February 23, 2022

The good news about the cannabis sector is that after a year-long decline, the stocks are cheap, and the sector is building a bottom.

The bad news is that we don’t have an uptrend yet.

But I do see a lot of constructive chart patterns, and as fourth-quarter reports are released in the weeks ahead (there’s one tonight), I’m optimistic that buyers will find their way back to the stocks of this great growth industry.

Full details in the issue.

Yours for wealth and wisdom.

Sector Overview

Preparing for the Next Uptrend
While the broad market struggles with a nascent market downturn that has the potential to go lower, and the world focuses on the problems on the Ukraine front and the inflation front, my attention in this advisory has focused lately on the increasingly attractive valuations in the cannabis sector.

As evidence, consider this table, which looks at the price/sales ratios of our six leading cannabis companies. (The price sales ratio is the market capitalization divided by the past 12 month’s revenues.) A year ago, as the sector peaked, the price/sales ratios of these companies were in nosebleed territory, but today, they’re dramatically cheaper, both because all the stocks have come down (roughly 50% on average), lowering their market capitalizations, and all the companies’ revenues have gone up (by an average of 61% in the latest reported quarter). Bottom line, these stocks are cheaper than they’ve been in years!

Additionally, business is very good at all these companies. While the Canadian market cratered after nationwide legalization led to overproduction and subsequent cutbacks, the uncoordinated state-by-state legalization process in the U.S. (both medical and recreational), where every state determines its own pace of opening and decides who will participate, has actually been great for these well-capitalized, vertically integrated multistate operators, who are focusing their attention on states where they can make a profit (ideally large population states with limited license availability) and largely ignoring states where cannabis is available cheaply.

As a result, four of these six industry leaders now have positive earnings, and the others will certainly follow, once they cool down their activities on the acquisition front.

Additionally, as always, the trends toward legalization continue, on both the medical and recreational side. I have no idea when we’ll get to full national legalization (though as I have said many times, that day is likely to mark a top for the sector), but for me, that’s not the goal. For me, the goal is to make money by investing in the strongest stocks in the sector when the sector is trending up—and to preserve capital by shifting to cash when the sector is trending down.

So far, it’s working, and I have no doubt that we will see some great profits as we ride the strongest stocks in the next uptrend.

But while I have seen solid basing action in recent months, I don’t see an uptrend yet. To see a true uptrend, we need to see breakouts on good volume, solid follow-through action, buying on pullbacks, and 50-day moving averages turning up. Theoretically, all this could come very quickly. The stage is set. The base is in place. And while we could see the sector strengthen even while the broad market is weak—it’s very hard to swim against the main trend for long. So what I’d really like to see is the broad market return to health as well.

In the meantime, we’ll soon see fourth-quarter reports from our companies, and the results should be very interesting.

Marijuana Index

The marijuana index shows a downtrend that lasted nearly twelve months and erased 71% of its value, with the late January bottom (in concert with the broad market’s bottom) marking a possible end to the downtrend. Now we watch closely for signs of strength.

PORTFOLIO

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

What to Do Now
Last week I did a webinar in which I stressed the importance of market timing while investing in this sector; if the sector trend is not up, you really can’t expect much. But I concluded by saying that for aggressive investors who want to bet on a new upturn, my favorite three stocks for buying now are Cresco Labs (CRLBF) for its value and its chart; Curaleaf (CURLF) for its size and speed of growth; and Verano (VRNOF) for its speed of growth and its chart—so those stocks are rated buy in today’s issue. But since the portfolio is already in, I’m not buying more. The one change I’m making today is downgrading ScottsMiracle-Gro (SMG) to Sell. Details on the next page.

New Recommendations

CURRENT RECOMMENDATIONS

Cresco Labs (CRLBF)
Chicago-based Cresco is one of the five leading marijuana companies in the U.S., with 47 operational dispensaries, 47 retail licenses and 20 production facilities in 10 operational states. It’s the market-share leader in Illinois and is strong in Pennsylvania, where it recently acquired three additional dispensaries. So, Cresco is growing, but with revenues up 41% in the third quarter, it’s growing more slowly than the leaders. Reflecting that, it’s the cheapest on a price/sales basis. Additionally, on the technical side, CRLBF has the healthiest chart of all the stocks in the portfolio, as it’s trading above both its 25- and 50-day moving averages. CRLBF is the portfolio’s largest holding. BUY

Curaleaf (CURLF)
Based in Massachusetts, Curaleaf remains the revenue king of the industry, and is likely to remain the king in 2022. Curaleaf now operates in 23 states with 121 dispensaries, 25 cultivation sites and over 30 processing sites. Plus, it’s still growing at good speed; third-quarter revenues, at $317 million, were up an impressive 74% from the year before. The company recently announced the completion of the acquisition of Bloom Dispensaries, an Arizona company with four dispensaries and 2021 revenues of roughly $66 million, and at the same time, announced plans to open two additional dispensaries in Florida, bringing its footprint in the state—where it had a 15% market share last year—to 44. So, growth is good. On the product side, the company’s Select brand, which it sells wholesale, has a chance to be the Marlboro of the industry. As for the stock, it sank to new lows in late January and early February, but rallied strongly as the market bounced, and has now retreated to its 25-day moving average, not strong but ripe for buying. Fourth-quarter results will be released after the market close on March 3. BUY

