April 27, 2022

It’s been a challenging year for investors in cannabis stocks, but the good news today is that with the broad market very weak as well, eventually the weakness will turn to strength—and the best of our stocks will soar.

In the meantime, our portfolio is more than a third in cash, waiting patiently for the turn.

Full details in the issue.

Yours for wealth and wisdom.

Sector Overview

It’s Always Darkest Before the Dawn
While the market was up this morning, recent trends have been terrible. The major indexes have been testing their March lows, and Cabot’s long-term and intermediate-term market timing indicators are both negative.

Plus, the news is bad! Inflation is very visible, particularly at the gas pump. (I drive an electric car, but I heat my house with oil, and I just received the biggest oil bill of my life.) Shortages of materials and workers show no signs of abating; where did all the workers go? And the war in Ukraine continues.

But as experienced investors know, it’s always darkest before the dawn (even if meteorologically, that’s not quite true). Every loss by an index is eventually followed by a gain that recovers the loss and more. Thus, while I am currently preaching a cautious stance (our portfolio is more than a third in cash), I have no doubt that the long-term trends for the cannabis industry will pull this sector out of its slump and send many of these stocks to record highs—quite possibly on the day that Federal legalization kicks in.

I say that because previous big legalization events (Colorado, California, Canada) have also marked tops for the sector, and while the current progress toward legalization in Washington is frustratingly slow for advocates, I believe that once we reach a tipping point (and no one can predict when that will come), progress will come quickly.

In the meantime, the state of New Jersey began legal sales of recreational cannabis last week, so that’s one large step closer to the goal.

Signs From Canada
Canada legalized cannabis across the country way back in October 18, and as the industry has evolved, it’s been interesting to watch established consumer companies tiptoe into the industry.

Canopy Growth (CGC) has a big investor (sugar daddy?) in Constellation Brands (STZ); Organigram (OGI) is being supported by British American Tobacco (BTI); and HEXO (HEXO) has a beverage agreement with Molson Coors (TAP), which happens to be recommended by Cabot’s value stock guru, Bruce Kaser. Those three companies are in the alcohol and tobacco businesses, which are accustomed to a perception as “sin” industries, but as attitudes evolve, there’s no reason why any big consumer company in food or beverage or healthcare couldn’t get involved—once we’re over the hurdle of federal legalization. Hershey’s, Coca-Cola, CVS? It will be interesting to watch!

Marijuana Index

The marijuana index shows a downtrend that has lasted over 14 months and erased 75% of its value. The rebound from the March bottom showed signs of strength and even convinced me to do some new buying, but the broad market’s weakness since then has pulled the sector back down.

PORTFOLIO

Note: The table reflects the state of the portfolio holdings before acting on any new recommendations.

What to Do Now
In our portfolio, most stocks are holding above their March lows, and I’m optimistic that the best will continue to do so. But I will continue to hold substantial cash until I see some real strength, ideally with volume and the broad market confirming. And I’ll continue to increase exposure to the strongest stocks and reduce exposure to the weakest—which this week means selling half our position in Trulieve (TCNNF). If you’re a new subscriber, or you’re underinvested in the sector, I think buying some of these stocks here (those rated buy) will work out very well—but there’s no rush.

New Recommendations

CURRENT RECOMMENDATIONS

Cresco Labs (CRLBF)
Chicago-based Cresco has long focused on the wholesale side of the business, a strategy prioritizing volume over margins. But with the acquisition of Columbia Care (CCHWF), (still in process), the company is getting a strong retail network to balance its wholesale business. Theoretically, the acquisition could make Cresco the industry leader by revenue, but practically, it looks like the required divestments in Florida, Illinois, Massachusetts, New York and Ohio (and possibly more) will make that unlikely. Still, the company looks great from a fundamental perspective. And its stock remains the portfolio’s cheapest on a price to sales basis—just 1.6. I don’t like the way the stock has fallen below its March low this week—most of our stocks are holding up above that reference—but the transgression is minimal at this point, so I’m sticking with it. CRLBF remains the portfolio’s largest position. HOLD

