BY: MARK NOBLE, SENIOR VICE-PRESIDENT, ETF STRATEGY, HORIZONS ETFS
July 9, 2019
The second quarter was a difficult one for the Marijuana sector. The sector, as represented by the Horizons Marijuana Life Sciences Index ETF (HMMJ) was down about 15% on the quarter, although on a year-to-date basis, the ETF is still up more than 30%.
The first quarter saw increased confidence in the sector resulting from revenue growth of the Canadian Licensed Producers (“LPs”). In the first quarter, revenue and sales growth largely exceeded expectations with some of the bigger LPs, such as Aurora and Canopy Growth, posting very large revenue growth numbers with the addition of recreational marijuana sales from the Canadian market.1
In the following quarter, optimism about the growth of the sector has been replaced with concern about both valuations and how much opportunity exists in the Canadian Marijuana sector.
Both concerns are valid. Let’s start with valuations. The top five Canadian LPs, which are held in the HMMJ portfolio and comprised an approximate CAD $48 billion market capitalization following the 1Q 2019 rally, all trade at negative earnings.2 This sector has always traded on its growth potential, but the Canadian market may never be big enough to warrant the lofty valuations of the sector.
Without positive earnings data, it’s important to look at other metrics. By examining the price-to-book value, you can see that the top-ten holdings of HMMJ (as at June 28, 2019) still trade at high valuations, in-line with growth stocks – but nowhere near the levels they were at the end of the first quarter. Canopy Growth, for example, is trading at a price-to-book ratio of 2.59 vs. 2.82 at the beginning of the last quarter. Some of the names that had excessive price-to-book ratios, such as Tilray and Cronos, have seen their price-to-book ratios drop (from 35 to 11.75 in the case of Tilray, and 23 to 7.22, in the case of Cronos).
The good news, as can be shown in the sales growth numbers, is that there are real sales being generated by most of the LPs with year-over-year gains coming from both increased medical and recreation marijuana sales. When these numbers started to appear in mid-February, it was a big catalyst for the recent leg-up seen in the stock prices.
Table 1: HMMJ Top Holdings
| Name | Ticker | PB Ratio | Sales Growth (29/06/18 to 28/06/19) |
| CANOPY GROWTH CORP | WEED CN Equity |
2.57 | 190.37% |
| AURORA CANNABIS INC | ACB CN Equity |
2.37 | 205.51% |
| CRONOS GROUP INC | CRON CN Equity |
7.21 | 284.69% |
| TILRAY INC-CLASS 2 COMMON | TLRY US Equity |
11.8 | 110.00% |
| GW PHARMACEUTICALS -ADR | GWPH US Equity |
— | 27.08% |
| APHRIA INC | APHA CN Equity |
1.37 | 80.62% |
| SCOTTS MIRACLE-GRO CO | SMG US Equity |
8.84 | 0.81% |
| HEXO CORP | HEXO CN Equity |
3.42 | 20.43% |
| CHARLOTTES WEB HOLDINGS INC | CWEB CN Equity |
2.64 | 73.72% |
| ORGANIGRAM HOLDINGS INC | OGI CN Equity |
4.25 | 117.53% |
Bloomberg, as at June 28, 2019
What’s caused such a precipitous drop in valuations over the second quarter when sales growth seems strong? Clearly sentiment plays a key role. In the absence of any significant industry news in the quarter that could drive growth forward, many investors appear to have lost some of their optimism for the space. The primary factor is likely the second concern mentioned, which is fading optimism about the Canadian Marijuana market.
Canopy Growth, which reported earnings in mid-June, showed a precipitous decline in recreational marijuana revenue quarter-over-quarter. As the clear market leader in Canadian Marijuana market, this has market observers concerned. There was some expectation of strong sales amid the initial euphoria from recreational legalization. Canopy Growth said it took in CAD $68.9 million in the quarter from sales of recreational cannabis, down from CAD $71.6 million the quarter before, when legal sales began two weeks into the quarter.
This decline so early in the implementation of recreational marijuana in Canada clearly has some investors concerned. Canopy Growth is one of the more diversified LPs with significant investment in many non-Canadian operations. Very few of these operations are generating significant revenue. For now, the primary source of revenue for the Canadian LPs is Canada, a market that seems to be struggling to meet its sales growth expectations.
Part of the reason for the disappointment in recreational sales may be blamed on the somewhat lackluster roll-out of recreational distribution. In Ontario, by far the largest market in Canada, there was the delayed rollout of brick and mortar stores.
This delayed rollout may have resulted in less enthusiasm for legal avenues in the space, which could dampen overall revenue opportunities in the near-term. Overall, according to ArcView Research and BDS Analytics, Canada’s total Marijuana sales are expected to surpass CAD $1 billion in 2020 with the added revenue streams of edibles, and reach potentially $4.8 billion by 2024.3
All of this was more than priced-into the current valuations of the Canadian LPs. Until foreign revenue streams from Europe and the United States start to factor into sales, we could potentially see more volatility in the Canadian LP space.
