Investments in cannabis companies: What you need to know for 2021

How do we extract value from this opportunity?
Investments in cannabis companies: What you need to know for 2021
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This article was translated from our Spanish edition using AI technologies. Errors may exist due to this process.
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By Diego Magallón, Canncura's financial advisor

The topic of cannabis has become a main topic in investor forums around the world. In general, the question we ask ourselves is "How do we extract value from this opportunity?" With this in mind, we share with you the factors that will directly impact the ways in which the industry develops, the companies that comprise it and what has happened during this 2021 in private companies and those that are listed on the Stock Exchange.

1. Who are you as an investor and what is your investment horizon?

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It is important that you are clear about your profile as an investor, your added value (in addition to capital), the level of involvement and exposure to risk that you want to have.

Currently the investment possibilities both in the Stock Market and in live companies are limited, however, there is the expectation that as the industry transformation process progresses, so will the opportunities.

There are two main risks to any opportunity in the cannabis industry: volatility in company valuations and the time horizon in which things happen.

Basically, the success of any position they acquire (Stock Market or direct investments) depends on the capital flows that enter that specific industry or company, and the regulatory environment that shapes the industry.

2. Main catalysts for the cannabis industry in the coming years and in the United States

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In our perspective there are five important factors that directly influence the times, forms and amount of capital that enters the cannabis industry. We believe that investors who decide to get involved in these times should be clear about them.

SAFE Banking Act: It is a reform of the law of the United States, which will authorize financial institutions to provide services to companies in the cannabis industry. Currently in the United States, companies in the sector cannot access capital or services such as bank accounts, financing, POS terminals, etc.

Schedule I - Controlled Substances: List of controlled substances that both the US government and the UN have where they categorize the most risky substances, which they do not want to be exploited as a business, much less encourage industries around them. Cannabis is currently part of these lists with the prospect of being removed, since being building a regulatory framework around industrial and recreational medical uses in different states, it does not make sense for it to be on that list.

Taxes (280E): Businesses in the cannabis industry currently pay up to four times more taxes than any traditional industry. This is the case of section 280E of the federal tax law of the United States that derives from the inclusion of cannabis in Schedule 1. The implication of this tax is that companies pay gross profit taxes, as a consequence companies cannot directly deduct concepts such as: marketing, R&D , administration expenses, etc.

US Federal Legalization: Reform of US federal law in which a federal regulatory framework would be approved, which will open the doors to foreign trade, in which case Mexico will greatly benefit.

Cannabis companies listing on the Nasdaq: Approval by the statutes of the Stock Exchange to include and encourage companies in the industry to fund through the tools of the stock market.

There is expectation that these five conditions will change and when they do, companies will see positive impacts in terms of increased contribution margins, access to more capital with much lower costs, access to more markets and opportunities.

The main argument for assuming that more capital will enter lies in knowing the investment mandates of the institutional ones, where they define that they cannot enter industries that have any of the conditions described above. That is why there is strong pressure for them to change since capital wants to enter without having to modify their investment mandates.

3. 2021 Cannabis Stocks in the US and Canada: What to Expect

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After 2020 the cannabis industry proved to be resilient, so far this year 2021 we have seen a growth in the number of M&A with the aim of consolidating its position in the market or in the supply chain. The fundamentals for optimal development of the industry are at their most positive, the approval of the people according to the polls is at all-time highs, the support from the Democrats is clear. We can assume that we are facing a turning point in the industry, making the note that not all companies generate value and a deep analysis of the strategy must be had.

Regarding the valuation of the companies (analyzed by multiples) we are in quite acceptable multiples, at the date of writing this opinion. The shares appreciated quite significantly after the victory of Joe Biden, however, during the last two months some of them have entered a discount of up to 45% , which places them at an interesting price level to take risks.

The appreciation of the valuation of the shares is totally correlated to the times and the ways in which the five fundamental factors change. As for what we can expect this year, from our point of view, a SAFE Banking Act that, although it will not fully open the doors to money flows, will be an expected and incremental change for the industry.

4. The path of the cannabis industry in Mexico

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Mexico, with the potential to be a key player in the cannabis industry in the world, is some steps behind with respect to the legalization of the cannabis industry. This is good from the perspective that we can leverage the good and bad experiences of more advanced markets down the road.

In the case of Mexico, it is seeking federal legalization of the first instance, an ambitious and necessary objective to be able to capture the value of this industry in transformation. Everything indicates that by the month of September 2021 we will have more clarity on this legislation.

There is a lot of interest in participating in all the supply parts, currently the capitals are in the structuring stage, without a doubt the capital flows for the industry in Mexico have not yet entered and they have everything to grow, it will be an important year for the industry of the cannabis in different parts of the world.

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