In this month’s commentary, we discuss our rationale for increasing our Healthcare exposure through names such as JNJ, UNH, BAX. On the cannabis front, we provide an update on The SAFE Act, The CAOA and other federal legislative initiatives, in addition to a legal challenge to cannabis being a Schedule 1 listed narcotic in Nevada that could have implications throughout the US. We examine the recent opening of New Jersey adult use sales with a focus on those cannabis companies that will benefit from the opening of that market including CCHW, TER, GTI, VRNO. We also address the dominoes that are about to fall in the US northeast in response to the New Jersey announcement. Finally, we look at the growth in state cannabis excise tax collection vs alcohol tax collection, a key factor in more states adopting adult use sales. The analysis of mature cannabis state markets shows that cannabis has overtaken alcohol in terms of excise tax.
During the month of April, investors witnessed several challenges that caused increased volatility in equity markets. Geopolitically, the world continues to deal with the increased inroads Russia makes in its drawn out war with Ukraine, daily reporting causing volatility in energy markets. Investors are also seeing rising interest rates from the Bank of Canada and warnings from the US Federal Reserve, both suggesting their goal is to create a soft landing from runaway inflationary pressure. Previous consumer and equity market reactions to rising rates suggest that they can cause increased volatility and that is very much an issue in the current environment. The market is also witnessing softness in some of the names that worked well during the pandemic such as the “work from home” stocks. The tech heavy NASDAQ 100 is down 21% YTD, the S& P500 is down 12.9% while the S&P Healthcare sector has been more defensive sector down 7.2% YTD.
We discuss our positive views on healthcare and top fund holding JNJ below. The US cannabis market opened another significant northeast market with New Jersey beginning its recreational market during the week that many celebrated 4-20. Despite stronger sales in the month and the growth anticipated from NJ, market reaction continues to be muted in cannabis names as investors continue to focus on Washington rather than the significant upside opportunity while many names in the sector trade at value stock valuation multiples.
As we consider the cloudier overall macro environment for 2022 it is useful to consider how cannabis performs in less robust economic environments. Although there is less historical data, cannabis consumption has tended to follow other so-called “vice” sectors such as alcohol. While consumers may change their preferences, seeking better value for example, overall sector demand has proven to be quite resilient. This demand resilience along with the expanding list of states moving to adult use will allow the cannabis industry to continue to produce attractive sales growth.
Federal Legislative Updates
While members of both parties recognize the growing popularity of US legalization amongst the voting electorate, Democrats seem to be stuck in disagreement within the party on what the priorities should be when it comes to cannabis legislation. While there appears to be support in both the Senate and House for approval of SAFE Banking, Senate Majority Leader Chuck Schumer announced a delay in the release of his revised cannabis legalization bill, the CAOA. It was expected around 4-20 but Schumer backed away from the announcement. Significant legislation is generally not tabled in the summer of an election year as there is not enough time to debate nor hold committee hearings. We see this as supporting our view that Schumer wanted to be seen supportive however was never going to table the legislation. At a time when New Jersey and New York have both announced significant social equity license awards for dispensary and cultivation, a stronger light is shining on the glaring gap that prevents social equity licensees from accessing the capital required to build their business. While market leaders in US cannabis can raise hundreds of millions in debt at single digit yields, social equity participants are strapped. The pressure boosts prospects for the SAFE Act to provide federal banking access for these new legal cannabis companies. We are hopeful that this will help push Democrats to support the more limited SAFE act rather than continuing to hold out for their “dream” legislation which is simply unattainable at this point.
