Investors in the cannabis sector have reached the “show me the money” stage of their financing, but question marks remain over where the greatest returns will emerge.

Financial consultancy PAC Partners said it remained to be seen which part of the value chain will provide the greatest return for investors.

“Is it cultivation, is it medicine production, is it distribution? The jury is still out,” director of corporate finance Sean Kennedy said.

Sean Kennedy - Cannabis Australia - Cannabiz
Sean Kennedy: These guys are not trading on the sizzle of the sector

However, he suggested the future could be uncertain for companies without cultivation operations, warning those “who don’t control cultivation, don’t control their destiny”.

Meanwhile, Cann Group chief executive Peter Crock suggested the economic slowdown caused by Covid-19 could see “consolidation opportunities” in the market.

The comments came during a conference discussion on capital raising, with Kennedy believing investors are now taking a hard-nosed approach to what has become a more sophisticated sector.

“Investment capital was quite unsophisticated two or three years ago but the guys are a lot more sophisticated now,” he said. “At the end of the day fund managers are cash flow driven, they are not trading these stocks on news flow and the sizzle of the sector, they are looking for strong cash flow returns.

“The industry has gone through several iterations. The sizzle piece of the market was cannabis 1.0, even 2.0, and we are now at 3.0 – show me the money.”

He said investors are now starting to value companies by EDITDA, rather than revenue multiples.

“We are seeing a mixed bag [in terms of profitability]. There are certainly some companies making revenue and some making small EBITDA returns. It’s a scale game.” 

But among the “tricky” aspects of valuing cannabis stock is what to compare it against.

“If you grow a lot of plants, the golden benchmark in the cultivation space, whether it’s grain, almonds or anything else in the agri business sector, is a 15% ROI. If you are going to comp yourself to an agri business company, that is the magic number.”

However, in the pharmaceutical sector, they trade on forward revenue multiples of six to eight times, Kennedy said.

“It comes down to the investor and how they comp these companies. That is the tricky part when it comes to valuations.”

Kennedy described the market as “high growth”, with cannabis companies only scratching the surface of the “massive” market potential.

“The question is how fast can companies like Cann Group access these patients,” he said.

But the industry was being hampered by “bottlenecks”, he told the discussion, with GP reluctance to prescribe medicinal cannabis, the lack of clinical evidence and no financial reimbursement for medicines among the issues.

Cann Group’s Peter Crock said the initial focus is establishing an industry that meets the TGA and Good Manufacturing Practice requirements and produces a medicine “that doctors expect to see”.

Peter Crock - Cannabis News Australia - Cannabiz
Cann Group CEO Peter Crock: Local market will “explode”

That, he said, takes “time and capital”.

“We are starting from a very low base. While we have imported products that have been provided to patients under the Special Access Scheme, what is really going to change is when we come online with volume that meets that demand from Australian production.

“That is really important and that is where we will see profit come out the other side.”

Crock also said the export market will play a critical role.

“While we know there is going to be a significant patient base in Australia, to get costs down to a globally competitive level we need to set up and scale and play in that export market.”

Crock acknowledged that the number of people accessing medicinal cannabis through the Special Access Scheme was rising, but said it needed “to move to the next level”.

That will happen, he predicted, as more medicinal cannabis products roll off local production lines.

“In terms of the Special Access Scheme and getting patients coming through, that is going to explode when we’ve got product at scale available here and which is meeting all the requirements,” Crock said.

“One of the early frustrations is that some of the imported product didn’t meet TGA requirements and doctors are unwilling to prescribe what they don’t fully understand or what is not presented to them as a normal pharmaceutical grade product. But we’ll see that move. That is the next stage.”

Crock, who also heads the Medicinal Cannabis Industry Association, added that current market conditions caused by the global Covid pandemic could pave the way for industry rationalisation.

“[Covid] has slowed everything down,” he said. “It’s going to be interesting [to see] whether there’ll be consolidation opportunities.”