Introduction
In recent times, cannabis has gained more acceptance in different parts of the world because of its many uses. Its medicinal uses include treatment for multiple sclerosis, migraine, and other forms of nerve pain. Although as widely known, it is also, and probably primarily, used as a recreational substance.
As investors, we are probably more interested in whether the cannabis industry can help us outperform the market. This is what I try to answer here:
POTX; Global Cannabis Proxy
Global X’s Cannabis ETF (NASDAQ:POTX) focuses on stocks across the cannabis sector. This includes companies that grow and produce cannabis to companies involved in distributing and packaging cannabis products for end user sale and consumption. POTX also gives you exposure to companies that provide financial services to the cannabis sector. Here’s what its composition looks like:
POTX ETF Composition
Sector Split
Unsurprisingly, the vast majority of the sector exposure for the cannabis themed POTX is in healthcare with 57.6% of the overall ETF’s weight.
Geography Split
Canada is one of the most liberal countries when it comes to cannabis usage. Both recreational and medicinal cannabis is legal in the country. Hence, it is natural for it to have many cannabis-related stocks to contribute a total of 67.5% toward POTX’s overall exposure.
Top 5 Holdings
It certainly surprised me when I found out that the largest weight in POTX was Innovative Industrial Properties (IIPR), a real estate company that acquires and manages specialized medicinal usage cannabis facilities. Within the top 5 holdings, there is also AFC Gamma (AFCG), which is a mortgage REIT (mREIT) player providing loans to the cannabis industry.
mREITs are a unique and often overlooked asset class. Previously, I have shared my analysis on an mREIT ETF (MORT) here and an mREIT stock (PMT) here.
Other companies in the Top 5 holdings of POTX include Tilray Brands (TLRY) (TLRY:CA), Canopy Growth (CGC) (WEED:CA) and SNDL (SNDL).
Overall, the POTX index is top-heavy with the top 5 holdings making up 60.5% of the overall exposure and the top 3 holdings making up almost 50% of the overall exposure.
Fundamental Monitorables for POTX
Profitability and Debt Levels
Legal Cannabis sales have been on the increase lately. In fact, we saw a 48% increase in the years 2019-2021. However, these sales do not translate to material profits in many cases. Indeed, the largest cannabis production companies are still unprofitable with high levels of debt.
For example, Tilray Brands has -48% net income margins as of Q3 FY22. Its net debt is $167.2 million.
Canopy Growth has -188% net income margins of of Q3 FY22. Its net debt is $239.4 million.
SNDL Inc. has -43% net income margins as of Q3 FY22. SNDL has a net cash position of $47.9 million.
The combination of losses and high debt places these stocks in a precarious position in a period of economic downturn, dragging down sales, and higher rates, increasing cost of capitals.
Government Sentiments
Due to the controversy surrounding the use of cannabis, the impact of governments’ sentiments weigh heavily on the performance of POTX.
Recently, attempts to pass the SAFE banking act for Cannabis by lawmakers failed. This proposed regulation attempts to make financing easier for companies and individuals engaged in cannabis related activities.
The failure of this act to pass as legislation has exacerbated bearish outlooks for the cannabis industry and hence POTX.
Given that fundamental backdrop, let’s explore the technicals:
If this is your first time reading a Hunting Alpha article using technical analysis, you may want to read this post, which explains how and why I read the charts the way I do, utilizing the principles of Flow, Location, and Trap.
Read of Relative Money Flow
No significant candlesticks movement is forming at this point, and I see the prices starting to fall down. It is also very unlikely for a retracement to the monthly support level because of the lower highs and lower lows being attained after the price cut through the monthly resistance level.
However, despite the strong bearish momentum, there is no evidence of a bull-trap to justify high probability sells.
Read of Absolute Money Flow
POTX is currently in a consolidation/declining phase. This phase may continue from short-term to mid-term until a new, genuine bullish development occurs for the industry.
Conclusion
The cannabis sector still has much untapped potential. However, investing today based on long term potential, without any heed to the current headwinds can be a recipe for failure. Late investors into Cathie Wood’s funds (ARKK) (ARKF) (ARKX) have probably learnt that lesson.
I cannot join the sells now as I believe it is too late. So although I am bearish, I will have to keep this on my watchlist and track the profitability, leverage levels and government regulatory environment for additional catalysts.
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