Curaleaf (CURLF)
Based in Massachusetts, Curaleaf was the revenue king of the industry in the first quarter, with $320 million, and its industry-leading market capitalization of $3.9 billion tells us that investors value it highly. Like most of its peers, Curaleaf has been acquiring selectively, with the latest catch being Bloom Dispensaries, an Arizona company with four dispensaries and 2021 revenues of roughly $66 million. With 128 retail locations in 23 states, (including 45 in Florida), Curaleaf is certain to be a powerhouse for years to come. Last week, as New Jersey went legal, Curaleaf opened its Bellmawr dispensary to recreational users and promised that its dispensaries in Edgewater Park and Bordentown would soon follow. The concern across the state is that a surge in demand from recreational users might interfere with the regular supply for medical users—but Curaleaf says they’ve got it covered, and their regular medical users will be provided for. Meanwhile, outside the U.S., management claims that Curaleaf International is the largest vertically integrated cannabis company in Europe. As for the stock, it’s tracked with the sector and is holding up well above its March low. First-quarter results will be reported after the market close on May 9. BUY

Green Thumb (GTBIF)
Headquartered in Chicago, Green Thumb was the fourth-largest vertically integrated multistate operator in the U.S. in the first quarter, and like the others, it’s been growing both organically and by acquisition. The company currently has 77 operating retail locations in 15 states (California, Colorado, Connecticut, Florida, Illinois, Maryland, Massachusetts, Minnesota, Nevada, New Jersey, New York, Ohio, Pennsylvania and Virginia). It’s building a national portfolio of brands that address the customers’ spectrum of well-being (from healthy to comfortable to happy). And it has an enviable record of profits, showing positive earnings in each of the past six quarters. As for the stock, it has held up above its March low, but just barely. First-quarter results will be released May 4, after the market close. BUY

Innovative Industrial Properties (IIPR)
Our marijuana REIT, Innovative Industrial Properties, has a great business as the country’s leading landlord for cannabis companies, and the stock now provides a hefty 4.7% yield. But the stock was hit by a short attack two weeks ago that alleged, in brief, that the company is not only acting as a REIT but also as a lending institution, in that it overpays for properties so tenants can get cash, and then expects to get high rents in return for many years; and that its two largest tenants (private companies) have shaky finances, while its many public company tenants (including Cresco, Curaleaf, Green Thumb, and Trulieve) have seen the value of their stocks diminish so much that they might have trouble getting new financing. IIP’s management immediately rebutted the accusation, explaining that the short-sellers were ignorant of the improvements it made to properties before tenants moved in. But the stock, which was already down 36% from its high when the short-sellers’ report came out, has continued to sink. And I’m not surprised. The stock outperformed all expectations from our initial 2017 investment to its 2021 top and could easily give a lot more of that back. Fundamentally, the company is still growing at a good pace, but IIPR is still expensive, trading at a price-sales ratio (PSR) of 20, while the average REIT trades at a PSR of 9.4. I reduced our holding last week, and IIPR is now the portfolio’s smallest position, so I’ll stick with it here. The company is expected to report results for its first quarter after the market close on May 4. HOLD.

Organigram (OGI)
Organigram is the number three producer of cannabis in Canada, and number one in dried flower, with its flagship brand Edison. Fiscal second-quarter results, released two weeks ago, saw revenues of $31.8 million, up 117% from previous year (making this the fastest-growing company in the portfolio), and while the net loss was a penny a share, EBITDA turned positive, two quarters ahead of the company’s initial estimate. In December 2021, the company acquired Quebec-based Laurentian Holdings, strengthening its position in the second most populous province of Quebec. It recently received $6.3 million from British American Tobacco (BTI), which increased its equity position to 19.4% and could easily increase that in time. And all business trends are good: Gross margins have been steadily expanding as economies of scale are achieved, and the company is investing in automation to reduce its dependence on manual labor. Additionally, and this really puts the company at the front of the development curve, Organigram has been developing a biosynthesis process that uses patent-pending yeast strains and enzymes to produce pure cannabinoids (not synthetic) without growing cannabis plants! If successful at scale, the process has the potential to “create a scalable supply of pure cannabinoids at a fraction of the cost and time of traditional cultivation using smaller environmental footprint.” As for the chart, it’s holding above its March lows. BUY

