depends not only on new states, such as Connecticut, New Jersey, New Mexico, New York State and Virginia, which all have plans to implement new adult programs, but also several. other factors, including adding capacity or additional stores in markets that are constrained and expanding retail in municipalities or counties that previously placed limits on sales to adults. This continues to play out and will be the engine of further growth. Another driver of future growth is the continued erosion of the illicit market.
This decline over the past eight months has been very different from the previous one. Recall that the vaping crisis at the end of 2019 triggered a capital crisis that left the industry struggling to develop. At the time, most operators were not yet generating positive cash flow. Despite low stock prices, selling stocks seemed like one of the only options at the time.
We’ve discussed how capital is increasingly becoming available to cannabis companies, whether through debt, mortgages, or sale-leaseback. This continues to be the case, with substantial transactions announced by major debt or leaseback providers last week, continuing a trend that has been in place for several months. While the stock prices of cannabis companies appear to reflect pessimism, the actions of these capital providers suggest that the growth we are discussing will indeed take place over time. Unlike the recent 4.6% drop in the U.S. Cannabis Operator Index from its previous low on 9/14, the three publicly traded REITs that cater to major MSOs have seen their stocks go down. appreciate since then:
The strong relative performance reflects strong demand for capital, and we believe REITs will be able to help finance the construction of grow facilities in existing and new markets. If their investors didn’t believe the funds could be deployed effectively, stocks likely wouldn’t recover. This is great news, as it reduces the likelihood of stock offerings by traders to fund the expansion.
Several weeks ago, we spotted a potential negative warning sign in the price action of hydroponics suppliers, as their investors believe demand will slow. Today we see the strength of a set of companies that are relying on exactly the same trends. In the near term, shares of hydroponics companies and cannabis operators may not reflect fundamentals properly. Instead, technical factors, including tax loss selling, may play a role. Perhaps there are too many concerns about short-term sales trends, with investors extrapolating slower growth over longer time periods. We remind readers, however, that these new markets are coming online and that several existing markets that continue to be underserved by the legal market are booming. The strong performance of REITs suggests that at least their investors understand this dynamic.
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Alain and JoÃ«l