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Cannabis industry shouldn't count on legalization for 'next 10 years,' analyst says

Cowen Managing Director and Senior Research Analyst Vivien Azer joins Yahoo Finance Live to discuss the state of the cannabis industry, regulatory reform, investing in cannabis, inflation, and the outlook for the cannabis industry.

Video Transcript

- Cannabis stocks kicking off the year with no sign of legal reform in sight after the Safe Banking Act failed to make its way into Congress's year end spending package. That would have given the industry access to normal banking services. So to discuss what's next for the space as industry debt continues to rise, we've got Cowan Managing Director and Senior Research Analyst Vivien Azer. Vivian, great to have you here with us this morning. So what next in terms of any types of legal reform or actually just any type of legislation that can move forward from here or at least give the cannabis industry some hope for that regulation to come forward to be able to operate more safely, if you will?

VIVIEN AZER: Well, unfortunately, given the lack of progress that we saw the last Congress and save not being added to the omnibus bill, we're really in a status quo situation. So we haven't changed any of our estimates in terms of industry growth because the industry will continue to rely on state level legalization. We've got-- New Jersey is a new state that came online last year and New York this year and a couple of others in the northeast. But our outlook is not at all constructive on regulatory reform in the 118th Congress.


- And Vivian, it's Julie here. The backdrop otherwise for cannabis isn't fantastic either in terms of the debt that a lot of these firms have taken on in a rising interest rate environment. Is 2023 a year in which we're going to see some of these guys go out of business?

VIVIEN AZER: I think the reality is yes. We did try to flag that in our follow up note after the disappointment around the omnibus bill that this would, we think, lead to a shakeout. The cost of capital remains incredibly high in the cannabis industry, and the unfortunate reality is, given the state by state nature of the industry, there is a lot of capacity that's come online. And so price deflation has been a headwind that the industry has been contending with for the better part of 12 months now.

- Vivian, which cannabis player is best positioned this year and why?

VIVIEN AZER: We continue to like Green Thumb Industries as our top idea, that they have a nicely diversified geographic footprint in close to over a dozen states. They have one of the highest adjusted EBITDA margins in the space, and they're operating cash flow positive.

- And so do you expect that we'll see some type of M&A environment now continue to kind of move forward within the industry for more of that vertical integration in the absence of some of the legislation that was supposed to come forward?

VIVIEN AZER: I mean, I think asset prices are going to come down. You've certainly seen it in the public equity markets. But given the amount of price deflation that you're seeing, you are going to find that there are going to be certain operators that are really challenged to finance that debt, to your point. And so you could see further consolidation in the industry, to be sure.

- When can we expect, if ever, federal legalization at this point, Vivien?

VIVIEN AZER: We're not counting on it in the next 10 years. It's not factored into our model, unfortunately.

- Wow. 10 years! I mean, this is something people in the industry have been talking about for a long time, and there seemed to be a decent amount of optimism as recently as this past year.

VIVIEN AZER: We've never factored in federal legalization into our modeling work. That just seemed really optimistic. I'm really grateful to have Washington policy partners at Cowen as part of the Washington research group that have really helped inform the way that we think about legislative change, and we've consistently tried to be on the conservative side there since we continue to get disappointed by Congress.

- And so if you have to take the US out of-- and the market here in the US out of some of the valuations, then, for these companies, where are the growth prospects elsewhere in the world, and is there legislation moving forward there?

VIVIEN AZER: Well, I should just reiterate that the underlying growth for the US cannabis industry continues to look very, very good.

- Got you.

VIVIEN AZER: We are modeling for a double digit compound top line growth just with incremental states coming online, like New York, which is going to be a big one, as I noted. But Germany does seem to be moving forward with their own adult use legalization. There are certainly other EU member states that are watching that very closely.

- Vivien, have you arrived at that point where cannabis is finally being viewed by consumers as a true replacement to alcohol? I know we've talked about it for a few years, but we're seeing a lot of new formulations out there notably in the gummy space.

VIVIEN AZER: We think so. So we did a deep dive on that, revisiting some analysis that we had started doing over the last six years we've been covering the cannabis industry. And what we were able to do was to look at Nielsen data for alcohol sales, beer, wine, and spirits by state.

We were also able to look at BEA data by state. And what we've been able to show is that over the last couple of years, you finally are starting to see a divergence in alcohol purchase behavior whereby consumers that live in states where they have access to legal cannabis, either adult use or medical use, aren't buying nearly as much alcohol. There's about a 1% difference in alcohol growth rates when cannabis is available.

- Vivian, I'm going to take a little bit of a left turn and ask you about psychedelics also. And I don't know if this is in your coverage universe at all, but considering you were on the cutting edge of marijuana research when the industry was really just starting, now we're seeing similar effect in psybicilin, for example, which just became legal in Oregon for therapeutic use. We're seeing definitely more interest in that area. Do you think we'll see a similar arc that we have for cannabis, or do you think that's a really different story?

VIVIEN AZER: Yeah, I don't cover that subcategory for us. We actually cover that out of our biotech team.

- Got you. OK, fair enough.

- All right, we'll leave it there. Cowan managing director and senior research analyst Vivien Azer. Good to see you as always. Happy New Year.

- Happy New Year.