6 reasons an investment in the pot industry will likely go up in smoke: Olive

6 reasons an investment in the pot industry will likely go up in smoke: Olive
The Great Pot-Stock Bubble is upon us. Investors will be tempted to get in early on one of Canada’s fastest-growing industries.

Resist that temptation.

The spectacular stock-market performance of many cannabis companies is a powerful lure to investors. In the past three months, investors have driven up the stock-market value of Canadian industry leaders Canopy Growth Corp., Aurora Cannabis Inc. and Aphria Inc. by 107 per cent, 147 per cent and 49 per cent, respectively.

Late last month, the $9.8-billion (sales) Constellation Brands Inc. of upstate New York paid $245 million for a 9.9 per cent stake in Canopy Growth, world’s largest publicly traded marijuana company. The marketer of Corona beer and Black Velvet whisky wants in on the ground floor ahead of the day America decriminalizes pot at the federal level.

But the current euphoria for marijuana investments is identical to the irrational exuberance of the ill-fated dot-com era of the late 1990s, which yielded exactly one change-the-world success story – Inc.

Here’s a short list of what should worry prospective investors in the nascent Canadian cannabis industry.

1) The commercial pot market isn’t as big as it looks

The Canadian market for medical marijuana products is estimated at $1.3 billion. That market has already plateaued, a worrisome sign.

The market for recreational pot is estimated at $6 billion by 2021. But that assumes the black market and homegrown pot will simply disappear, and be absorbed by the legal market.

That’s a poor assumption.

The black market isn’t weighed down by the legal industry’s many costs. They include navigating a regulatory labyrinth, including GST remittances; operating bricks and mortar and online shopping channels; and the federal mandate to provinces and territories to test the quality of marijuana products, which will show up in retail prices.

The black market will thus enjoy a cost advantage over the legal market. And biker gangs and “the pusher who sells drugs in the stairwell” (Prime Minister Justin Trudeau’s expression) have little to fear from an under-resourced criminal justice system that cannot even enforce the laws on driving while texting, a growing cause of death and injury.

2) Too many players

There are about 70 publicly traded marijuana firms in Canada, a ridiculous number for a relatively small market like Canada. That is an accident owing to America’s refusal to decriminalize pot at the federal level, prompting start-ups to favour the Great White North.

There are at least another 20 privately held Canadian cannabis firms. Most of these are hoping for a stock-market listing so that they too can tap Main Street investors for the enormous amount of capital they require.

There will be a “shakeout” of those firms. Some will be merged out of existence, while most will simply perish.

3) Prices and margins will fall

As provinces like Ontario and Alberta begin purchasing marijuana wholesale, recreational pot prices will plummet. They are forecast to fall from the $7 to $12 per gram currently paid for medical marijuana, to $4.50 to $5.

That in turn will cut producer profit margins at least in half, from as high as 80 per cent to 90 per cent currently – a big draw for today’s investors – to less than 40 per cent by this time next year.
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