In recent months I’ve been telling you that cannabis stocks were incredibly cheap and overdue for a bounce, and now it seems the world is starting to agree, as all our cannabis operators have seen their stocks climb in the past month.
Of course, the broad market’s rebound has helped, but the broad market doesn’t have the compelling fundamentals of the cannabis industry’s top stocks.
Bottom line: while the first six months of 2022 were rough, that’s history, and we are now on the path toward renewed profits as the leaders of this growth industry see their stocks come under accumulation once again—and we wait patiently for federal legalization.
Full details in the issue.
Cabot SX Cannabis Issue: August 31, 2022DOWNLOAD ISSUE PDF
Valuations are Compelling
Two months ago, I presented you with some compelling statistics on cannabis stock valuations, and today I want to update them, because despite the recent strength in the sector, these stocks are still very cheap! The best metric for comparing stock valuations is usually price/earning ratios, but because most cannabis companies are still in the investing phase—focused on getting larger rather than on making profits—there are precious few earnings to measure, so for this sector, price/sales ratios are more useful.
Today, the average price/sales ratio of the stocks in our portfolio is 2.49, up from 2.33 two months ago. For comparison, we can look at two similar industries, which are very mature and have far less growth potential: tobacco and alcohol. The average price/sales ratio of the five biggest tobacco companies is 2.91, while the average price/sales ratio of the five biggest alcohol companies is 4.09. By that measure, cannabis stocks are still very cheap, and even more so considering the growth potential of the industry.
Growth Continues—but Is Slowing
Yes, the rate of growth is slowing; our companies averaged 31% growth in the second quarter. But slowing growth is natural as companies get larger. Part of the recent slowdown of growth has been from pricing pressure at the wholesale level, where the U.S. market has been experiencing the challenges of oversupply that plagued the Canadian market previously. But this is a short-term phenomenon, and as the least efficient producers get washed out of the industry, I have no doubt that supply will stabilize, just as it has in the tobacco market.
More important is that the legal market in the U.S. continues to grow, state by state, and eventually full federal legalization will arrive—though no one can say when. But what we can say today is that it’s become increasingly clear who the industry leaders will be (we own them all) and that as the industry grows, the barriers being erected by these increasingly established companies will make it difficult for competitors to make inroads.
Charts Are Healthy
The good news today is that these charts are looking increasingly healthy. After a long 17-month decline that saw the average stock fall 85% from February 2021 to the end of June 2022, the sector is now strengthening, as investors slowly creep back in. We still don’t have a legal environment that will allow all institutions to invest in the sector, and the result of that is lower trading volumes, particularly in comparison to the Canadian cannabis stocks, and less price stability. But there is still hope that we will get banking legalized before use is legal nationwide, and if such a move opens the floodgates for institutional investors, you’ll be very glad you were invested before them.
Bottom line, the trends are clear, and by investing now, when the stocks are still very cheap, you’ll be in a position to see your investments multiply manyfold as these stocks first recover their recent losses and then move out to new highs. It’s an exciting prospect.
I’ve noted before that this index tends to be held back by the numerous small companies failing to thrive, while the stocks of our successful companies look far better, and it’s never been truer than now—so I continue to advise against holding cannabis ETFs. The index today shows the last 12 months of a downtrend that has lasted over 17 months and erased 85% of its value. But the odds are very good that the downtrend is over, because valuations are now extremely compelling, because Cabot’s intermediate timing system (the Cabot Tides) is now positive, and because the individual charts of our stocks are looking increasingly healthy.
|Stock||Shares||Current Value||Portfolio Weighting||Price Bought||Date Bought||Price 8/31/22||% Change|
|Ayr Wellness (AYRWF)||1,692||$7,447||3.4%||$5.10||7/28/22||$4.40||-13.7%|
|Cresco Labs (CRLBF)||9,180||$38,922||17.9%||$3.99||4/30/20||$4.24||6.3%|
|Green Thumb Ind. (GTBIF)||3,203||$41,516||19.1%||$7.25||04/30/20||$12.96||78.8%|
Note: The table reflects the state of the portfolio holdings before acting on any new recommendations.
