From a traditional investment perspective, referring to an emerging sector with low earnings and lots of regulatory challenges as a value investment could be considered a misclassification. Yet, at no point during the existence of the Horizons Marijuana Life Sciences Index ETF (HMMJ), launched in April 2017, have the fundamental valuations on these stocks been as compelling as they are today.

To understand why the marijuana sector might be offering a potentially attractive entry point for long-term investors to consider, we first have to address why things were so difficult for this industry last year. The marijuana sector across North America faces significant challenges to growth, which have far outweighed the rosy optimism that investors had for the sector going into 2021.

Much of the excitement over the cannabis sector resulted from a generally high level of anticipation that a Democrat-led Congress and Presidency would lead to federal legalization in the United States in 2021. As 2021 unfolded, this did not materialize. The emboldening of partisan politics between the Republicans and Democrats will likely continue to forestall any federal initiatives until after the November 2022 mid-term elections. 

This puts investors in a challenging position because the potentially massive windfall that awaits the sector  upon a legal announcement is not diminished. Still, in the interim, investors will have to be patient for any such regulatory advancement to materialize. As a result, investors who entered the sector in 2020 and 2021 have likely sustained significant losses. For example, HMMJ lost ~19% in 2021, and our U.S.-focused Horizons US Marijuana Index ETF (HMUS) lost ~32% in 2021.

The dramatic pullback in the sector could create a potentially attractive entry point for investors because, while the stocks have struggled, the sell-off might be ignoring some possibly attractive drivers of future returns.

The Marijuana Business Is a Real Business

What often gets lost in the discussion about the sector is that actual revenues are being generated by cannabis-focused companies in both Canada and the United States. Cannabis revenues in Canada hit a record high in 2021, surpassing $4 billion in sales, and will likely close in on $5 billion in revenue in 2022. On a quarterly basis, both Q2 and Q3 2021 saw revenues exceed $1 billion and seem poised to remain there for the foreseeable future.


Source: Statistics Canada and MJBiz, December 16, 2021 (Most recent public data on overall sales in Canada)

The challenge for Canadian Licensed Producers (LPs) has not been finding sales but rather the fragmentation of sales and the hyper-competitive market within Canada. Not a single major Canadian LP held by HMMJ is currently profitable based on their most recent quarterly earnings. There are simply too many producers, which has resulted in oversupply issues and, in many cases, declining margins. Looking at December Hyfire Data provided by CIBC World Markets, December retail sales of cannabis were highly fragmented with no individual provider establishing more than 11% market share of sales; instead, sales are dispersed closely amongst eight providers.

Part of the challenge for the larger LPs is that they cannot actively market their product in key markets such as Ontario. Hence, decisions at dispensaries (both online and in-person) largely hinge on factors such as cost and THC level. The decision process is typically different from an alcoholic beverage shop where branding is often the chief determining factor in the purchaser's decision. In many ways, smaller providers have equal footing with well-capitalized leaders in product recognition with potential clientele.
According to BMO Capital Markets (as at December 31, 2021), many of the top selling brands are value brands. These are lower-cost, lower-margin products that require considerable scale in sales to be profitable for producers.

The one bright spot for Canadian revenue growth is in edibles, which have seen very strong year-over-year consumption and are viewed in the industry as a critical product for the conversion of new consumers. This is likely due to edibles being more discreet and less stigmatized than smoking. In Canada, edibles have seen an 86% year-over-year growth in sales versus only 4% in flower sales, according to Hyfire. This is a startling statistic highlighting that the industry's future growth is primarily in non-traditional segments of the cannabis market, and the actual commodity of the flower is likely a product of declining margin and growth.

Many investors could look at these types of sales figures and grow concerned, and rightly so; however, the current situation in Canada highlights the need for mergers and acquisitions (M&A). As a large and profitable market, Canada is too fragmented for individual providers to generate profits. Out of necessity, M&A may need to occur and could serve a dual purpose of improving the overall returns of smaller Canadian LPs while also providing a potential path to profitability for companies in Canada that favour acquiring.

U.S. Legalization and the Path to Profitability

The most critical factor in the fortunes of the cannabis sector remains the potential for legalization, or at least liberalization, of cannabis laws in the United States. There are currently four pieces of legislation that have been approved in both the U.S. Congress and Senate, none of which seem likely to be approved in 2022 until after the mid-term elections.