New Jersey Rec Sales Begins
The New Jersey Cannabis Regulatory Commission (CRC) held a special meeting mid-April to provide an update on the state's adult-use program. After initially rejecting all applications in March, the CRC approved 7 of the 12 ATCs to launch adult recreational sales. Each of the 7 approved licensees have 3 dispensary licenses in the state. The approved operators include key fund holdings TerrAscend (TER) which is the most levered to NJ rec sales; Columbia Care (CCHW), Green Thumb Industries (GTI), and Verano Holdings (VRNO). In addition to the noted approvals, the CRC approved 34 licenses for micro cultivators, adding to the 68 conditional licenses issued in March. This is positive as more participants will lead to a buoyant wholesale market for the incumbent 12 license holders holding first-mover advantage in serving the New Jersey market, each with the ability to have canopy of 150,000 sq. ft. of cultivation, much greater than the new licensees. Important for investors to consider is the market potential when using the growth rates and per capita consumption patterns of established adult use state markets. While the current medical market in NJ generates annual revenues of $250 million (est. in 2021), while the adult use market is estimated to generate $1.5-$2 billion.
There are important implications for the wider cannabis industry to be drawn from NJ adult use sales. First, with New Jersey sales there could be significant growth courtesy of residents from New York and Pennsylvania. Once NY Gov. Hochul and state reps see the results, this could encourage New York to launch its own rec sales sooner than the mid 2023 expectations. With New York and New Jersey sharing a heavily populated and frequently crossed border, this issue will be both highly visible and financially material to New York. Second, NJ Senator Cory Booker has been an outspoken advocate of federal legislation, however supporting the ineffectual CAOA bill that Sen Majority Leader Chuck Schumer has been dangling in front of congress for almost a year. A successful New Jersey market with a lack of funding for social equity licenses could force Booker and others to support SAFE Banking as the most logical federal legislative step forward.
During April, the New York Cannabis Control Board approved the state’s first licenses to grow adult use cannabis, approving 52 conditional cultivation licenses to NY hemp farmers. This is significant as some of the licensees believe that their first harvests could be ready for sale within six months. The new licensees are all hemp farmers that have grown and harvested hemp during two of the last four years. The new license allows them to grow cannabis outdoor or in greenhouses with up to 20 artificial lights. Why is this happening now? As stated above, the announcement from New Jersey will have considerable weight and consideration in neighbouring jurisdictions as the ability to create jobs and generate tax revenue guides local and state governments.
State Regulatory Changes
The dominos continue to fall in the US Northeast with New Jersey adult use/recreational sales beginning the week of 420 and New York adding additional cultivation licenses for adult use scheduled to begin in early 2023. Not only is their combined population significant at close to 30 million residents, but these states will accelerate the plans of neighbouring states such as Connecticut, Pennsylvania, Maryland and Rhode Island leading to growth in the overall TAM for US Cannabis. Investors are not impressed but the fundamentals continue to improve.
US Cannabis Tax Revenue Generation Continues to Grow
In 2021, the 11 states that had legal cannabis sales brought in a total of approx. $3 billion in cannabis excise taxes, an increase of 33% vs the prior year. What is also noteworthy is that almost half of those states had more excise tax revenue from cannabis than from alcohol excise taxes. For the 11 states noted, cannabis excise taxes were 20% higher than alcohol excise taxes.
We note that because the alcohol industry is much larger than the legal cannabis industry, its overall tax contribution is greater when you include other fees, various local taxes, and other levies on alcohol sales. What is important is the rate of change of cannabis taxes in just a few years. The tax collection aspect to cannabis at the state level mirrors sales when states transition to adult use from medical only with revenues starting low but growing quickly as legal businesses ramp up production and sales.
Of all the “sin taxes” tobacco taxes raise the most at $5.9 billion however tobacco sales are declining over time. The percentage of U.S. adults who smoke has fallen 40% in the last 15 years. Even with tobacco’s greater reach, Colorado cannabis taxes were 17% higher than tobacco and Washington saw cannabis excise tax revenue 44% higher than tobacco.