Now more than ever, investors should be looking at diversification, for two key reasons:
Single stock earnings disappointment: Canopy Growth is one of the largest holdings in HMMJ and has been the clear sector leader. We often hear investors say they would rather own WEED than HMMJ. For context, WEED was down for the month of June, around 2.96%, while HMMJ was down about 0.86% for the same period. HMMJ holds a much more widely diversified portfolio of stocks. Other holdings like Aurora actually had positive returns.
Canada is priced-in: In my mind, the single-most important talking point with Marijuana equities is the fact that Canada is priced-in. We see that with the Canopy Growth earnings, there’s only limited growth from Canadian revenues. Investors might want to look into diversifying to companies that have exposure outside of Canada. One way to do this is by purchasing an ETF with exposure to non-Canadian cannabis operators and diversifying outside of only holding Canadian LPs directly.
U.S. Growth
Certainly with HMMJ, we see much more of a non-Canadian diversification occurring. In the latest rebalance, of the 10 new index constituent issuers added, six were businesses largely focused on the U.S. market. Three of the new additions, Abacus Health Products, cbdMD and Youngevity International, are U.S.-focused CBD providers.
According to a study by the Brightfield Group, the CBD industry in the U.S. alone could be worth USD $22 billion within the next two years4, which puts that single market by itself at roughly the same target market size of the entire Canadian Marijuana industry. Opportunities to use CBD in pharmaceuticals, alternative health products and even food and beverage represents a very large investment opportunity.
According to ArcView Market Research and BDS Analytics, legal CBD spending is already at $624 million in the U.S.5 To give context, that’s likely more than the total Canadian recreational marijuana sales will be in 2019. Already, CBD producers are generating revenues from both dispensaries and pharmacies. The rapid growth of this sub-sector of the industry has resulted in the rapid rise of U.S.-focused CBD companies reaching market-caps that make them eligible for inclusion in HMMJ.
Investors may also lose sight of the fact that even though marijuana usage in the United States remains federally illegal, its legal state usages already represent a larger market than Canada.
The chart below shows that in 2019, cannabis spending in the U.S. will already dwarf the five-year projection numbers for the Canadian market. The U.S. Marijuana market is already thriving.
Source: ArcView Market Research/BDS Analytics as at May 30, 2019.
A key reason why Canadian LPs remain attractive is they have cash reserves to expand into the U.S. market and potentially acquire the smaller U.S. Multi-State-Operators (MSOs). The shareholder approval of a $3.4 billion takeover by Canopy of Acreage Holdings in June provides a strong template of how the Canadian companies can expand into these markets, even if they are not yet federally legal. Under this agreement, Canopy Growth would fully acquire Acreage as soon as marijuana cultivation is made federally legal in the U.S.
Without this particular deal, the Canadian LP market could have seen even more significant pullback, but the ability of the LPs to use first mover advantage to put stakes in the ground on the U.S. market, allows them to remain attractive for future growth.
Directly related to the MSO market, Horizons ETFs launched the world’s first U.S.-focused Marijuana index ETF in April, the Horizons US Marijuana Index ETF. HMUS is a passively managed index ETF, which seeks to replicate, to the extent possible, the performance of the US Marijuana Companies Index (“Underlying Index”) net of expenses.
Its Underlying Index is designed to provide exposure to the performance of a basket of publicly-listed companies having significant business activities in, or significant exposure to, the marijuana or hemp industries in the United States. Constituent companies will primarily include those with business activities as a producer, developer, or supplier of marijuana or hemp-based products, and can also include investment companies focused on investments in the Marijuana or Hemp industries, or companies with businesses ancillary to the Marijuana or Hemp industries.
Constituents of the Underlying Index are selected from Canadian and U.S. exchanges. While some securities may be listed on major North American exchanges, the majority of the securities currently trade on North American exchanges that include but are not limited to the Canadian Securities Exchange and Aequitas NEO (NEO).
The MSOs that comprise the majority of HMUS’s portfolio have had even stronger sales growth than their Canadian counterparts, while trading at similar valuations.
