It’s been a tough year for investors in cannabis stocks, and in the broad market as well, as all major indexes are in downtrends.

Yet prospects for the cannabis industry remain bright, as state-by-state legalization trends continue.

But until trends turn up, there’s no urgency to buy, so our portfolio sits roughly half in cash, waiting for the upturn.

Full details in the issue.

Yours for wealth and wisdom.

Cabot SX Cannabis Issue: May 25, 2022

Bad News/Good News
The bad news is obvious.

Market trends are clearly down. Inflation is raging. The war in Ukraine continues. And the growing schism between left and right in Washington means prospects for progress on numerous important matters, including cannabis legalization, are dim.

But there’s good news as well.

Four years ago, when the cannabis sector was red-hot, I was tracking 167 stocks, and there was no way of knowing back then who the eventual winners would be. Today, thanks to acquisitions and delistings, I’m following just 98 companies (that’s a drop of 41%), and only 18 are trading above a dollar today, so the investable universe is much smaller. More important, the industry leaders, as measured by revenues, are very clear. We own them all.

And these stocks are cheap! True, some are not operating profitably yet, but some are, and there’s no question that all the leaders will be profitable once they get through the investing/acquiring phase that has characterized the past few years.

Given the lack of positive earnings across the board, I’ve been looking at stock valuations through the lens of the price/sales ratio (PSR), and the good news now is that because the stocks have fallen while revenues have continued to grow, the PSRs of our portfolio have become very attractive. In fact, the average PSR of the six cannabis companies in the portfolio (leaving out the REIT) is now just 2.87, which compares very favorably to the average PSR in the alcohol industry (2.77) and the tobacco industry (2.63). But those two industries are mature and stagnant, while the cannabis industry has great growth ahead, given the continuing state-by-state trend toward legalization.

Also, even though prospects for national legalization look dead for now, there’s still momentum toward legalizing cannabis banking through the SAFE Banking Act, which would not only make financial transactions for this cash-heavy industry simpler and safer but also make investing in the industry more attractive for institutions who’ve been avoiding it.

Lastly, investor sentiment is terrible, which is totally expected given the losses seen this year and the obvious fundamental problems in the world. But as experienced investors know, sentiment is always worst at the bottom—which is not to say that I’m calling this the bottom, but it might be! The bottom line for me, in any case, is that the potential upside from here for the stocks in our portfolio dwarfs the potential downside—and that’s why we’re invested.

Thus, while things look pretty grim today, particularly for investors who bought into the sector higher, I do remain optimistic that holding is the right course. Somewhere ahead, the fundamental news will be good again. Markets will be strong and our stocks will be hitting record highs as cannabis goes legal. And it’s then, remembering the history of stocks in this industry topping out on big legalization events, that we’ll take our profits! Until then, patience.

Marijuana Index

The marijuana index shows a downtrend that has lasted over 15 months and erased 80% of its value. It’s possible the early May low may turn out to be the bottom, but that’s just optimism talking; for now, the trend is clearly down.

PORTFOLIO

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, I think buying some of these stocks here (those rated buy) will work out very well—but there’s no rush. Until we see the sector turn up—and ideally, the broad market too—cash is the more sensible option. Today the portfolio is 51% in cash, and that’s where it will stay for now.

CURRENT
RECOMMENDATIONS

Cresco Labs (CRLBF)
Chicago-based Cresco released its first-quarter results on May 18. Revenues were $214 million, up 20% year-over-year, but down just over 1% from the prior quarter, and adjusted EBITDA was $51 million, or 24% of revenue, an increase of 45% year-over-year. Wholesale revenue was $95 million, as the company maintained its position as the #1 seller of branded cannabis products in the U.S., but retail revenue is growing, and was up 44% year-over-year, to $119 million. The company opened four new stores in the quarter (three in Florida and one in Pennsylvania), and now has 50 stores in 10 states. And when the acquisition of Columbia Care (CCHWF) is complete—Columbia has 84 stores and had first-quarter revenues of $123 million—the company will have a stronger retail network, which should justify a higher valuation multiple. But as it stands today, this stock remains the portfolio’s cheapest on a price-to-sales basis—just 1.6. At least one analyst expects to see the company turn profitable in the second quarter, but the stock remains weak, trading very close to its recent low. BUY

Curaleaf (CURLF)
Massachusetts-based Curaleaf was the second-largest multistate operator by revenues in the first quarter (just $5 million behind Trulieve), and Cresco’s acquisition of Columbia, when completed, will make it a contender, too—so it’s a horse race between those three at the moment. But Curaleaf is the clear leader on the valuation front; its market capitalization of $3.7 billion tells us investors expect a lot from the company. And some of that is due to its international operations; Curaleaf has operations in eight European countries as well as Israel. So the future is bright, and the chart looks pretty good for this sector, as it bottomed back on May 10 and has been working its way higher since. BUY