Nevada Court Case Challenges Schedule I Listing
The American Civil Liberties Union (ACLU) of Nevada is taking the State of Nevada to court over the Nevada State Board of Pharmacy’s list that still maintains cannabis as a Schedule I drug. The Plaintiffs are seeking an order directing the Nevada State Board of Pharmacy to remove cannabis and cannabis derivatives from the Schedule I substances list. The reason there is a case to be made is that in 2000, Nevada voters ratified an amendment to the Nevada Constitution to legalize marijuana for medical use. In 2016, Nevadans then voted to legalize cannabis for recreational use. The lawsuit focusses on the fact that the Nevada Medical Marijuana Act legalizing cannabis at the state level has failed to comport with the will of Nevada voters and the state Constitution. Instead of removing cannabis and its derivatives from its list of controlled substances, the state Board has continued to regulate them as Schedule 1 substances. The Nevada Schedules of Controlled Substances and similar to the controlled substances cited by the United States Department of Justice. The plaintiff’s claim is that this is a constitutional and statutory violation that can only be remedied by removing cannabis from the Schedule 1 listing. The state cannabis Schedule 1 designation is the same as the US (federal) classification of cannabis. If successful, the decision could set an interesting precedent at the state and federal levels.
A key theme that is providing stability and growth to the portfolio is our US healthcare exposure. We continue to see opportunities for growth with several factors contributing to our view. First, the pandemic suppressed medical care over the last two years from COVID lockdowns and limitations, resulting in delayed or cancelled patient visits and surgical procedures. As the pandemic is coming to an end, medical consumers are likely suffering from two years of neglected conditions. Second, there is significant inflationary pressures and recessionary fears in the eyes of medical consumers which historically provides a tailwind for healthcare consumption. There is a strong correlation between recessionary fears and demand for health services as US employees look at the potential of losing insurance and decide to have elective surgeries before health insurance is lost. A third related factor is the pressure on patients that is being exerted by the potential redeterminations (reduction of coverage) of Medicaid benefits when the COVID public health emergency (PHE) ends. Originally that was to end mid-April but has been extended 90 days. These factors are pushing people to elective visits which is translating to higher demand for staffing, surgical equipment and medical devices.
To support the demand for healthcare services, Jefferies’ recent hospital survey provides insights into hospital staffing, procedure demand and forecasts for the year. The survey includes the input from 50 hospitals across 20 states.
60% of hospitals surveyed continue to have procedure backlogs. 80% of respondents indicated that they've seen an increase in elective procedures since mid-February due to declining COVID cases in their facilities, and with respect to elective surgeries, 64% of respondents said they're running above pre-COVID volume levels. 90% of hospital administrators stated they have staffing shortages while 44% said staffing shortages have worsened relative to pre-COVID levels. Key fund holdings that we see growth in 2022 include Johnson & Johnson (JNJ), Baxter International (BAX), AMN Healthcare (AMN), UnitedHealth Group (UNH).
Canadian cannabis industry sales have weakened in Q1 declining 5% QoQ as per retail data from Hifyre. Forecast growth is approximately 11% for 22 down from the previous estimate of 18%. Important to note are the sales declines by company as market heavyweights continue to see sequential sales declines. In Q1, sales fell 20% for each of Tilray (TLRY), Canopy Growth (WEED), and Aurora Cannabis (ACB), while Hexo (HEXO) had mid-teens reductions. In total, the top 5 companies continue to lose overall market share, accounting for 38% of the rec market in Q1-22 vs. 48% in Q2-21 and 60% in March 2021. Public companies that were outperforming with flat sales included Village Farms International (VFF) brand Pure Sunfarms and Organigram (OGI) in this declining market. To maintain investor interest and provide upside opportunities, various Canadian LPs focus on the potential outside of Canada along with optionality in the U.S., as well as through diversification into CPG categories and CBD.