Table 2: HMUS Top Holdings
| Name | Ticker | Weight | PB Ratio | Sales Growth (29/06/18 to 28/06/19) |
| HARVEST HEALTH & REC INC SUBORDINATE VTG |
HARV CN EQUITY |
9.88% | 4.67 | -56.75% |
| CURALEAF HOLDINGS INC SUBORDINATE VTG |
CURA CN |
9.54% | 7.56 | — |
| CRESCO LABS INC SUB VTG | CL CN EQUITY |
9.33% | 5.05 | — |
| CHARLOTTES WEB HOLDINGS INC . | CWEB CN EQUITY |
6.88% | 2.64 | 73.72% |
| TRULIEVE CANNABIS CORP SUB VTG | TRUL CN EQUITY |
6.80% | 13.68 | 574.32% |
| MEDMEN ENTERPRISES INC CL B SUBORDINATE VTG |
MMEN CN EQUITY |
6.72% | 12.96 | 1388.99% |
| GREEN THUMB INDUSTRIES INC SUB VTG |
GTII CN EQUITY |
6.64% | — | — |
| COLUMBIA CARE INC . | CCHW CN EQUITY |
6.43% | — | — |
| ACREAGE HOLDINGS INC SUB VTG | ACRG/U CN EQUITY |
5.18% | — | — |
| IANTHUS CAPITAL HOLDINGS INC . | IAN CN EQUITY |
3.72% | 0.84 | 184.03% |
Bloomberg, as at June 28, 2019
HMUS provides diversified exposure to allow investors to get access to the early-stages of the U.S. market. As highlighted by the Acreage/Canopy deal, not only do these stocks have strong sales prospects in the rapidly growing U.S. market, but they are attractive takeover targets as well.
Q2 Rebalances:
As mentioned the strong growth in the U.S. market in the last quarter resulted in a number of new additions to both the HMMJ and HMUS portfolios.
The HMMJ portfolio recently expanded to include the following 10 constituents:
| Company Name | Ticker | Exchange |
| SPROUTLY CANADA INC. | SPR | CANADIAN SECURITIES EXCHANGE |
| VALENS GROWORKS CORP. | VGW | CANADIAN SECURITIES EXCHANGE |
| ABACUS HEALTH PRODUCTS INC. | ABCS | CANADIAN SECURITIES EXCHANGE |
| CORBUS PHARMACEUTICALS HOLDINGS | CRBP | NASDAQ |
| CARDIOL THERAPEUTICS INC.-A | CRDL | TORONTO STOCK EXCHANGE |
| ENWAVE CORP. | ENW | TSX VENTURE EXCHANGE |
| INTEC PHARMA LTD. | NTEC | NASDAQ |
| PYXUS INTERNATIONAL INC. | PYX | NEW YORK STOCK EXCHANGE |
| CBDMD INC. | YCBD | NYSE AMERICAN |
| YOUNGEVITY INTERNATIONAL INC. | YGYI | NASDAQ |
This was the first rebalance of HMUS since the ETF was launched in April. This rebalance included the addition of 11 new index constituents.
| Company Name | Ticker | Exchange |
| ABACUS HEALTH PRODUCTS INC. | ABCS | CANADIAN SECURITIES EXCHANGE |
| BODY & MIND INC. | BAMM | CANADIAN SECURITIES EXCHANGE |
| IGNITE INTERNATIONAL BRANDS | BILZ | CANADIAN SECURITIES EXCHANGE |
| CANNEX CAPITAL HOLDINGS INC. | CNNX | CANADIAN SECURITIES EXCHANGE |
| DIXIE BRANDS INC. | DIXI/U | CANADIAN SECURITIES EXCHANGE |
| JUSHI HOLDINGS INC. | JUSH/B | AEQUITAS NEO |
| TRANSCANNA HOLDINGS INC. | TCAN | CANADIAN SECURITIES EXCHANGE |
| TILT HOLDINGS INC. | TILT | CANADIAN SECURITIES EXCHANGE |
| CANSORTIUM INC. | TIUM/U | CANADIAN SECURITIES EXCHANGE |
| VIREO HEALTH INTL-SUB VOTE R | VREO | CANADIAN SECURITIES EXCHANGE |
| CBDMD INC. | YCBD | NYSE AMERICAN |
HMJR Rebalance
HMJR seeks to replicate, to the extent possible, the performance of the Emerging Marijuana Growers Index, net of expenses. This index is designed to provide exposure to the performance of a basket of primarily North American publicly listed small-capitalization companies primarily involved in the cultivation, production and/or distribution of marijuana.
HMJR invests in companies with market capitalizations generally between CAD $50 million and CAD $500 million. The ETF's portfolio is 100% invested in marijuana producers and distributors, and it can have exposure to companies outside of North America.