Green Thumb (GTBIF)
Headquartered in Chicago, Green Thumb is one of the five U.S. industry leaders, with 16 manufacturing facilities and 73 operating retail locations in 15 states (California, Colorado, Connecticut, Florida, Illinois, Maryland, Massachusetts, Minnesota, Nevada, New Jersey, New York, Ohio, Pennsylvania and Virginia). The company’s most recent acquisition brought it one of the two vertical licenses in Minnesota, along with five retail locations (in Eagan, Hibbing, St. Cloud, St. Paul and Willmar). 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. As for the stock, it sank to new lows in late January, but bounced strongly with the market, and the pullback since then has been relatively small, which is encouraging, and makes it one of our two stocks sitting above both its 25- and 50-day moving averages. Fourth-quarter results will be released before the market open on Tuesday, March 1. The portfolio is overweight in GTBIF. HOLD

Innovative Industrial Properties (IIPR)
Our marijuana REIT, Innovative Industrial Properties, has a great business as the country’s leading landlord for cannabis businesses, and the stock provides a hefty 3.1% yield. It’s been a great diversification play for our portfolio over the years, bringing astounding profits, but since peaking in November (long after the true cannabis stocks), most of the stock’s action has been on the downside—and I think that was justified, given the stock’s sky-high valuations at the top. The stock is now the portfolio’s smallest holding. But I’m happy holding that stake for now because the stock, now 38% off its high, is working on building a base at 180. Additionally, I still like the diversification it adds to our portfolio. The company will report fourth-quarter results after the market close today. HOLD

TerrAscend (TRSSF)
As the smallest of the vertically integrated multistate operators in our portfolio, TerrAscend is different from our other multistate operators in numerous ways: The third quarter saw revenues grow just 29% from the year before, which is slow for this crowd. Its stock is the lowest priced of our stocks, which means extra risk—but also extra opportunity. And its chart has been basing since bottoming at 5 way back in early November—so technically it has the potential to climb rapidly once buyers step in. As for fundamentals, TerrAscend already has a strong share of the Pennsylvania market, with 6 dispensaries, and additional dispensaries in New Jersey, Maryland and California, and its pending acquisition of Gage should bring it a leadership position in the Michigan market, so it could be a viable second-tier multistate operator—but it could also be an acquisition target! HOLD

The ScottsMiracle-Gro Co. (SMG)
ScottsMiracle-Gro is the biggest and oldest company in the portfolio, and the stock yields 1.7%, so it would seem to be a relatively low-risk investment. Yet our investment of late December is already off 16%, mainly because fourth-quarter results, which were released February 1, were worse than analysts expected. The patient part of me wants to hold onto the stock, which is now 48% off its April high, because logic says it will eventually turn around (the company is buying back its own stock). But there’s been very little buying power visible in the stock in recent weeks, and I really hate to see losses grow, so I’m going to sell here and plan to redeploy into a strong stock when the sector turns. SELL

Trulieve (TCNNF)
While it has long been the biggest seller of marijuana in Florida, where it has a 46% market share, Trulieve is now the second-largest seller of marijuana in the world, thanks to its October acquisition of Harvest Health & Recreation, which added great strength in the western U.S. and resulted in Trulieve operating in 11 states, with leading market positions in Arizona, Florida, and (maybe) Pennsylvania. Trulieve’s early focus on Florida, while other companies were expanding across multiple states, enabled it to post early profits; the company has now posted seven quarters of positive earnings. And it is now pursuing a strategy of developing regional hubs (Pennsylvania for Northeast; Florida for Southeast; Arizona for Southwest) that may or may not provide a strategic advantage as the rules of interstate cannabis commerce evolve in the years ahead. As for the stock, I was disappointed to see it fall hard in the late-January market weakness, but I believe that was the result of the stock being so popular before (the bigger they are the harder they fall). Since then, the stock has rallied strongly, but now it’s once again below all its moving averages. HOLD

Verano Holdings (VRNOF)
Verano, the smallest of the top five vertically integrated multistate operators, has 94 retail locations in 15 states (with over 100 more planned) as well as 13 cultivation and production facilities. The company is notable for having triple-digit growth in the third quarter (up 106% from the year before), and for its chart, which has been holding above support at 10 since early October. Translation: the sellers are done; the buyers will take charge next. Earlier this month, the company announced the acquisition of Goodness Growth, which includes one of ten licenses in New York and one of two in Minnesota, so good growth is guaranteed for 2022. BUY

The next Cabot Marijuana Investor issue will be published on March 30, 2022.