What to Do Now
If you’re a new subscriber, or you’re underinvested in the sector, you should buy some of these stocks (those rated buy) now. A month ago, we took advantage of the nascent uptrend to begin moving cash back into these stocks, taking our cash position from near 56% down to around 30%, and today we will increase our commitment further, first doubling our position in Trulieve (TCNNF) and then apportioning a third of the remaining cash among Cresco (CRLBF), Curaleaf (CURLF) and Green Thumb (GTBIF). That should get our cash position down to about 19%.
Ayr Wellness (AYRWF), our most recent addition, is a vertically integrated multistate operator based in Miami, Florida with 73 dispensaries in eight states (Arizona, Florida, Illinois, Massachusetts, Nevada, New Jersey, Ohio and Pennsylvania). It makes the #2 carbonated THC beverage in the U.S (Levia), it has its products in 475 third-party stores, and it has three adult-use stores coming to the very dense New Jersey market. Plus, it’s the cheapest of our stocks on a price/sales basis, and second-quarter results (released August 18), shed some light on the reason. Revenues were $110 million, up 21% from the prior year but down less than a percent from the first quarter, while the loss per share was $0.56, the biggest loss of the past two years. The company ended the quarter with $117 million in cash, so viability is not a problem; the problem is simply that growth is slowing, and that profitability now looks farther out than investors previously anticipated. Still, it’s cheap, and the stock has recovered from its post-earnings selloff, so I’ll continue to stick with our small position. HOLD
Cresco Labs (CRLBF)
Chicago-based Cresco has seen its stock climbing steadily for two months now and the reason is clear; the company is on track to become the biggest cannabis company in the world, once its acquisition of Columbia Care (CCHWF), expected to close by the end of the year, is complete. Cresco has long prioritized the wholesale market, and thus is currently the #1 seller of branded cannabis products in the U.S., with its products in over 1,100 stores. But retail revenue has been growing faster, and the addition of Columbia should create a balanced powerhouse. Second-quarter revenues (reported earlier) were $218 million, up 4% from the year before, while EBITDA was $51 million, or 23% of revenue, up 11% from the previous year. And management expects continued growth as seven more high-population states—New Jersey, New York, Pennsylvania, Ohio, Virginia, Florida and Maryland—transition to legal adult use. The stock’s uptrend means it can be bought anytime, though a pullback to the 25-day moving average or even the 50-day would be ideal. BUY
Massachusetts-based Curaleaf was the industry leader in the second quarter, with revenues of $338 million from 22 states and 136 dispensaries and its European operations but will likely be surpassed by Cresco once the Columbia Care acquisition is complete. Still, Curaleaf is the clear leader on the perception front; its market capitalization of $4.5 billion tells us investors expect a lot from the company—and its price/sales ratio of 3.5 is the highest of our U.S. operators. Some of that is due to its international operations; Curaleaf has operations in eight European countries as well as Israel and earlier this month announced the acquisition of a majority stake in Germany’s Four Pharma, a licensed producer and distributor of medical cannabis that has more than 10% market share in Germany. Some may be due to the perception that the company’s R&D based on rigorous scientific research will pay dividends in the future as the industry goes more mainstream; the company recently announced the launch of Plant Precision, a curated collection of edibles and a topical gel that contain minor cannabinoids that are non-psychoactive and do not create the euphoric feeling that THC does, but are designed to target specific wellness categories for the growing numbers of Americans who say they would be more likely to use cannabis as a health solution if it came in small, controlled doses. And some may be due to the company’s healthy balance sheet—$90 million at the end of the second quarter. In any case, the future is bright, and the stock’s performance over the past two months reflects that perception. You can buy now or on any pullback. BUY
Green Thumb (GTBIF)
Chicago-based Green Thumb is the portfolio’s largest position, and a glance at the stock’s chart, which is the strongest in the portfolio, will tell you that’s one reason our portfolio is beating the sector index. Green Thumb was the third-largest cannabis company in the U.S. in the second quarter but will likely fall to fourth after Cresco’s acquisition of Columbia is complete. Yet it has been the most profitable multistate operator of all the big ones, based on its consistent record of profitability over the past eight quarters—a sign of good management. Second-quarter revenues were up 15% from the previous year to $154 million, while earnings per share were $0.10, unchanged from a year ago. Revenue growth was driven mainly by increased retail sales in New Jersey as the legal market opened, increased retail sales in Illinois, 19 new locations opened since last year and increased traffic in most of the company’s 77 stores. If you already own the stock, hang on tight, and if you’re looking to buy, try to pick the bottom of the current correction—ideally below 11. BUY
