How The Impending Recession Could Change The Cannabis Industry: 'Everybody Is Going To Raise Capital'

Alan Brochstein, founder of 420 Investor and New Cannabis Ventures, joined Benzinga’s PreMarket Prep show Monday to discuss how the cannabis industry and its main players are navigating the looming recession.

In recent weeks, some financial commentators have viewed the recent spikes in cannabis sales as a predictor of a bright future for the industry. Brochstein’s expectations paint a less rosy picture for cannabis companies. 

The investor said he remains confident that some operators will make it out the other end of the crisis. 

Cannabis Sales Will Come Down, Brochstein Says 

The 2020 recession represents the first time an established cannabis industry has had to face an economic downturn.

In 2008 and 2009, only a handful of states had medical marijuana programs, and adult-use seemed more like a dream than an actual possibility.

Codie Sanchez, managing director at Entourage Effect Capital, argued last week that cannabis could be a recession-resistant investment.

Reasons behind this statement include the designation of cannabis as an essential service industry by multiple states, along with the double- and triple-digit sales growth driven by social distancing and quarantines. 

Brochstein agrees that consumers are inclined to continue using products like cannabis and tobacco, as well as alcohol and coffee, in times of crisis. Yet he views the spike in sales across the U.S. and Canada as an isolated event that comes as a result of consumers stocking up. 

The sales increases will not remain a constant, he said. 

Emily Paxhia, co-founder and managing partner of Poseidon Asset Management, also weighed in.

“Even in spite of the fact that cannabis has been deemed 'essential' in many key markets, operators will have to prepare for further disruptions and potentially for one of the worst economic downturns many of us will see in our lifetimes.”

Industry Already Squeezed Before Pandemic

Before analyzing possible demand trends for cannabis products in the near future, investors must remember that the entire industry was already in a capital crunch before the coronavirus crisis, Brochstein said. 

Better cannabis companies were already seeking financial relief in the form of sale-leasebacks and accessing the debt market, he said. 

“The better cannabis companies were already doing things like sale leasebacks and accessing the debt market."

Poseidon's Paxhia said cannabis stocks have been in a bear market for 26 months. Many have underdelivered, she said. 

“Capital has been destroyed by many irresponsible operators across the MSOs and Canadian LPs, damaging the potential for others to attract investment," Paxhia said, adding that the COVID-19 pandemic has only exacerbated these concerns. 

Some Cannabis Companies Will Thrive, But Others Might Not Survive 

Marijuana companies need to be lean on a macro level, said Eoin Keenan, head of content at the cannabis research firm Prohibition Partners. 

“Investors will remain risk-averse in the short-term and a lot of big producers, with high costs and low liquidity, will need to weather the storm,” Keenan said.

For Brochstein, what will define winners and losers in today’s market is positive cash flow.

In the U.S., the largest multistate operators like Cresco Labs CRLBF, Curaleaf CURLF, Green Thumb Industries GTBIF and TrueLeaf have positive cash flow in some of their more mature assets but not at the corporate level, he said. 

TrueLeaf, for example, has positive cash flow in Florida but not in aggregate, Brochstein said. 

Brochstein recommends investors stay vigilant when cannabis companies are looking for new capital.  

“Be very careful in the market. Everybody is going to raise capital,” he said, adding that some companies will do so to avoid bankruptcy, while others will do it as a way to secure their market share.

On Monday, Aurora ACB, announced a reverse split of its stock and a renewal of its at-the-market offering in order maintain the minimum stock price for an NYSE listing. 

Aurora is an example of a company with positive cash flow that is well-positioned but still has to adjust to a problematic environment, Brochstein said.

Aurora reports having around CA$205 million ($146.8 million) in cash, which will be of assistance in supporting the large cash-consuming operations it has established. Canopy Growth CGC and other Canadian LPs could be in a similar position, he said. 

Both Brochstein and Paxhia discarded the possibility of the federal government bailing out cannabis companies. As a federally illegal business, federal aid is out of reach, they said. 

Crisis Could Hit Differently Depending On Sector

Earlier stage product companies that are undercapitalized will struggle, said Poseidon's Paxhia.

“They have not yet developed consumer traction and loyalty and now have to break through online for order ahead and pick up," she said. "There are no more in-store sampling opportunities and marketing is severely limited in cannabis.”

The same is true for earlier stage retailers that have not been able to quickly pivot to a largely direct-to-consumer model, with customers ordering online for pick-up or delivery, Paxhia said. 

In Brochstein’s view, the biggest takeaway from the situation is the fact that cannabis is being positioned as an essential product for both consumers and legislators.

This “is certainly a good long-term driver for the industry,” said Brochstein. "This paves the way, in the future, for more states to legalize."

Prohibition Partner’s Keenan said regulators could turn to legal cannabis as a way to boost job creation and tax revenue in a post-COVID recession.

While many cannabis companies will experience drawbacks and some will eventually go out of business, the industry as a whole is well-planted and will continue to grow as more and more consumers turn to cannabis products as a way to deal with crisis-related anxiety, Paxhia said. 

“You can hide a multitude of sins in a bull market, but if you can survive the bear, you know you have a real business," she said. "We believe that not only will the industry survive, but we will see the true cannabis businesses and operators thrive."

Photo from Matthew Brodeur and CDC on Unsplash.