/DBRS gives Canadian cannabis industry a non-investment grade

DBRS gives Canadian cannabis industry a non-investment grade

TORONTO — Ratings agency DBRS Ltd. is giving the Canadian cannabis industry a non-investment grade for now, but says that the credit risk profiles of licensed producers could significantly improve in the future as the sector stabilizes.

In a new report, the Toronto-based global credit agency gave the sector as a whole a B rating — one that it usually defines as having very unpredictable cash flow from operations, negative net income and poor size with no purchasing power.

While there has already been significant excitement for the cannabis industry from an equity standpoint, DBRS’ senior vice president of communications and retail, Michael Goldberg, said the credit agency is choosing to stay cautious.

“Because there’s so much uncertainty with respect to competition, the regulatory environment, growth opportunities … credit ratings at this point are non-investment grade,” Goldberg said.

According to the report, DBRS remains cautious because there is no data available on how the sector has performed to this date. The medicinal marijuana market, which only reached $600 million in sales in 2017 in Canada, can not be used to gauge the value of the newly-born wholesale recreational market, which the agency estimates could be worth between $4 billion to $6 billion annually.

The cannabis market is also still quite a small sub-sector of the Canadian economy, the report said, falling significantly behind the tobacco sector and the alcohol sector. According to the firm’s projections, the cannabis industry may follow more in-line with the coffee sector — which generates $6.2 billion annually.

Once data on how consumers and regulators are reacting to the legalization of cannabis becomes available, the firm suggests that its credit rating for the sector could improve. Individual companies such as Tilray Inc. and Canopy Growth Corp., for example, could also separate themselves from the pack and earn higher ratings — a BBB rating would come with a reasonable comparative size in sales and positive net income each quarter — while the sector as a whole maintains a lower grade.

“The companies that are winners — they’re larger, they have more market share, more popular brands, they operate more efficiently,” Goldberg said. “Those companies would definitely be rated higher than the companies that don’t have those attributes.”

There is significant growth potential when it comes to the industry, the report said. This is especially true if Canadian licensed producers turn their attentions overseas and supply cannabis to countries that follow in Canada’s footsteps and legalize the drug either medicinally or recreationally. Some companies have already begun exporting to Germany, the report said, which appears poised to become one of the largest global cannabis markets after legalizing the drug for medicinal use in 2017.

As the market stabilizes, DBRS will monitor whether any licensed producers carve out their market positions and diversify. Brand strength could also play a key role in reversing the agency’s grade.

As of now, there are no bonds for investors to buy, Goldberg said, and so investors should be taking the time to prepare for the future so they can be “better armed to make investment decisions when the opportunity avails itself.”