Forget Canada and Buy U.S. Pot Stocks, Says This Investment Firm

Sean Williams, The Motley Fool - Posted 4 years ago

Few industries have had investors seeing green quite like the legal cannabis industry over the past couple of years. Investors who had the foresight, wherewithal, and luck to buy into some of the most popular marijuana stocks at the beginning of 2016 could find themselves up well in excess of 1,000%.

There's little denying the opportunity that could await investors. Canadian legal weed sales are expected to reach as high as $6 billion by 2022, with various Wall Street investment firms projecting that $50 billion to $75 billion in global annual sales are possible by the end of the upcoming decade. This makes cannabis a potentially once-in-a-generation investment opportunity.

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A black silhouette of the United States, partially filled in with cannabis baggies, rolled joints, and a scale.

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U.S. marijuana stocks are the place to be, according to this Wall Street firm

But deciding where to park your money within the marijuana industry is a topic of great debate. Whereas most Wall Street firms favor the well-established pot stocks to our north that have laid the infrastructure to be successful in domestic and foreign markets, one Wall Street investment firm believes you'd be smarter to buy U.S. pot stocks instead.

A recent research note from Compass Point Research & Trading analysts Rommel Dionisio and Isaac Boltansky, courtesy of Barron's, says U.S. pot stocks look considerably more attractive than Canadian pot stocks. Specifically, the duo sees the United States producing nearly 80% of the world's legal cannabis sales in 2019, and they note that the sales multiple attached to Canadian stocks relative to U.S. marijuana stocks makes little sense.

At the time the research note was released, the combined market caps of five of Canada's leading producers – Canopy Growth, Aurora Cannabis, Cronos Group, Tilray, and HEXO â€“ was $36 billion. Yet, aggregate 2020 sales for this group should only hit $2.7 billion, per Dionisio and Boltansky.

Meanwhile, the combined market caps of the top-10 U.S. pot stocks equates to just $17 billion, but these companies expect to see aggregate sales of $4.8 billion in 2020. Thus, Canadian pot stocks are, as a whole, trading at more than 13 times 2020 sales, whereas U.S. pot stocks are valued at roughly 3.5 times next year's sales.

The duo also notes that while marijuana remains an illicit drug at the federal level, some 30% of Americans now live in recreational-legal states following the passage of a recreational cannabis bill in the Illinois Legislature, which at this point is merely waiting for Gov. J.B. Pritzker, a Democrat, who intends to sign the bill soon. 

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These four U.S. pot stocks may have more than 60% upside

So, which U.S. marijuana stocks should investors consider buying? According to Compass Point, Curaleaf Holdings (NASDAQOTH: CURLF), Cresco Labs (NASDAQOTH: CRLBF), Acreage Holdings (NASDAQOTH: ACRGF), and Green Thumb Industries (NASDAQOTH: GTBIF) are all rated as a buy, with each company having more than 60% upside from current levels.

In the here and now, no vertically integrated dispensary operator is bigger than Curaleaf, which has more than half of its existing stores open in Florida. It currently operates 45 open dispensaries in a dozen states, along with 12 cultivation sites and 11 processing facilities, allowing Curaleaf to control its supply from seed to sale. Curaleaf gained significant notoriety when its cannabidiol-infused topical products were chosen by CVS Health to be placed into approximately 800 stores in eight states earlier this year.

Cresco Labs' claim to fame could be its impending acquisition of Origin House (NASDAQOTH: ORHOF) in an all-stock deal that could top $800 million. Although Cresco is a vertically integrated dispensary operator with more than 50 retail licenses in its portfolio (on a pro forma basis), the purchase of Origin House, a key cannabis distribution license-holder in California, will allow Cresco to get its in-house-branded products into more than 500 California dispensaries. Since California is the crown jewel of the marijuana legalization movement, Cresco Labs is looking forward to incorporating Origin House into the fold.

Acreage Holdings has found itself in the news for a variety of reasons. As a vertically integrated dispensary operator, it is projected to lead all of its peers in terms of multistate presence. Assuming all of its announced acquisitions close, Acreage will have a retail, processing, or cultivation presence in 20 states. It's also the U.S. dispensary operator that Canopy Growth agreed to buy for $3.4 billion, contingent on the U.S. federal government legalizing marijuana.

Lastly, there's Green Thumb Industries -- which, as you can probably guess from the theme so far, is a vertically integrated, multistate dispensary operator. Green Thumb, which brands its retail locations under the Rise or Essence name, has just over a dozen manufacturing facilities and licenses to open as many as 89 retail stores in 12 states. Recently, Green Thumb completed the acquisition of Integral Associates, which owns the Essence brand of retail stores in Nevada, a potential billion-dollar cannabis market.

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Two possible faults in Compass Point's research

Although I don't dispute Dionisio's and Boltanksy's findings that U.S. pot stocks are cheaper on the basis of forward price-to-sales, their analysis overlooks two key risks.

First, there's that little fact that the federal government has held firm on its belief that cannabis is a Schedule I drug. This means it's entirely illegal, prone to abuse, and has no recognized medical benefits.

Even though approximately 30% of Americans now live in a recreationally legal state, this doesn't factor in political risks. Sure, we've witnessed sentiment toward marijuana improve considerably among the public over the past decade, but this isn't necessarily the case with Congress. As long as Republicans control at least one house of Congress, there remains significant risk to the chances of reform at the federal and state levels.

The second concern here is that, despite rapid sales growth, Compass Point may be overlooking the ramp-up in spending that could be necessary to facilitate seed-to-sale expansion in multiple states.

For example, the reason vertically integrated pot company Trulieve Cannabis has been so profitable is its laser focus on the Florida market. Of its 30 open dispensaries, 28 are in its home market. By building its brand in Florida and not overextending its reach, at least in the early going, Trulieve has easily been one of the most profitable U.S. marijuana stocks.

Comparatively, trying to expand into a dozen or more states at once could be incredibly costly. The brand building and marketing associated with such a move will be costly and time-consuming, which Dionisio and Boltansky may not be fully factoring in.

Only time will tell if U.S. pot stocks are the deal that Compass Point makes them out to be.

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Sean Williams owns shares of CVS Health. The Motley Fool recommends CVS Health, HEXO., and Origin House. The Motley Fool has a disclosure policy.