Fire and Flower (FAF), the Canadian cannabis retailer with 105 dispensaries in Canada along with its Hyfire technology platform, announced that a subsidiary of Alimentation Couche-Tard Inc. (ACT), has confirmed that it will exercise its warrants to acquire 8,288,067 common shares of FAF. Following the exercise, ACT's ownership of FAF will increase from14.49% to approx. 35.32%. Implications for the increased ownership really solidifies the long-term opportunity that ACT and its vast retail distribution channel, Circle K convenience stores becomes the primary cannabis distribution vehicle for FAF across North America.
Recall that ACT’s initial investment in FAF came in the form of convertible debentures which, upon conversion, would have allowed ACT to obtain a 9.9% stake in the equity of FAF. Concurrent with the debentures, ACT received three series of share purchase warrants which, if fully exercised, would give the company a controlling stake (50.1%) of FAF on a fully diluted basis.
Green Thumb Industries (GTI) was the first MSO to report Q1-22 financial results and we would suggest that in light of a slowdown in industry sales caused by the combined removal of stimulus and the negative impact of inflationary pressures on average basket sizes and the frequency of store visits, Q1 expectations suggest flat revenues at best. We must keep in mind that industry wide sales were down 5% QoQ after top line revenue grew 24% YoY in Q4-21. Overall, the industry faces tough YoY comps in 2022 but this begins to fade in the second half of the year. It is worth noting that adult-use state revenues improved 8% QoQ.
Q1 revenues increased 25% YoY reaching $243 million beating consensus of $235 million, however fell short of Adj EBITDA estimates of $74 million with the company posting a healthy $67 million in EBITDA benefitting from its scale and operating leverage. Sales were supported by the opening of retail dispensaries across its markets in addition to new state operations as GTI entered Virginia, Rhode Island and Minnesota during the latter half of 2021. Adjusted operating EBITDA declined 12% from $76M in Q4, with management referred the decline to pricing pressure in Pennsylvania, Nevada and Massachusetts, as well as inflationary pressures related to raw material supplies. Another key component of increased operating cost involved start-up costs associated with adult use sales in New Jersey however we see opportunity for expansion as the NJ adult-use market began April 21st which should provide sales and margin acceleration in 2H22. Q1 was the 7 consecutive quarter of positive US GAAP net income, at $29 million or $0.12 per share. As at quarter end, the company had 76 stores in operation and revenues derived from 15 US markets.
It is apparent from review of industry data that several states are seeing pricing pressures from weaker competitors that are starved for cash while equity markets are shut off. While margins may soften slightly near-term, it will remove competitors from the market and enable GTI to cement its leading position. Long term, GTI’s brand leadership, balance sheet and operational scale, combined with leverage to new transitioning states will provide needed support for this name. GTI is part of the first wave in the adult-use transition in New Jersey a market that is estimated to reach $2 billion in sales in the next couple of years in addition to its operations in other northeast states NY, RI and CT that are scheduled to transition to adult use over the next 12-18 months.
Innovative Industrial Properties REIT (IIPR)
The US focused cannabis REIT generated revenues in Q1 of $64.5 million above consensus of $61.9 million as the company continues to drive adjusted funds from operations (AFFO), continuing to be the leader in funding the growth of cultivation, processing and dispensary development across the US. Investors have been concerned with the growth of IIPR as new state markets and transition to adult use have slowed recently, however the results show that IIPR continues to fund quality operations of the leading MSO’s. AFFO came in at $53.8 million while the company paid a quarterly dividend of $1.75 (88% of AFFO) which represented a 33% y/y increase in growth which surpasses nominal dividend growth in the REIT industry.
Verano Holdings (VRNO)
Reported delayed Q4 results with revenue of $211 million, a QoQ increase of ~2.2% in line with consensus while adjusted EBITDA was $84 million, short of consensus at a ~39.5% margin, ~11% QoQ decline, well under consensus of $94 million. The company saw reduced Gross Margin to 54.1%, higher than most MSO’s while facing headwinds in Q4. Management discussed seasonal holiday discounting, along with temporary Illinois production issues along with a planned reduction in New Jersey wholesale to build inventory in anticipation of the launch of recreational that began April 21st.