OrganiGram is the number three producer of cannabis in Canada, and number one in dried flower, with its flagship brand Edison. And it’s now the fastest-growing company in the portfolio; second-quarter revenue (technically the firm’s fiscal third quarter) was $38.1 million, up 88% from the year before, which was in stark contrast to many Canadian producers, who are still shrinking thanks to falling wholesale prices. And the loss per share was just a penny, unchanged from the preceding quarter. Part of the company’s growth comes from the international market; during the quarter, OrganiGram made two shipments totaling $1.3 million to Australia, and since then it has shipped a further $5.4 million of product to Australia and Israel (and it’s looking seriously at opportunities in the German market). But the major reason for growth was expanding market share in Canada, as investments in automation reduced dependence on manual labor and enabled continued price competitiveness. British American Tobacco (BTI) is a big investor in OrganiGram, owning 19.4% of the company, and the stock looks okay today, trading pretty much in line with its 25- and 50-day moving averages. BUY
While it has long been the biggest seller of marijuana in Florida, where it has a 46% market share and does 70% of its business, Trulieve has been expanding across the country in the past year (it had seven acquisitions in 2021), with the October acquisition of Harvest Health & Recreation (the largest cannabis transaction to date) being the big one. The upside of that expansion effort (short-term) is that it made Trulieve #1 in the U.S.—a title it will likely cede to Cresco. The downside (again, short-term) is that it ruined the company’s record as the “most profitable” multistate operator, as its record of seven consecutive profitable quarters has now been broken by three consecutive quarterly losses. Long term, however, Trulieve has great prospects and has a unique geographic hub system, with Florida the company’s Southeast hub, Pennsylvania its Northeast hub, and Arizona the Southwest hub, all serving the company’s current operations in eleven states. As of June 30, Trulieve had $181 million in cash, and as of August 10, the company had 175 retail outlets in 10 states. Management expects full-year revenue to hit $1.25 to $1.3 billion this year (that projection is down a little) and expects positive free cash flow in 2023. As for the stock, it’s got a two-month uptrend going, though the trend hasn’t been as strong as some of our other stocks, but big volume came into the stock last week, pushing the stock above both its 25- and 50-day moving averages, and this is reason enough for us to increase our position. The portfolio will now double its position in the stock. BUY
The next Cabot SX Cannabis Advisor issue will be published on September 28, 2022.
About the Analyst
Timothy Lutts is Publisher Emeritus of Cabot Wealth Network, leading a dedicated team of professionals who serve individual investors with high-quality investment advice based on time-tested Cabot systems.
Timothy is also the chief analyst of Cabot Marijuana Investor.
Under his leadership, Cabot advisories have been honored numerous times by Hulbert Financial Digest, Dow Jones MarketWatch and Timer Digest as the top investment newsletters in the industry.
After working in this business for more than 33 years, Timothy says, “There are 8 things I know.
- The business of investing can provide great rewards to those who work at it and are willing to learn. Those who refuse to learn will lose money.
- To succeed as an investor in growth stocks, it’s best to buy when upside potential dwarfs downside potential, to cut losses short, and to let winners run.
- To succeed as an investor in value stocks, it’s best to buy low and hold patiently, until the stock is fully valued.
- Your greatest enemies are your own emotions and the daily news (generally bad) which distracts you from a long-term focus. Try to ignore them both.
- On the other hand, use your imagination to consider how great companies might evolve, remembering the power of the unforeseeable and the incalculable. When it began renting DVDs by mail, did anyone imagine Netflix could become a leading producer of content? When it began selling books, did anyone imagine Amazon would eventually sell almost everything?
- For over two centuries, the long trend of the markets has been up, reflecting the growth of asset values, and I recommend that you invest in synch with that trend. Your greatest ally is time.
- However, there will always be bull markets and bear markets, and you can use these to your advantage, particularly if you pay close attention to both chart patterns and investor sentiment.
- Lastly, have faith in the ability of intelligent, innovative men and women to adapt, as they always have, and to solve the problems of the future in ways that are unimaginable to people of today. Invest in these people when you can.
Timothy has appeared on numerous podiums as an investing expert, including Bloomberg TV and the World Money Show, led Investor’s Business Daily discussion groups and been interviewed by Dow Jones MarketWatch,TopStockAnalysts.com, VoiceAmerica.com, AOL Finance and numerous other business news organizations.