Will COVID-19 fire up cannabis legislation or kick it into the weeds?
The economic downturn has pushed some cannabis companies to breaking point, but demand for tax revenue could see the sector get thrown a lifeline. What do our North American experts predict for cannabis as the COVID crisis wanes?
For the medical cannabis sector, 2020 has already been a wild ride.
After starting the year amid optimism about growth and markets, listed stocks have seen sharp falls, with market values halving between early January and mid-March as investors priced in COVID-19 and a souring economy on sales.
Some of the biggest companies have shown signs of distress. The world’s largest cannabis company, Canopy Growth, this month confirmed it will sell out of South Africa and Lesotho, close a growing facility in Colombia and two in Canada.
While dispensaries in many parts of the world reported an early increase in demand as people stockpiled before lockdowns, others were forced to close if they failed to secure ‘essential business’ status.
“This crisis is going to cause them to rethink the legalization of cannabis because the sales tax alone is so considerable.”
– Chris Rux
The economic turmoil has also presented challenges. The sector in the US has been left out of stimulus packages, while the SAFE Banking Act, which should have made it easier for the sector to access banking in the US, has stalled in the Senate.
Amid all the bad news, however, demand remains —and some observers see medical cannabis as a way for states and countries to generate much needed revenue when the COVID-19 lockdowns finally lift.
“When we get out of this COVID-19 crisis there is going to be a lot of attention on how we revive the economy,” says Chris Rux, Healthcare and Life Sciences Industry Leader at Cherry Bekaert.
“The US states are loosening a lot of restrictions, and it’s purely because of the economy. So what that tells me is that money and the search for tax revenue are going to drive all the decisions, ultimately, by the states and the federal government.
“The federal government just put out a $2 trillion stimulus package where they just printed money and you can’t just make more money — you need to find ways to collect it.
“I think that this crisis is going to cause them to rethink at the federal level and at state levels about the legalization of cannabis because the sales tax alone is so considerable.”
Past downturns have demonstrated that it can take years for economies to recover, Mr Rux says, and as traditional sources of revenue like income taxes decline, governments need to get creative.
“Even when we come out of the crisis, the economy is still going to be depressed, and the government may need to provide more stimulus — it’s the nature of the beast,” he says.
“If you have legalization nationwide it would reduce the black market because there is no need for a black market if you have legal access.”
– Chris Rux
“They are going to need money. Where do you get money? In the fastest growing industry in the country and the world.”
Although the cannabis sector may be sitting on the sidelines of existing stimulus packages, the decision by many states in the US to keep medical cannabis dispensaries open has helped legitimize the sector, says Baker Tilly International Director of Services & Industries Jake Luskin.
It might also change the way the industry is perceived more broadly.
“Many states have deemed dispensaries essential businesses so they are open,” he says.
John Sinclair, Managing Partner of Baker Tilly Canada’s Toronto office, added: “In Canada, before they even came out with the essential business list they said liquor stores, beer stores and dispensaries would remain open so that shows where they fit.”
The US cannabis sector is estimated to be worth about $56 billion in 2020, although it is thought that as much as 90 per cent of sales remain on the black market rather than through legal channels.
Mr Rux says legalization could help reverse that trend, and pour money into state and federal coffers.
Crisis makes supply chain issues clear
While COVID-19 has had an impact on all countries and sectors, it has also served to expose the cracks already present in the North American market for medical cannabis.
Some of those issues include the restrictions on transport across state borders in the US, a lack of certainty in supply chains and, in Canada, challenges with accessing supply due to international border closures.
“It is another element of the COVID situation that demand has gone up exponentially,” says Mr Sinclair, “and so one of my clients in particular is now scrambling to get the supply.
“It’s unfortunate because he could sell whatever he gets, but he can’t get enough.”
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Mr Rux says the crisis has exacerbated some of the challenges that might have not been apparent in the industry around imports, exports and cross-border trade, as well as what happens when parts of the supply chain cannot operate or are restricted.
“This whole thing has helped the industry identify a lot of issues that need to be addressed quickly,” he says.
“In Florida, where I sit, because every company has to be vertically integrated, grow their own, produce their own, sell their own, they seem to be doing fine.
“But there’s other states where you can have a dispensary licence and buy from the wholesale market, but because of the demand you can’t actually source the product.
“Before this whole crisis it is worth recalling that the state of Oregon had three years’ worth of supply sitting on the sidelines, but they can’t ship to other states.”
Innovation in the middle of chaos
The virus has also revealed those businesses that have been able to pivot in the midst of the crisis, changing business models or adapting faster than competitors to the restricted environment.
Across North America there’s been increased interest in home delivery, to counter store closures, with Colorado and other states allowing online sales of medical cannabis this year and recreational cannabis by 2021— something the industry has been lobbying for.
Ontario, which was criticised in early April when it dropped cannabis from the essential business list, now allows curbside pickup and delivery.
“One of our clients has a subsidiary that has delivery licenses in Nevada and in California and from what I understand that side of the business is thriving right now,” says Mr Rux.
“Notwithstanding it’s an essential business, people still don’t necessarily want to leave their homes for a range of factors, so the business is seeing a big pick-up in the delivery side.
“But of course, you need a different licence for delivery and it is a state-by-state license. You can’t source in Nevada and drive it to California for delivery.”
Curbside pickups have been a key growth driver in comparable consumer industries such as liquor, with customers placing orders by phone and arranging a time and date for collection.
In Pennsylvania, liquor stores filled more than 25,000 orders for about $2.3 million in the first three days of curbside sales.
Liquor consumption in Oregon rapidly moved away from bar and restaurant licensees to purchases for home consumption in March, according to data released by the Oregon Liquor Control Commission.
Licensee purchases in March 2020 were down 53 per cent compared to 2019, while liquor sales for at home consumption jumped 44 per cent.
Mr Luskin says companies need to be looking at this shift in practice and preparing — even if they don’t need to move into delivery right now.
“Companies need to be digitally ready to be able to accept those orders,” he says.
“If you don’t have a digital infrastructure, you’re at a disadvantage.
“With delivery becoming increasingly popular for more businesses during this stay at home period, it’s going to have some knock-on effect once restrictions ease. I won’t speculate on how much, but it’s clear that if a company can provide the same or a similar product through delivery, it should be considered in their business plan.
“At the end of the day cannabis companies are all selling a commodity so they’re competing on innovation and customer service.”
What next for the sector?
Baker Tilly Canada’s John Sinclair remains optimistic for the cannabis sector, but expects the COVID-19 experience to accelerate investor demand for companies to show strong, professional management.
The experience in Canada, which he expects to be replicated in the US, will be an investor rush accompanying legalization.
But that will see companies able to access money and list before they have the systems, human resources and capital focus to sustain that growth.
“Companies need to be digitally ready. If you don’t have a digital infrastructure, it’s almost impossible to get orders.”
– John Sinclair
Mr Sinclair says successful companies will be those that can transition from capital raising to retail, able to build customer loyalty, improve user experience and offer a seamless process for selecting, ordering and receiving product.
“It’s not just retail, bricks and mortar. It’s also about performing online,” he says.
“I’ve got a client who is essentially web-based who is buying companies that can optimize the online experience of consumers to increase the sales and value per click.
“There’s the technology that you need in place to make this happen — when we come out of COVID we are going to be a society buying more than ever online.
“And there’s the consumer experience piece. A lot of these businesses are still being run by capital markets guys, whose job is to raise money, but these are large consumer product businesses now.
“Very quickly they have to make the shift from raising the money to being in the consumer products business and you need to understand how you market this and brand it within the rules.”