Many of these new constituents are companies focused on non-Canadian markets. HMJR now has significant exposure to emerging global Marijuana markets, including Australia, Israel, and of course the United States. Many of the new entrants to these markets start as smaller-capitalization stocks, meaning that HMJR tends to get exposure to the early entrants into these new markets. The HMJR portfolio recently expanded to include the following 20 constituents:
| Name | Ticker | Exchange |
| MGC PHARMACEUTICALS LTD. | MXC AU EQUITY | ASE |
| THC GLOBAL GROUP LTD. | THC AU EQUITY | ASE |
| CRESO PHARMA LTD. | CPH AU EQUITY | ASE |
| VIREO HEALTH INTL. | VREO CN EQUITY | CANADIAN SECURITIES EXCHANGE |
| CANSORTIUM INC. | TIUM/U CN EQUITY | CANADIAN SECURITIES EXCHANGE |
| BENCHMARK BOTANICS INC. | BBT CN EQUITY | CANADIAN SECURITIES EXCHANGE |
| CANNABIS ONE-SUBORDINATE A | CBIS CN EQUITY | CANADIAN SECURITIES EXCHANGE |
| ZENABIS GLOBAL INC. | ZENA CN EQUITY | TORONTO STOCK EXCHANGE |
| SUGARBUD CRAFT GROWERS CORP. | SUGR CN EQUITY | TSX VENTURE EXCHANGE |
| IGNITE INTERNATIONAL BRANDS | BILZ CN EQUITY | CANADIAN SECURITIES EXCHANGE |
| BODY & MIND INC. | BAMM CN EQUITY | CANADIAN SECURITIES EXCHANGE |
| STEM HOLDINGS INC. | STEM CN EQUITY | CANADIAN SECURITIES EXCHANGE |
| MJARDIN GROUP INC. | MJAR CN EQUITY | CANADIAN SECURITIES EXCHANGE |
| TRANSCANNA HOLDINGS INC. | TCAN CN EQUITY | CANADIAN SECURITIES EXCHANGE |
| RAVENQUEST BIOMED INC. | RQB CN EQUITY | CANADIAN SECURITIES EXCHANGE |
| ICC INTERNATIONAL CANNABIS C | WRLD/U CN EQUITY | CANADIAN SECURITIES EXCHANGE |
| AGRAFLORA ORGANICS INTERNATIONAL | AGRA CN EQUITY | CANADIAN SECURITIES EXCHANGE |
| AUXLY CANNABIS GROUP INC. | XLY CN EQUITY | TSX VENTURE EXCHANGE |
| CANNARA BIOTECH INC. | LOVE CN EQUITY | CANADIAN SECURITIES EXCHANGE |
| ORGANIC FLOWER INVESTMENT GR | SOW CN EQUITY | CANADIAN SECURITIES EXCHANGE |
| ICC INTERNATIONAL CANNABIS C | WRLD/U CN EQUITY | CANADIAN SECURITIES EXCHANGE |
Performance Update as at June 30, 2019*
| 1 Month | 3 Months | 6 Months | YTD | 1 Year | Annualized Since Inception |
|
| HMMJ** | -0.86% | -14.50% | 31.00% | 31.00% | 7.44% | 37.73% |
| HMJR** | -8.10% | -21.20% | 10.92% | 10.92% | -20.87% | -29.41% |
| WEED | -2.96% | -14.50% | 44.41% | 44.41% | 37.61% | 60.59% |
| North American Marijuana Index | -2.04% | -15.98% | 29.85% | 29.85% | 4.43% | 20.64% |
| US Marijuana Companies Index | -7.64% | -21.23% | 17.09% | 17.09% | -4.08% | -14.63% |
| Emerging Marijuana Growers Index | -11.01% | -24.41% | 5.68% | 5.68% | -26.30% | -38.99% |
* Bloomberg, as at June 28, 2019.
**Source: Horizons ETFs, as at June 28, 2019
1Bloomberg, “Canopy gains as revenue offsets drop in production, margins”, Kristine Owram – 15/02/2019
2The State of Legal Cannabis Markets, 7th Edition – Arcview Market Research and BDS Analytics
3The State of Legal Cannabis Markets, 7th Edition – Arcview Market Research and BDS Analytics
4https://www.brightfieldgroup.com/post/hemp-cbd-market-to-reach-22-billion-by-2022
5The State of Legal Cannabis Markets, 7th Edition – Arcview Market Research and BDS Analytics
The indicated rates of return are the historical annual compounded total returns, including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. Additionally, index returns do not take into account management, operating or trading expenses that may be incurred in replicating the index. The rates of return above are not indicative of future returns. ETFs are not guaranteed, their values change frequently, and past performance may not be repeated. The indices are not directly investible.
The views/opinions expressed herein may not necessarily be the views of Horizons ETFs Management (Canada) Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.
There are risks associated with this product. HMUS is expected to invest in the Marijuana industry in certain U.S. states that have legalized marijuana for therapeutic or adult-use, which is currently illegal under U.S. federal law. HMUS will passively invest in companies involved in the marijuana industry in the U.S. where local state law regulates and permits such activities, as well as in companies involved in the Canadian legal Marijuana industry. HMUS will not be directly engaged in the manufacture, importation, possession, use, sale or distribution of marijuana in either Canada or the U.S. Please read the full risk disclosure in the prospectus before investing.