December 29, 2021

As we come to the end of a difficult year for marijuana stocks, it’s worth remembering that the best buying opportunities occur when the picture looks gloomiest; perhaps we’re there now, because the stocks look pretty bad, even though the fundamentals of the industry are terrific!

If so, our portfolio is well positioned to benefit, as we own all the leading companies in the industry, as well as a few more conservative peripheral stocks for diversification.

This week’s issue brings one small change, the addition of well-known ScottsMiracle-Gro, which is currently trading 37% off its high.

Full details in the issue.

Sector Overview

Don’t Buy Cannabis ETFs—Buy Cannabis Stocks
In most sectors of the investment world, buying an ETF is a reasonable strategy if you don’t want to take the trouble to invest in individual stocks. The main downside is that you won’t have any huge winners, but for most people, that’s offset by the comfort of not having any big losers.

But buying a cannabis ETF has not been a good strategy yet. Just take a look at the table below, which shows the results of the biggest six cannabis ETFs since their launch dates compared to the results of Cabot Marijuana Investor over the same period. (The first ETF, MJ, was launched in December 2015, before Cabot Marijuana Investor was in existence, so I’ve moved its start date up to the time of this service’s launch—but for the record, that ETF is down 50% since inception.)

Bottom line, holding any of these ETFs has been a terrible way to make money. And why is that? First, it’s because these ETFs hold a wide variety of stocks in the sector, and a lot of the smaller companies in the industry have been failing. Second, it’s because this sector is prone to extremes of investor behavior. The money gushes in when the stocks have been hot for a while, but it gets withdrawn when the stocks have been cold for a while, and this has the effect of forcing the ETF manager (even those that are passively managed) to buy high and sell low. Third (though significantly less important), most of these ETFs are small, so they don’t have the economies of scale that work for larger ETFs.

Now, this is not to say that holding the individual stocks has been a picnic. As readers who’ve stuck with me through this year know, 2021 has been a rotten year for most stocks in the sector, and while our portfolio has lost less than the index (preserving our record of beating the index every year), it’s still a loss, and that loss could have been avoided if I hadn’t been so darn optimistic. (For the record, I went from fully invested to 45% cash on February 10, getting out on the exact day of the top, but I started buying again in mid-April, and that was clearly too soon.)

So what comes next? In the short term, the year-end forces that have pushed down the market’s losers (due to tax-selling) and pushed up the market’s winners (due to window dressing and just plain piling on) will fade to some degree as the calendar turns.

And eventually, regardless of what the broad market does, the stocks in the cannabis sector will turn up again, because business in this industry remains very good—and the top five companies in particular continue to mushroom in size as they grow both organically and by acquisition.

Lastly, federal legalization will arrive someday, because it’s what the American people want. But I’ll remind you once again that history tells us the official opening of cannabis markets will be a great opportunity to take profits. Contrarily, the time to buy is now, when the performance of the stocks looks terrible and there’s little optimism about legalization in Congress.

Marijuana Index

That marijuana index tells a sorry tale, showing a 10-month correction that’s erased nearly two-thirds of its value. But a turn will come.

PORTFOLIO

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

What to Do Now
Be optimistic, but not foolish. In today’s issue, I have all the stocks of the U.S. multistate operators rated buy, because I see a good chance for a January rally, so feel free to buy a little here. But don’t go crazy; until we see real trends, we won’t know where we should focus our efforts. In this issue I do have one new addition, tailored for conservative investors; it’s ScottsMiracle-Gro (SMG), which we’ll take a 5% position in. Details below.

New Recommendations

CURRENT RECOMMENDATIONS

Canopy Growth (CGC)
Canopy was the most popular marijuana company in the world a couple of years ago, but because the Canadian market didn’t grow as expected, all the Canadian stocks have retreated dramatically, and CGC is now off 83% from its all-time high. (The more popular a stock, the deeper and longer its unwinding. Networking giant Cisco, for example, is still below its 2000 dot-com peak). But I’m still holding an underweight position in Canopy, because the company has the might of alcohol giant Constellation Brands (STZ) behind it, and it has an inroad to the U.S. market via TerrAscend. In November, the company announced the departure of its chief financial officer and chief product officer (a welcome development, given that the third-quarter report revealed a decline in revenues, both YoY and sequentially) and the initiation of a search for their replacements. And earlier this month, the company announced the divestiture of its German subsidiary, C³ Cannabinoid Compound Company, to a German pharmaceutical company, Dermapharm Holding, for roughly $85 million, noting the move would “avoid future operational complexities associated with C³ and significantly reduce short-term capital investment requirements.” The stock is certainly not a buy here, but for long-term investors who still have profits, I think patience will pay. CGC is the portfolio’s smallest position. HOLD

