Is it Finally Time to Invest in U.S. Cannabis Stocks?

Dabbling in drugs when you travel is playing with fire unless you can properly read the room. Take Barbados as an example, an island country with 250,000 people that we recently visited to cover the country’s independence sneak into the press box to drink Mount Gay and ogle Rhianna. Walking the main beach in town that weekend you’d be hard pressed to find anyone not smoking a spliff. And none of that Mexican brick weed stuff. Nearly everyone was smoking Saint Vincent ganja, brought in on the backs of jacked up speedboats driven by jacked up dudes.

Picture showing me and the fam liming in my 900-horsepower speedboat - Credit: Nanalyze
Nothing to see here, just me and the fam liming in my 900-horsepower speedboat – Credit: Nanalyze

A 45-minute plane ride away from Barbados is the country of Saint Vincent Grenadines. You’ll hear the rumors before you arrive. When the banana growing thing fell through, the country’s cash crop became cannabis. It’s one of those don’t ask, don’t tell arrangements. Within two hours of arriving we stumbled upon a proper grow operation – guard tower, barbed wire fence, and some outdoor colas that smelled sinful. This raised an interesting question. If weed is illegal in numerous countries, but everyone smokes it anyway while the police turn a blind eye to the whole thing, why is there a need to legalize it? It’s largely so that corporations and the state can take their pound of flesh.

Ever since our first article on cannabis, we’ve been eyeballing the cannabis industry from afar given our risk-averse approach to investing. However, we’ve recently began noticing that the entire cannabis theme has gone out of favor and the biggest cannabis stocks are largely bouncing off 52-week lows. With everyone preoccupied buying digital pictures of rocks propped up by greater fool theory, now may be the time to invest in this massive total addressable market (TAM).

Chart showing Cannabis Sales in billions in 2020 in the U.S., Canada, and U.S. Black Market. Credit: Nanalyze
Credit: Nanalyze

Problem is, this ain’t your average blue ocean TAM.

The Cannabis Black Market

While all you Reddit-types were still rolling around in diapers, some of us were funding our higher learning by slinging ounces of the best skunk weed known to man. For as long as anyone can remember, the thriving United States cannabis market has been serviced by some of the craftiest entrepreneurs around – the black market – which has operated very efficiently and effectively. Customer relationships, optimal growing configurations, unique strains, and no burden of taxes or regulation mean that the black market has a unique advantage. In the State of California, it still constitutes around 30% of the entire cannabis market, a share that could grow in times of economic turmoil because illegal growers can produce cheaper products.

Maybe looking at the alcohol industry can give us some color. When alcohol was made legal, how long did that black market last? Who knows, but it’s non-existent today. Can we conclude that the commercial market for cannabis will eventually consume the black market? We’re not so sure, but the strength of the black market is one reservation we have about capitulating into cannabis stocks.

Legalizing Cannabis at a Federal Level

A bigger concern we have surrounds the risks associated with a business that’s illegal at a federal level. We’ve proposed that the least risky way to invest in the marijuana industry would be to wait for decriminalization to take place first. However, that may not be the best idea. Should cannabis actually become legal at a federal level, you’d want to already be holding the leaders to capture the alpha all that attention will bring. Is there a chance that weed might never be entirely decriminalized? It seems increasingly unlikely, and here’s why.

(We don’t talk politics here at Nanalyze but we need to make an exception here. We promise to tread as lightly as possible.)

Traditionally, Democrats have supported decriminalization while Republicans have opposed it, but that seems to be changing. Republican Rep. Nancy Mace of South Carolina has introduced legislation to federally decriminalize marijuana noting that a record 68% of Americans now support this including nearly half of all Republicans.

Graph showing americans' views on legalizing Marijuana reach new high. Credit: Gallup
Credit: Gallup

An article by Politico does a good job of explaining – in a bipartisan fashion – why this may be some clever political maneuvering in disguise, but that’s irrelevant. What matters is that the recreational cannabis market is growing in size and that momentum only increases the likelihood of future decriminalization at the federal level.

Marijuana reform is poised to make gains in red states now that so many blue states have already legalized it. Advocates are trying to place adult-use legalization initiatives on the 2022 ballot in Arkansas, Oklahoma and Missouri. Supporters in Wyoming and Idaho are collecting signatures for medical marijuana and decriminalization measures after state lawmakers have punted on the issue.

Credit: Politico

The more states that legalize the devil’s lettuce, the more likely it becomes that we’ll finally see legalization at a federal level. Maybe now it’s finally time to think about throwing some chips down on U.S. cannabis stocks.

