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Report on Business Cannabis Professional Cannabis stocks to extend volatility into 2019, small LPs seen facing challenges

Cannabis stocks are widely expected to maintain their volatile streak into 2019, with investors keeping close tabs on retail expansions and business acquisitions while honing in on companies that increase their overall scale of production to reduce costs and establish footholds in the rapidly rising CBD market.

Share prices of publically traded cannabis companies surged in the months leading up to the October legalization of recreational pot in Canada, but violently declined shortly afterwards. The North American Marijuana Index fell to a one-year low in December as a supply shortage hurt sales and hindered retail store openings in Canada, and as a flood of small cannabis companies went public.

Between January and October, cannabis companies raised $2.5-billion on the Canadian Stock Exchange (CSE), accounting for 70 per cent of the new financing during those 10 months. Of this, $1.5-billion came from 50 companies with U.S. operations, the CSE said.

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In total, more than 110 of the roughly 450 listed securities on the CSE are companies that operate in the cannabis sector, fuelling record share volume and value traded at the CSE in 2018, the exchange said.

“Performance in 2019 will largely be limited to those LPs [licensed producers] that can execute well on their stated business plans considering most LPs are behind on their production targets, and there is still a large question whether they can catch up by the second half of 2019,” said David Doritty, vice-chair of Echelon Wealth Partners, stating his comments represented his opinion and not that of Echelon.

“Another part of the volatility in the space in 2019 will be born out of increased mergers and acquisitions simply based (on) market necessity. This process may even be sped up by the market issues still lingering from the poor roll-out of legalization causing huge supply and demand issues that still have not been fixed.”

Jason Zandberg, cannabis analyst for PI Financial in Vancouver, also expects market volatility to continue in 2019, with investors taking cues from Canadian retail sales.

“Pretty much anything you can grow that is a passable standard is being sold in the Canadian market. The shortages will continue but won’t be as bad in late 2019,” Mr. Zandberg said.

“We do see an inflection point where we get to oversupply. It could happen in 2020 or 2021.”

Investors will look for LPs to follow up on their output and product promises ahead of the legalization of edibles, with particular interest in the falling cost of production as growers increase their scale and reduce per-gram costs.

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“The average selling price per gram is now pretty much a requirement,” said Karl Grywacheski, director of corporate finance for Origin house, a cannabis products and brands company in Canada and the United States.

“That’s a very key metric today that is telling in terms of the value of marijuana companies.”

Investors are increasingly looking to gauge the efficiency and potential of LPs through average selling costs and capacities, though they also want to know details around their supply deals with provinces, he said, while speaking at the O’Cannabiz Conference in Vancouver in December.

Small LPs looking to come online, however, may face an uphill battle, even though the legal recreation business is still in its infancy.

“Some of these smaller producers that are just getting licensed now are going to have a hard time. I don’t expect a lot of the smaller growers to be able to raise capital in 2019,” Mr. Zandberg said.

“Larger LPs will be able to sell at lower prices due to economy of scale.”

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Some ancillary cannabis businesses, however, such as data providers, will likely be able to raise capital in 2019 if they have a solid niche and good management, he said.

“Retail’s a good example of a trade that’s been overlooked this year. I do believe the retail space will be highly profitable for investors,” Mr. Zandberg said, referring to retailers with good profit margins and can expand into multiple provinces.

Matt Bottomley, research analyst of alternative pharmaceuticals for Canaccord Genuity Inc., said tracking LP sales will be a key theme in 2019 as well as M&A, such as what has already taken place among some of Canada’s biggest LPs to enter the beverage industry. He expects recreational cannabis growth to be modest versus overall market expectations.

“There are so many unknowns in the assumption in how these companies will ramp up revenue, what the profits will be, that it is a very hard sector to time. Volatility is something to expect going forward,” Bottomley said.

“There are many relatively cheap stocks versus others and companies might use their equity to fill any holes they may have, whether it be research or overall reach into other provinces,” Mr. Bottomley said.

What will be critical in 2019, however, will be clarity on international opportunities as roughly 30 countries appear on track to legalize medical marijuana, which will provide a huge revenue opportunity for LPs, he said.

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Investors are also keenly watching the flurry of companies that aim to get in on strong demand for cannabidiol, the non-psychoactive compound found in cannabis and industrial hemp that is associated with health benefits. It is more commonly called CBD, which has quickly become a household word with the December passing of the U.S. 2018 Farm Bill that federally legalized the byproduct when derived from industrial hemp.

“Hemp is going to become the elephant whose toenail will be called cannabis,” said Sumit Mehta, founder and chief executive of Mazakali, a U.S. company that helps cannabis businesses find capital.

Mehta cited the multiple byproducts that come from hemp as a reason he expects hemp companies will thrive, adding others that focus on data, wellness, and genomes will also be big plays in 2019, while increasing scale appears vital, he said.

“The alternative to growing with the market is to buy growth,” Mr. Mehta said.

And in cannabis, growth also includes selling the right accessories.

“My belief is vape pens will be the big product category that will make a huge difference. It will be a product category that you have to have. The overall volume of sales will likely increase with the introduction of vape pens,” said Mr. Zandberg of PI Financial.

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“It’s a lot cleaner than smoking. There’s not that cannabis smell and they have those nice fruity aromas. We’ll see that as a main product over edibles next year.”

Other products, such as cannabis beverages, are widely expected to be vital to company growth.

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