After a ghastly year that’s seen the AdvisorShares Pure U.S. Cannabis ETF (NYSEMKT: MSOS) fall by more than 74%, marijuana investors are desperate for a return to the heyday of 2021 when shares were skyrocketing. Alas, there is no relief in sight, and 2023 is likely to be almost as gloomy as 2022.
Here are three upcoming headwinds for the industry that explain why.
1. Oversupply and its consequences
The number one headwind for cannabis stocks this year will be simply far too much marijuana on the market. When there’s more cannabis than what the market demands, selling prices fall, and when they do, it compresses sellers’ margins substantially, which makes their earnings reports worse. And barring any hype, the lagging earnings will likely drive share prices down.
Signs of a cannabis glut in previously vibrant state markets are already becoming hard to ignore. In Massachusetts, the average selling price per gram of cannabis has fallen from $12.64 at the start of 2022 to reach $8.07 as of November. Likewise, Colorado’s wholesale selling prices per pound are down 25% compared to the average price in 2021. Both of those markets are in line with the national trend, which saw wholesale prices drop from around $1,310 per pound in December 2021 to reach $956 in December 2022.
Even the industry’s leaders in the U.S. are starting to feel the sting. Cresco Labs (OTC: CRLBF) cited price compression in its third-quarter earnings report as being a contributing factor to its top line shrinking by 2% year over year, and Green Thumb Industries‘ (OTC: GTBIF) Q3 update highlighted this too.
Expect companies with extensive cultivation operations to scale down or sell off their excess output capacity. Competitors focusing on high-margin products such as edibles, distillates, or vaporizers might be able to bear the brunt of falling prices a bit more gracefully than those focused on wholesale or on the sale of low-margin offerings like dried flower.
2. Rising interest rates, dwindling cash reserves
Another serious headwind for marijuana stocks this year is that inflation remains stubbornly high, and that means the Federal Reserve will likely continue to hike the federal funds rate, which in turn controls the cost of borrowing money. That’s part of the reason why growth stocks like cannabis stocks have suffered so much in 2022, and it’s also why they’ll continue to suffer in 2023. Growth businesses need to borrow capital to expand, and so the valuations of their stocks are very sensitive to economywide increases in borrowing costs.
What’s more, an additional risk to investors is that most cannabis companies remain unprofitable or only narrowly profitable, and for many, cash holdings are starting to run low. Both of those factors will drive the cost of borrowing even higher on average. For example, Trulieve Cannabis‘ (OTC: TCNNF) most recent debt financing on Dec. 22 requires them to pay a fixed interest rate of 7.3% for the first five years, then a different rate linked to the payout of five-year Treasury bonds, plus a kicker of 3.5% for the remaining five years of the payoff period.
Those terms aren’t too bad, but smaller and more indebted businesses are liable to pay even more. And debt has risen sharply as a proportion of equity over the last year for all of the businesses mentioned so far in this article, as well as doubtlessly many others. Expensive debt isn’t going to sink players that take out only as much as they need while costs are high. But it’ll be a headwind nonetheless.
3. Labor shortages
The final headwind that’ll chill marijuana stocks in 2023 is the presence of a labor shortage in the U.S. and also in the cannabis industry specifically. Per a report by Leafly, there were over 428,000 legal cannabis jobs in the U.S. in 2021, more than 100,000 of which were added that year. And 2023 might see similarly paced growth in jobs.
With such an incredible demand for employees, it’s no surprise that marijuana businesses are having a hard time finding people. But just as a glut of cannabis leads to falling prices, a deficit of workers leads to rising wages, which could translate to narrower margins. Keep an eye on the companies that have a reputation for being good places to work, like Cresco Labs and Green Thumb Industries, as they are less likely to suffer from turnover.
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Alex Carchidi has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Cresco Labs, Green Thumb Industries, and Trulieve Cannabis. The Motley Fool has a disclosure policy.