The two most important pieces of legislation are the Secure and Fair Enforcement Banking Act of 2021 (SAFE Banking Act), which provides safe harbour for U.S. marijuana distributors, and the more comprehensive Senator Schumer draft of the Cannabis Administration & Opportunity Act, which would effectively legalize marijuana usage federally. They've found their way into Congress, but nothing has been signed into law. Both pieces of legislation require Republican support, which seems unlikely at this juncture given the high level of partisan division in both U.S. legislative bodies.
The marijuana business in the United States is highly profitable with sales in 2021 expected to have surpassed $37 billion (Prohibition Partners, December 16, 2021). However, the challenge for U.S.-based marijuana producers and cultivators, referred to as U.S. Multi-State Operators (MSOs), is their current inability to access many traditional banking services or U.S. stock exchange listings as their existing businesses are illegal at the federal level. Hence, MSOs tend to prefer the SAFE Banking Act.

If this bill becomes law, it would mean that licensed cannabis producers and related businesses would be treated similarly to other legally operating entities. This law provides the possibility for financial institutions, such as banks, to conduct business with cannabis enterprises that are licensed in states which allow cannabis for either recreational or medical use. If passed at all levels of government, this legislation could open the door for U.S. MSOs to access domestic capital markets. Once they can access the larger U.S. retail investment market through U.S. listings, it would likely provide the injection of capital they would need to expand within their state jurisdictions. Very quickly, there could be a significant reversal in flows toward U.S. companies actively growing their businesses. On the flip-side, Schumer's proposed legislation could negatively impact MSOs at it would likely increase regulations (similar to Canada) and eliminate the vertically integrated model.

Fundamentally, the MSOs held by the Horizons U.S. Marijuana Index ETF (HMUS) have higher revenue growth potential and better projected earnings before interest, tax, depreciation and amortization (EBITDA) relative to the large Canadian LPs. However, without means to access investment capital, they remain vulnerable to expansion by the Canadian LPs and potentially at risk of having their margins compressed by federal legalization. This means that big sector swings based on industry news tend to result in flows to the Canadian LPs, which are U.S. listed.

This has created a weird scenario where Canadian LPs are more likely to see a more significant rally from positive news on potential U.S. legalization relative to the U.S. names. 

The challenge for Canadian LPs is that a lot of their valuations price in growth that assumes a level of expansion outside of Canada; however, right now, there does not appear to be a clear path for them to reliably enter the U.S. market.

This doesn't mean that the LPs that make up the bulk of HMMJ can't unlock their investment potential by eventually gaining access to the U.S. market. For example, large tobacco and alcohol giants, such as Constellation, Altria and British American Tobacco, have substantial ownership stakes in leading Canadian names, such as Canopy Growth (Constellation), Organigram (British American Tobacco) and Cronos (Altria). All have substantial stakes in growing their global footprint, and there are some interesting ways they can enter the U.S. marketplace. 

Tilray, Canopy Growth and Cronos have already taken some action in creating optionable scenarios where they can purchase U.S. assets, such as MSOs, when/if legalization were to occur in the next few years. Canopy Growth has taken the most direct lead in this area by owning an option to buy a large MSO: Acreage Holdings. Most recently, they established another option to purchase edible manufacturer Wana Brands for $297.5 million. Federal legalization also brings in a more profound impact to the U.S. MSO market as it would allow for inter-state production and distribution of cannabis.
It will require patience on the part of investors for Canadian LPs to potentially unlock this avenue if legalization is to happen, which again is unlikely in 2022.

If there is liberalization of U.S. federal marijuana laws, we anticipate that HMMJ will have more upside than HMUS and other U.S.-focused cannabis ETFs; the problem is that these companies are struggling to grow more revenue in the meantime.

Compelling Valuations?

The valuation on HMMJ is amongst the lowest it has been since the inception of the ETF. While the sector faces numerous challenges, a lot of this negative news is priced in to the stocks trading at a relatively low 1.5x book value despite an average sales growth of nearly 37%.