Is it Finally Time to Invest in U.S. Cannabis Stocks?

In addition to the increasingly optimistic outlook for federal legalization, there are other compelling reasons why now might be a good time to invest in cannabis stocks. Be greedy when others are fearful, and cannabis share prices are depressed across the board. Even rumors that the Republicans plan to back a cannabis bill couldn’t budge share prices of the largest multistate operators (MSOs). Here’s what that list looked like back in August of this year.

Bar chart showing a list of the biggest U.S. MSOs by Market Cap as of last August 2021. Credit: Nanalyze
Credit: Nanalyze

And here’s how those market caps have changed over the past four months.

Bar chart showing the top 5 Multi-State Operators comparing last August and today. Credit: Nanalyze
Credit: Nanalyze

Some companies are clearly missing from the above list. Harvest Health was acquired by Trulieve making the latter the second biggest MSO on our list. Both Acreage Holdings and MedMen are too small to bother with so they’re dropping off our radar. We can then begin to evaluate the five remaining companies which have all decreased in valuation significantly since we last looked. Here’s how our simple valuation ratio looks for the remaining five companies compared to this past August.

Aug-21Today
Curaleaf Holdings115.3
Trulieve Cannabis Corp75.6
Green Thumb Industries95.1
CRESCO Labs42.5
Columbia Care52.0

With revenues steadily increasing for all five companies and market capitalization simultaneously dropping, the valuations have decreased meaningfully. Here’s a look at year-to-date returns for all five U.S. cannabis stocks.

YTD-Return
Curaleaf-28%
Trulieve Cannabis Corp-21%
Green Thumb Industries-23%
CRESCO Labs-24%
Columbia Care-54%

We always talk about the importance of benchmarking and this is a great example of that. For a benchmark, we can use the Canadian Securities Exchange (CSE) Composite Index which all these companies are members of (Curaleaf is actually the largest member with a 17.22% weighting with GTI in second place with a 12.4% weighting). Jokingly referred to as the Cannabis Securities Exchange, the CSE has fallen -26% year-to-date. In other words, it’s no surprise that a falling tide has lowered all the boats.

What you’re buying with these stocks is cheap growth. Even if the black market only gives away half its market share to legalized cannabis, that’s still a $50 billion opportunity. Annualized revenues for all five companies don’t even break the $5 billion a year mark, so they’ve only captured about 10% total market share assuming the black market gets cut in half.

Which Cannabis Stocks Should We Buy?

Since no cannabis ETF fits the bill when it comes to a compelling list of constituents, cannabis investors may need to look at individual stocks. We recently talked about how our tech stock portfolio contains 11 categories of technology plus cannabis. With 12 total themes, we’ve targeted 3 slots per theme with a 10% buffer giving us 40 maximum stocks to hold. We’re currently holding 34 tech stocks which means we have 6 free slots to fill maximum. Stocks we’re currently eyeballing to hold include names like Planet Labs (space) and AutoStore (robotics), so we need to consider how many cannabis stocks we would hold should we go long on this theme.

We have 5 MSOs to choose from. Holding one cannabis stock is too few and we don’t want to burn up five slots by holding all five cannabis stocks. Holding two cannabis stocks could make sense. What if we find three attractive? We’ll cross that bridge when we come to it. Now, we’re going to throw this task over the wall to our research team who will work on finding the best cannabis stocks to hold as we prepare to put some chips down on one of the most enjoyable themes we cover which also presents a lot of upside growth that should enjoy the recession-proof characteristics of sin stocks.

Conclusion

Cannabis was all the rage back in 2016 when every newbie investor and his brother wanted to know which stock to invest $100 in. Now that the dust has settled, maybe it’s time to place some bets on the future of cannabis in the United States, a $100 billion potential market waiting to be captured. With cannabis share prices depressed and the likelihood of decriminalization increasing, it may finally be a good time for retail investors to invest in U.S. cannabis stocks.

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2 thoughts on “Is it Finally Time to Invest in U.S. Cannabis Stocks?
  1. Cresco Labs:
    Market cap: $1.9B
    Last quarter revenue: $215M, Annualized revenue: $860M
    P/S ratio: 2.2 – very low.
    4th quarter is expected between $235 million and $245 million.

    1. All large MSOs are trading at very low valuations, but that could be because they all packed their balance sheets with goodwill by overpaying for licenses and who knows what else. It’s also a very risky space considering cannabis is illegal at the federal level. That said, the thesis seems attractive at these valuations, and there are any number of ways to play it, though we believe the large MSOs are where it’s at for risk-averse investors.

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