VRNO has growing operations in 13 US markets, including its entrance into Connecticut, store openings in Florida, Nevada, and Pennsylvania with a total of 96 operational dispensaries and ~1,100,000 sq. ft. of cultivation/production space. VRNO is about to close on its acquisition of Goodness Growth (GDNS) having cleared the 30-day waiting period under HSR antitrust regulations, with remaining requirements for closing such as state regulatory license approvals and a shareholder vote. The primary value in GDNS is that they are one of only two operators in Minnesota’s medical cannabis market and one of 10 licensees in New York where the state is transitioning to adult use within the next 12 months.
Pfizer Inc. (PFE) reported Q1-22 financial results that topped analyst estimates on both top line and earnings per share. PFE reported Q1-22 revenues of $25.7 billion ahead of consensus estimates of $24 billion. PFE reported Comirnaty global sales of $13.2B, driven by global uptake including pediatric and booster doses, following a growing number of regulatory approvals and temporary authorizations. Other drugs supporting PFE growth includes Prevnar (vaccine helps against types of pneumococcal bacteria), up 59%, driven by strong retail and wholesale stocking for the adult dosage and for the drug Vyndaqel/Vyndamax (treatment of transthyretin-mediated amyloidosis in adults to reduce cardiovascular mortality) which saw global growth of 41%. During the Q1 call, the company reaffirmed its 2022 sales guidance of $98.0-102 billion as well as reaffirming its 2022 revenue guidance for its COVID 19 vaccine Comirnaty at ~$32 billion, in addition to guidance for its COVID anti-viral pill Paxlovid of ~$22 billion.
AMN Healthcare (AMN) released results that beat estimates, yet the company did reiterate previous 2H-22 guidance for $1.0B in quarterly sales and 15% adjusted EBITDA margins due to what they see as price reductions in the latter half of ‘22. The Fund has done very well with this position over the last 18 months, however we have decided to take profits. The company expects demand to be maintained at a floor of over 8% above pre-pandemic levels, however growth during this last 12-month period is likely not to be maintained. Healthcare employment had a challenging January due to omicron variant increases however US healthcare staffing has seen a rebound in February, March and in April added 34,000 additional jobs. The non-COVID hospital volume trend continues to improve and crisis staffing levels and spot prices continue to come in, which should be positive for providers. In economic periods of inflation and reduced consumer confidence, health care is a sector long in part because consumption of health services is a tailwind even before adding in additional demand from deferred care.
Johnson & Johnson (JNJ) announced sound Q1-22 results with revenue growth of 5.0% to $23.4 Billion led by medical devices driven by the healthcare market’s recovery post COVID. The company reported adjusted diluted EPS of $2.67, $0.09 above consensus. Overall, the company saw 9% organic growth as the company continues to see a recovery in hospital visits and elective surgeries. MedTech or medical devices which includes devices, testing equipment and surgical supplies beat street consensus. Primary drivers were seen in the 11% YoY growth in hip replacements, and 9% growth in knee surgery and replacements, which supports the rebound in medical procedures. Additional strength was seen in cardiac testing and treatments, surgical vision products and surgical wound closure products. On the pharmaceutical side of the business, sales grew 9.3% led by Darzalex, a cancer medication to combat multiple myeloma; Stelara a monoclonal antibody medication for the treatment of Crohn’s disease; and Tremfya used for the treatment of plaque psoriasis and psoriatic arthritis in adults. The one surprise from JNJ was its suspension of guidance with respect to its COVID-19 vaccine due to changing consumer preferences in reaction to government mandates around the world and reduced interest in vaccination post Omicron.