Cresco Labs (CRLBF)
Chicago-based Cresco is one of the five leading marijuana companies in the U.S., with 45 operational dispensaries, 47 retail licenses and 20 production facilities in 10 operational states—and it’s still growing. The third quarter saw revenue growth of 41% from the year before, and since those results were released, the company has closed on the acquisition of three Pennsylvania dispensaries, opened two more dispensaries in Florida (Pensacola and Sarasota, making 13 in the state), and closed on the acquisition of Laurel Harvest, a Pennsylvania Clinical Registrant. Interestingly, Laurel Harvest is not only vertically integrated, with indoor growing space, processing space, one dispensary and the ability to open four more, it also has an academic clinical partnership with the Lewis Katz School of Medicine and six current ongoing cannabis research studies. As for the stock, we continue to hold an overweight position, as in all the industry leaders, but will need to see the stock perform on the upside when the sector’s trend turns for that to remain so. BUY

Curaleaf (CURLF)
Based in Massachusetts, Curaleaf remains the revenue king of the industry, and it’s still growing at good speed; third-quarter revenues, at $317 million, were up an impressive 74% from the year before. Curaleaf now operates in 23 states with 117 dispensaries, 25 cultivation sites and over 30 processing sites, and since our last issue, the company has announced plans to open four more Florida dispensaries (bringing the total in the state to 42), an agreement to acquire an Arizona dispensary (its 10^th in the state) and the acquisition of Bloom Dispensaries, which operates four dispensaries in Arizona. Fundamentally, this is all great; in fact, Curaleaf’s ambitious, but achievable goal, is to be the world’s leading cannabis company, and with its Select brand poised to be the Marlboro of the industry, it has a chance. But technically, CURLF remains under pressure. The portfolio is already overweight in the stock, and as with CRLBF, we need to see the stock participate on the upside when the trend turns. BUY

Green Thumb (GTBIF)
Headquartered in Chicago, Green Thumb is one of the five U.S. industry leaders, with 16 manufacturing facilities and 68 operating retail locations in 14 states (California, Colorado, Connecticut, Florida, Illinois, Maryland, Massachusetts, Nevada, New Jersey, New York, Ohio, Pennsylvania and Virginia). Third-quarter revenues, at $234 million, were up a solid 48% from the prior year. And the company recorded its fifth consecutive quarter of positive earnings, which makes it stand out among the majority in this industry who are spending money as fast as they make it. As for the stock, it bottomed at 18.40 back on November 3, and has held above that level since, so it’s marginally stronger than CRLBF and CURLF, but I still can’t call it strong. BUY

GrowGeneration (GRWG)
Based in Denver, GrowGeneration is not a marijuana company, but a hydroponic products retailer focused on serving commercial cannabis growers. And the trajectory of its stock in recent years offers a sobering reminder of the potential for stocks to make unexpectedly large moves—in both directions. From the time we first invested just over two years ago until its peak in February, the stock was up an incredible 1,328%. (We sold half our position on that top day.) But since then the stock is down 80%, reminding us that the hotter they get, the faster they can cool off. At bottom, there’s nothing wrong with the company (although two weeks ago the company did announce the retirement of its chief operating officer); revenues in the third quarter were up 111% from the year before and analysts are looking for continued (though slowing) growth. But stocks like this can easily go to extremes, and after they do, it takes time for the aftershocks of such moves to dissipate so the stock can get back on a normal course. The portfolio has been underweight the stock since March, and while there’s a possibility I’ll move to sell in the near future, for now I’ll hold, and see what kind of bounce the new year can bring. HOLD

Innovative Industrial Properties (IIPR)
Our marijuana REIT, Innovative Industrial Properties, has been our other great diversification play, and this stock is still quite healthy, trading right at its up-trending 50-day moving average. The main reason, in my opinion, is its hefty 2.3% yield, but that’s no guarantee that this trend will last forever; in fact, I can guarantee that it won’t—I just don’t know when it will end. But I do know that the REIT is without peer in its field of operation, which is serving as a landlord for a wide variety of companies in the cannabis industry who are unable to get traditional financing (because of federal illegality) and thus find it expedient to sell their properties to IIP and lease them back. In fact, just two weeks ago, the firm announced its biggest group of deals yet: a portfolio of 24 properties in Colorado, two properties in Pennsylvania and one in North Dakota. Sixteen of the properties are leased to subsidiaries of Columbia Care (CCHWF); four are leased to subsidiaries of Medicine Man Technologies; three are leased to subsidiaries of Curaleaf; three are leased to subsidiaries of LivWell Holdings; and one is leased to a subsidiary of Southwest Alternative Care. The majority of these are smaller properties; the deal increased the firm’s total rentable area from 7.4 million square feet to “just” 7.7 million square feet. But with 103 properties now leased to a wide variety of operators across the country, IIP has great diversification and highly dependable cash flows. Our portfolio, which has taken profits in IIPR several times, is once again overweight in the stock because it keeps going up. By some measures, it’s overvalued, but demand for yield is high these days and IIPR provides plenty of that. Just make sure you’re aware of the tax consequences of investing in a REIT before you buy. BUY

