Cannabis companies haven't made many deals outside of its own industry, but a couple of the more notable ones have involved tobacco. Altria (MO +6.53%) invested $1.8 billion into Cronos Group (CRON +3.49%) back in 2018 to take a 45% stake in its business. And last month, British American Tobacco (BTI +2.35%) invested roughly $176 million in OrganiGram Holdings (OGI +2.92%), which represents a 20% stake in the cannabis company.
Not only is the cannabis industry moving further into the mainstream as more states legalize marijuana, but there's also a growing pressure on the tobacco industry to diversify its offerings. And a new projection could put pressure on tobacco companies to act sooner rather than later.
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Could all the smokers disappear?
According to analysts at Jefferies, conventional smokers could be gone from many markets around the world within just two decades. This isn't because smokers won't still demand the products, but instead that countries are trying to move away from smoking and tobacco companies by offering reduced-risk products (RRPs). Analysts point to vaping and oral nicotine as alternatives that smokers may end up turning to.
Philip Morris International (PM +1.58%) sells IQOS, an electronic cigarette that heats tobacco rather than burns it. However, it still has a long way to go in proving it can be a meaningful alternative for smokers. One quarter of the $28.7 billion in net sales that Philip Morris generated last year was related to RRPs. And of that total, IQOS accounted for just 7%. Switching to other products likely isn't all about safety, either, as tobacco companies also need to find more avenues to grow. Philip Morris' 2020 revenue was down from 2019's tally of $29.8 billion, and its top line is nearly unchanged from what it was in 2017. British American Tobacco's sales also declined in 2020 and over two years are up just over 5%.
Why cannabis may be the ideal option for tobacco
A big reason why industries are hesitant to get involved with cannabis is that it's risky. Federal prohibition means that products can't be transported into the U.S. from abroad or across state lines, and some businesses aren't willing to risk damaging their wholesome images. That's what Berkshire Hathaway executive Charlie Munger pointed to in a 2019 interview, saying it would be a mistake if soft drink giant Coca-Cola were to ever attempt to mix marijuana with its products.
However, the tobacco industry doesn't have the squeaky clean image that a brand like Coca-Cola enjoys; the health risks surrounding smoking cigarettes have been known for decades. A tobacco company getting involved with cannabis isn't likely to hurt its reputation or turn off investors. Instead, it may help the business by expanding into a new segment, especially a high-growth one like cannabis. Research company BDSA released a forecast last month that estimates the global cannabis market will be worth nearly $56 billion by 2026, growing by more than 17% per year until then.
While marijuana's federal illegal status is an obstacle for tobacco companies, the Canadian market is open for business. And Mexico could soon become the third country (the other being Uruguay) to legalize cannabis for recreational use and production. Although it's early, the opportunities are there for tobacco companies to get into marijuana, and it may only be a matter of time before there are even more deals.
What should cannabis investors do?
If you want to cash in from big tobacco and potentially invest in cannabis, consider focusing on Canadian cannabis companies that already have well-performing vape products. Canopy Growth has a broad portfolio, but with a market cap of more than $12 billion, it's one of the more expensive options. A smaller company like Auxly (CBWTF +0.39%) strikes me as a better alternative. With a valuation of just $230 million and the company reporting a 19% share of the Canadian vape market last year. Acquiring Auxly could be a cheap way for a tobacco business to accelerate its diversification. Auxly has also been one of the few marijuana stocks that hasn't spiked to an egregious valuation over the past year, climbing just 10% in 12 months while the Horizons Marijuana Life Sciences ETF has risen 150%.
However, there are no guarantees that a tobacco company will invest in Auxly or any other cannabis producer. But investors still shouldn't overlook the opportunities in the vape market, because if the transition away from combustible cigarettes does happen over the long haul, there could be significant growth opportunities for companies that offer popular products in that segment of the industry. And investing in those businesses could lead to some fantastic long-term returns for your portfolio.