Green Thumb (GTBIF)
Headquartered in Chicago, Green Thumb was the third largest cannabis company in the U.S. in the first quarter (but will fall to fourth after the Columbia deal is complete), 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 seven quarters. As for the stock, it’s not impressive, having hit a new low last week before rallying. GTBIF is the portfolio’s largest position. 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 just last week it announced the acquisition of a property in Taunton, Massachusetts that is being leased to subsidiary of TILT Holdings, and will be used for cultivation, processing (it has a full commercial kitchen), dispensing and administration. Including this new deal, the company owns 110 properties in Arizona, California, Colorado, Florida, Illinois, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Nevada, New Jersey, New York, North Dakota, Ohio, Pennsylvania, Texas, Virginia and Washington, representing a total of approximately 8.2 million rentable square feet. And the company is still growing at a good pace, as first-quarter revenues were up 50% from the year before. But the stock has collapsed with the rest of the sector (even though one could argue that this is a REIT, not a cannabis company), and the reasons are not hard to find. First, IIPR was a very big winner until last year, partly because it’s legal for all institutions to own the stock, while many are still leery of the cannabis sector—and all great investors know that big winners that soar to irrational heights can turn into big losers when the bubble pops. Second, the stock, even down 57% from its peak, is still expensive, trading at a price-to-sales ratio (PSR) of 14.9, while the average REIT trades at a PSR of 9.4. Third, we’re in a bear market. The 5.7% yield may be tempting to some, but the biggest risk I see here is that as investing in cannabis becomes increasingly legal, the forces that inflated this stock until next year may never return. We’ve taken profits numerous times and IIPR is now the portfolio’s smallest position. HOLD

Organigram (OGI)
Organigram is the number three producer of cannabis in Canada, and number one in dried flower, with its flagship brand Edison. And with first-quarter revenues up 117% from the previous year, it’s the fastest-growing company in the portfolio. Organigram 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. As for the chart, it looks much like the rest of this portfolio, bouncing along just above a dollar, but a technical measurement known as A/D, which compares trading volume on up days to trading volume on down days, rates this stock as A, the best of the bunch! BUY

TerrAscend (TRSSF)
As the smallest of the vertically integrated multistate operators in our portfolio, TerrAscend is a potential acquisition target—perhaps by Canopy (CGC), a major player in Canada that already owns a good chunk of it—but that’s not why we own it; the company is doing fine on its own. First-quarter results, released May 12, saw revenues of $49.7 million, down 7% from the year before but up half a million from the fourth quarter of 2021. Adjusted EBITDA was $3.3 million as compared to $11.9 million in Q4 2021, but net income was still a loss. Adjusted gross margin for the quarter was 38.4% compared to 49.8% in the previous quarter. Jason Wild, Executive Chairman, explained that revenue and margins during the first quarter were hurt by the industry-wide vape recall in Pennsylvania and front-loaded operating costs in New Jersey ahead of the opening of the adult use market, and said he expects revenues and margins to increase materially in the second quarter and beyond as the investments in the company’s four key markets (New Jersey, Pennsylvania, Michigan and Maryland) pay off. As for the stock, its chart is weak. HOLD

Trulieve (TCNNF)
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. First-quarter results, released May 12, saw revenues of $318 million, up 64% from the prior year (the fastest in the portfolio among the U.S. providers as well as the biggest in the industry) and up 4% sequentially—so growth trends are good. However, after a long string of net profits, the company swung to a loss in the first quarter, reflecting the costs of the expansion effort. But now the company is much better positioned nationally, with 30% of its 165 retail locations located in 10 states outside Florida. It also has the industry’s leading footprint in Pennsylvania, and CEO Kim Rivers mentioned that she’s optimistic that Pennsylvania (as well as Maryland) will soon legalize recreational marijuana—but the company still has no presence in New York or New Jersey, two states that will be important markets going forward. Intriguingly, the company’s stock has the second-lowest PSR in portfolio, at 2.44, so it’s attractive on a valuation basis. As for the stock’s chart, it shows an uptrend dating back to May 5, but with fading volume. BUY

The next Cabot SX Cannabis Advisor issue will be published on June 29, 2022.

About the Analyst

Timothy Lutts

Timothy Lutts is Chairman and Chief Investment Strategist 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 for Cabot Stock of the Week and 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.

1. 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.
2. 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.
3. To succeed as an investor in value stocks, it’s best to buy low and hold patiently, until the stock is fully valued.
4. 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.
5. 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?
6. 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.
7. 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.
8. 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.