TerrAscend (TRSSF)
As the smallest of the vertically integrated multistate operators in our portfolio, TerrAscend is a potential acquisition target—but that’s not why we own it; the company is doing fine on its own. Like Cresco, it had been following a strategy of wholesale product development (in the latest period, 61% of revenue was from wholesale) but now the company is expanding fast on the retail front. It completed the acquisition of Gage, which added a strong retail network in Michigan (currently the third-largest cannabis market in the U.S.) in March, and just two weeks ago it announced an agreement to acquire Pinnacle, a dispensary operator in Michigan that includes six retail dispensary licenses, five of which are currently operational and located in the cities of Addison, Buchanan, Camden, Edmore and Morenci. Then just this week as the New Jersey market opened, the company announced that its dispensaries in Maplewood and Phillipsburg would be open for recreational customers and that it expects to open a dispensary in Lodi in the second quarter. TerrAscend saw revenues shrink 1% in the first quarter compared to the year before, but there’s little question that these recent acquisitions will put it on the growth track again. As for the stock, it has a long base, dating back to November, and while it is currently trading well above its lows, it still isn’t going up yet. But it will! First-quarter results will be released May 12 after the market close. BUY

Tilray (TLRY)
The largest cannabis company in Canada, Tilray is infamous for its stock, which peaked at the crazy price of 300 in September 2018, and then fell all the way to 2.4 in early 2020, having lost more than 99% of its value. But the problem was not the company; the problem was irrational investors. Tilray has been growing steadily, and it’s more than a Canadian company; it has operations in Europe, Latin America, Australia and New Zealand—20 countries in all. Last year Tilray merged with Aphria, one of its top Canadian competitors. And last month, Tilray assumed the outstanding debt of HEXO (another Canadian cannabis company) for a potential 37% ownership interest and a promise of a close working relationship that will increase efficiencies at both countries. Tilray can’t own U.S. cannabis properties yet, but it is paving the way, having acquired Colorado’s Breckenridge Distillery (the highest distillery in the U.S.) last December. First-quarter results, released three weeks ago, revealed that Tilray maintained its #1 position in Canada with 10.2% of the market, and achieved #1 market share in Germany as well. As for the stock, it looks much like the rest, still holding above its March low. But our buy was high, so the recent market-wide weakness has seen our loss grow unpleasantly large. Selling is an option here because cutting losses short is important, but I’m going to stick with it as long as it holds above its March low (technically 4.78). BUY

Trulieve (TCNNF)
While it has long been the biggest seller of marijuana in Florida, where it has a 46% market share, 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 being the big one. And just today it announced the closing of the acquisition of Greenhouse Wellness West Virginia Dispensaries, which holds a dispensary permit in Martinsburg. Trulieve currently operates medical dispensaries in Morgantown and Weston, and holds seven other permits in the state, so the company will be a major presence in West Virginia for years to come. And that makes sense because it borders Pennsylvania, which is Trulieve’s Northeast hub (Florida is the Southeast hub and Arizona the Southwest hub). The company now has 163 dispensaries in 11 states (including 113 in Florida), but it has none yet in New York or New Jersey, two states that will be important markets going forward. And maybe that’s what’s worrying investors here. In any case, the stock has now broken down below its March low, so a downtrend remains in effect, and the portfolio will now reduce exposure by selling half. SELL HALF

The next Cabot Marijuana Investor issue will be published on May 25, 2022.