Proctor & Gamble (PG) reported its Q3-22 financial results with net sales of $19.4 billion, an increase of 7% YoY, with organic sales growth of 10% (excluding acquisitions and divestitures). The organic sales increase was driven by a 3% volume increase and a 5% increase in pricing, while 2% was contribution from positive product mix. Of the major operating segments, PG health care saw organic sales increased 16% YoY while oral care also had high single digit increases due to continued growth of premium products and increased pricing. Within health care, the personal health segment was a standout with organic sales increased 30% due to a stronger cough, cold and flu season versus the prior year, and innovation in sleep and digestive wellness products. As many industries are facing inflationary pressures that are eating into margins, PG is demonstrating leadership from its brands, being able to generate growth in earnings despite significant and increasing costs. Their ability to power through with pricing increases with their leading brands enabled PG to raise its top-line growth outlook for the fiscal year and to maintain our EPS guidance range unlike many companies announcing quarterly results this period. Operating cash flow for the quarter was $3.2 billion while PG delivered $2.2 billion in dividends and diluted net earnings per share of $1.33, an increase of six percent versus prior year EPS.
Since inception of the option writing program in September 2018, the Fund has generated significant income from options premium of approximately $4.23 million. We will continue to utilize our options program to look for attractive opportunities given the above average volatility in the sector as we strongly believe that option writing can continue to add incremental value going forward. We will continue to write covered calls on names we feel are range bound near term and from which we could receive above average premiums and we also continue to write cash secured puts out of the money at strike prices that offered opportunities to increase our exposure or introduce to the portfolio, at more attractive prices.
Generally speaking, we are in an economic environment of slowing growth, accelerating inflation (for now), and increasingly tightening monetary policy conditions. Risk managing a growth and inflation slowdown is tricky, but we focus on it from a volatility perspective. The bond market is telling us that an economic slowdown is upon us. Cross asset volatility, collectively, currencies, fixed income, high yield, and treasuries have been misbehaving since the end of last year. Equity volatility continues to spike although being in the mid / late twenties makes it vulnerable for higher spikes. Risk happens slowly and then all at once. However, every spike in equity volatility (VIX) and the related spikes in volatility of volatility (VVIX) has been an opportunity to monitor correlations within health care/cannabis. Our current interpretation of cross asset volatility indicators and daily trading volume metrics indicate to us, for the time being, we will be selective traders of our preferred option trades, especially on decelerating volume. We need to see lower levels of trending volatility and accelerating volume signalling to us a healthier investing environment. We will continue to be macro aware, showing discipline, and focusing on investible volatility.
The Ninepoint Alternative Health Fund, launched in March of 2017 is Canada’s first actively managed mutual fund with a focus on the cannabis sector and remains open to new investors, available for purchase daily. An ETF version (NAHF) of the fund is also now available for investors. Utilizing our actively managed approach we can generate industry leading risk adjusted returns.
Charles Taerk & Douglas Waterson
The Portfolio Team
Faircourt Asset Management
Sub-Advisor to the Ninepoint Alternative Health Fund
|TR CAN/US HEALTH CARE BLENDED INDEX||-8.5%||-17.5%||-10.5%||-20.7%||-30.9%||-19.3%||-2.5%|
|FUND||TR CAN/US HEALTH CARE BLENDED INDEX|
1 All returns and fund details are a) based on Series F units; b) net of fees; c) annualized if period is greater than one year; d) as at April 30, 2022. The index is 70% Thomson Reuters Canada Health Care Total Return Index and 30% Thomson Reuters United States Healthcare Total Return Index and is computed by Ninepoint Partners LP based on publicly available index information.
The Fund is generally exposed to the following risks. See the prospectus of the Fund for a description of these risks: Cannabis sector risk; Concentration risk; Currency risk; Cybersecurity risk; Derivatives risk; Exchange traded fund risk; Foreign investment risk; Inflation risk; Market risk; Regulatory risk; Securities lending, repurchase and reverse repurchase transactions risk; Series risk; Specific issuer risk; Sub-adviser risk; Tax risk.
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