ScottsMiracle-Gro (SMG)
ScottsMiracle-Gro is a well-known lawn care brand (totally legal, of course) with Ortho being the company’s third well-known brand. Less well known, but growing faster than all these, is the company’s Hawthorne brand, which caters to the cannabis industry. ScottsMiracle-Gro is a mature company, without the growth prospects of our portfolio’s true cannabis companies, but as a lower-risk way to participate in the industry’s growth, I think it’s attractive now. The stock is currently selling 37% off its peak, partially because the whole cannabis sector has been soft, and an oversupply of cannabis in California reduced demand for its products. And then there’s the effects of Covid, which not only increased demand for home gardening supplies but also disrupted the supply chain and sparked commodity inflation, particularly for urea, resin and grass seed. For the full fiscal year of 2021, ended September 30, revenues were up 19% companywide and up 39% in the Hawthorne division. But the fourth quarter was rough, with revenues down 17% companywide and down 2% in the Hawthorne division. So now the bad news is out, the stock is down, and the company is planning to buy back as much as $300 million of stock, after buying back $113 million in 2021. To me, that signals a cheap stock. Plus, you get a yield of 1.6%. SMG is my favorite buy in the sector for aggressive investors. BUY

TerrAscend (TRSSF)
As the smallest of the vertically integrated multistate operators in our portfolio, this company has the potential to be a faster grower, but the third quarter saw revenues grow just 29% from the year before, which is a bit slow for this crowd. TerrAscend has number one market share in Pennsylvania, with 6 dispensaries, and additional dispensaries in New Jersey, Maryland and California. Its acquisition of Gage, announced in September, should bring it a leadership position in the Michigan market. And (quite unusually), TerrAscend has a 45,000 sq. ft. production facility in Ontario, where it is focused on building market share across the country (a competitive challenge) in both flower and edibles. And that makes sense because Canadian giant Canopy owns 29% of the company, in part because it will enable Canopy a quick entry into the U.S. market when it becomes legal. As the lowest-priced stock in the portfolio, TRSSF carries extra risk. But the stock has been building a base at the 6 level since dipping below 5 in early November, so it looks like the sellers are down and the next big move is up. The portfolio remains underweight the stock. BUY

Trulieve (TCNNF)
While it has long been the biggest seller of marijuana in Florida, where it now has a 46% market share, Trulieve is now very close to being the biggest seller of marijuana in the world, thanks to its October acquisition of Harvest Health & Recreation, which added great strength in the western U.S. Trulieve’s early focus on one big state, while other companies were expanding willy-nilly in multiple states, enabled it to post early profits; the company has now posted seven quarters of positive earnings. But that hasn’t prevented the stock from falling like the rest of the sector this year; today the stock is 52% off its high. But it has built a great base, stretching back to mid-September, which tells us there’s decent support by investors who expect this company to be a real contender. We averaged up in the stock in mid-November and are now overweight. BUY

Verano Holdings (VRNOF), the fifth of the top five vertically integrated multistate operators, was a new addition to the portfolio last month, and while the stock has made no progress since then, its base-building pattern tells us it’s ready to go up when the pressure comes off the sector. Headquartered in Chicago, the company has 93 retail locations in 15 states (with over 100 more planned) as well as 12 cultivation and production facilities. The company’s main brands are Verano (flower, pre-rolls, vapes and concentrates), Encore (gummies, hard candies, mints and chocolates), Avexia (the company’s medicinal brand, blending THC and CBD to alleviate pain and discomfort), Zen Leaf (retail dispensaries) and MÜV (medical dispensaries). Verano was the only one of the top five companies to maintain triple-digit revenue growth in the third quarter (fast growth is my favorite metric), though it will likely slow going forward. And the company is also notable for having stronger adjusted EBITDA margins than its competitors, thanks to careful vertical integration, which provides the ability to self-fund expansion, unencumbered by the sale leasebacks so many competitors use (often with IIP). Also, it’s notable for being the youngest stock among the top five (it only came public in April), so there are a lot of potential buyers who will discover the stock once the sector gets rolling. VRNOF is my favorite buy in the sector for aggressive investors. BUY

The next Cabot Marijuana Investor issue will be published on January 26, 2022.