Name Ticker


Growth (%)
Book Ratio
Innovative Industrial Properti IIPR US 18.48 57 34.05 4.20 61.76
Scotts Miracle-Gro Co/The SMG US 12.21 -17 1.82 8.83 17.19
Jazz Pharmaceuticals PLC JAZZ US 11.86 39 2.60 1.99 17.82
Tilray Inc.  TLRY CN 11.70 43 2.28 0.75 -3.29
Cronos Group Inc. CRON CN 8.68 58 25.11 0.90 -8.02
Canopy Growth Corp WEED CN 8.54 -3 7.38 1.02 -4.80
Village Farm International In VFF CN 3.46 68 1.99 1.44 -20.32
Hydrofarm Holdings Group Inc. HYFM US 2.85   2.10 1.96 200.08
Organigram Holdings Inc.  OGI CN 2.44 22 7.13 1.38 -4.22
Constellation Brands Inc. STZ US 2.34 5 5.51 4.21 28.00
Sundial Growers Inc.  SNDL US 2.13 -20 2.63 2.53 -1.11
Horizons Marijuana Life
Sciences Index ETF
HMMJ CN   36.90 2.61 1.5 -2.81

Bloomberg as at December 31, 2021

Similar valuations exist on HMUS. HMUS has a higher price-to-book ratio than HMMJ but a much better sales growth profile given the rapid expansion of the U.S. cannabis market.

2022 might be a challenging and potentially volatile year for marijuana investors. However, the current valuations might be a silver lining for those with patience who are willing to wait for further regulatory change in the U.S. and potentially lucrative M&A opportunities in the Canadian LP space.

Name Ticker Weight
Growth (%)
Book Ratio
Green Thumb Industries Inc. GTII CN 10.74 49 5.88 2.9877 59.81
Trulieve Cannabis Corp. TRUL CN 10.73 64 4.01 3.9696 24.52
Curaleaf Holdings Inc. CURA CN 9.77 74 5.49 3.6008 -55.89
Cresco Labs Inc. CL CN 9.59 41 2.39 4.1655 -27.41
Verano Holdings Corp. VRNO CN 7.98 328   1.5054 20.65
Terrascend Corp. TER CN 5.26 29 5.1 4.7436 -12.23
Ayr Wellness Inc. AYR/A CN 4.89 106 2.72 3.4739 -7.87
WM Technology Inc. MAPS 4.61   0.14 124.0102 -0.04
ColumbiaCare Inc. CCHW CN 4.41 172 2.13 1.5132 -7.82
Planet 13 Holdings Inc. PLTH CN 3.70 45 5.15 3.1285 -36.27
Horizons US Marijuana
Index ETF
HMUS CN   256.30 1.37 2.44 -0.81

Bloomberg as at December 31, 2021

Name Ticker 1m
1 yr 
North American
Marijuana Index
-8.21 -19.91 -39.71 -25.43 -25.43 -14.81 -5.95 -4.80
US Marijuana Companies
Index TR
-7.38 -22.94 -37.90 -32.66 -32.66 - - -28.29
Horizons Marijuana Life
Sciences Index ETF
HMMJ CN -9.38 -17.97 -39.82 -18.99 -18.99 -19.11 - -3.93
Horizons US Marijuana
Index ETF
HMUS CN -7.14 -22.80 -37.96 -32.32 -32.32 - - -26.46

Bloomberg as at December 31, 2021

The views/opinions expressed herein may not necessarily be the views of Horizons ETFs Management (Canada) Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.

Certain statements may constitute a forward-looking statement, including those identified by the expression "expect" and similar expressions (including grammatical variations thereof). The forward-looking statements are not historical facts but reflect the author's current expectations regarding future results or events. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. These and other factors should be considered carefully and readers should not place undue reliance on such forward looking statements. These forward-looking statements are made as of the date hereof and the authors do not undertake to update any forward-looking statement that is contained herein, whether as a result of new information, future events or otherwise, unless required by applicable law.

There are risks associated with HMUS. HMUS is expected to invest in the Marijuana industry in certain U.S. states that have legalized marijuana for therapeutic or adult-use, which is currently illegal under U.S. federal law. HMUS will passively invest in companies involved in the marijuana industry in the U.S. where local state law regulates and permits such activities, as well as in companies involved in the Canadian legal Marijuana industry. Neither HMMJ nor HMUS will be directly engaged in the manufacture, importation, possession, use, sale or distribution of marijuana in either Canada or the U.S. Please read the full risk disclosure in the respective prospectus before investing.

HMMJ will not knowingly invest in any constituent issuers that have exposure to the medical or recreational marijuana market in the United States, unless or until it becomes legal. HMMJ will not be directly engaged in the manufacture, possession, use, sale or distribution of marijuana in either Canada or the U.S. Please read the full risk disclosure in the prospectus before investing.

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