Since the year began, "going green" has been all the rage on Wall Street -- and I'm not talking about renewable energy.
With the legalization of recreational marijuana in Canada last year, followed by ongoing state-level legalization in the U.S. and abroad, opportunities for growth are budding for the legal cannabis industry. Arcview Market Research, along with BDS Analytics, foresees global legal sales growth of 38% to $16.9 billion in 2019, with sales pushing to $31.3 billion by 2022. This is a lot of revenue, and it has to wind up somewhere. Clearly, there are going to be winners in the marijuana space, and investors want their piece of the pie.
Operating profits are few and far between in the early going
But the early going has presented a mixed picture for pot stocks. While sales growth has been astronomical, so have operating losses. Among pure-play marijuana stocks (i.e., companies that generate all of their revenue for cannabis-related businesses), just four are currently profitable on an operating basis.
Mind you, we have seen International Financial Reporting Standards accounting, or investment-related dispositions or derivatives, assist some pot stocks to a quarterly profit. But this isn't the same as an operating profit, which would mean more gross profit than operating expenses without a bunch of one-time benefits and costs getting in the way. If you're looking for the real early-stage leaders in the weed industry, let me introduce you to the only profitable pot stocks on an operating basis.
Innovative Industrial Properties
Cannabis real estate investment trust (REIT) Innovative Industrial Properties (NYSE:IIPR) debuted on the New York Stock Exchange in December 2016, and it didn't take long for the company to generate recurring profits.
The marijuana REIT business model involves buying land and facilities (e.g., cultivation or processing) involved in the weed supply chain, then leasing out these facilities for an extended period of time in order to profit from the rental income. Many years down the road, these assets can be sold for a profit, and the capital received from the sale can be used to start the investment process anew.
In Innovative Industrial Properties' case, it has 13 properties in 11 states, and has been acquiring about five per year. The average length of its existing leases is more than 14 years, with a 3.25% annual rental increase, and 1.5% management fee based on a given year's rent, built into each lease contract. This way, the company can grow its adjusted funds from operations by adding new properties, as well as through organic means. Plus, with an average return on invested capital of 15.1%, it'll have a complete payback on what it's invested in less than five years.
As a REIT, Innovative Industrial Properties tends to have very low operating costs, and it avoids normal corporate income tax rates. But in order to avoid corporate tax rates, it's required to return a majority of its earnings to shareholders in the form of a dividend. Having recently declared a $0.45-per-share payout in April 2019, the company's dividend has tripled since June 2017. Long story short, no pure-play pot stock is making more on a per-share basis than Innovative Industrial Properties.
Check out the latest earnings call transcript for Innovative Industrial Properties.
Generally speaking, the vertically integrated dispensary space features high upfront costs tied to grow-farm development, dispensary construction/remodeling, and even delays in receiving cultivation licenses and sales permits. It's a part of the cannabis industry where some well-known companies (ahem, MedMen Enterprises) put up some ghastly losses. Then again, it's been a veritable cakewalk for Trulieve Cannabis (NASDAQOTH:TCNNF), which has generated $52.4 million in operating income ($28.4 million if we exclude a fair-value change in biological assets) through the first nine months of fiscal 2018.
Until late last year, Trulieve, which grows its own cannabis and has more than 125 unique SKUs within its stores, was laser-focused on Florida. The company has 25 open locations in the Sunshine State, which currently allows only medical marijuana to be sold. Although recreational weed is a larger potential market, medical pot patients are more willing to buy higher-margin alternatives products, such as oils. That makes the medical market, especially in Florida where residents tend to be older and more likely to have an ailment that medical cannabis could address, quite lucrative.
Of course, Trulieve doesn't want to pigeonhole itself into one market. Late last year, it announced acquisitions in Massachusetts and California. Massachusetts' fully legal market puts it on par with Florida's medical cannabis market, while California is expected to be the largest weed market by annual sales in the United States. What remains to be seen is if the cost to enter these new markets weighs on what has been a very profitable push out of the gate for Trulieve Cannabis.
Harvest Health & Recreation
Believe it or not, there are actually two vertically integrated dispensaries in the U.S. that are currently profitable on an operating basis. Harvest Health & Recreation (NASDAQOTH:HRVSF), which recently announced the largest U.S.-based acquisition in cannabis history, had $17.4 million in gross profit through the first nine months in fiscal 2018, and $14.4 million in total expenses. This roughly $3 million in operating income, sans fair-value adjustments to biological assets, is a rarity among pot stocks.
In an effort to spread awareness of its brand and lock up as much market share as possible in the early stages of state-level expansion, Harvest Health & Recreation announced an $850 million all-stock deal to buy privately held Verano Holdings last week. With Harvest Health currently operating 30 dispensaries, eight grow farms, and seven manufacturing facilities, the completed deal should lead to 70 open dispensaries, 13 grow farms, and 13 manufacturing facilities open by year's end. Plus, the combined 123 retail licenses these companies possess is more than any publicly traded, vertically integrated weed dispensary.
Perhaps the only downside here is that pot stocks have shown a tendency to overpay for acquisitions. We won't know what sort of goodwill is going to be associated with this transaction until it closes, but the possibility of future writedowns, as well as higher costs associated with opening a boatload of new locations, could weigh on Harvest Health & Recreation's bottom line.
Charlotte's Web Holdings
Fourth and finally is hemp-derived cannabidiol (CBD) producer and distributor Charlotte's Web Holdings (NASDAQOTH:CWBHF). CBD is the nonpsychoactive cannabinoid best known for its perceived medical benefits.
In December, President Trump signed the Farm Bill into law, which legalized the production of hemp and hemp-derived CBD products in all 50 states. Although certain states have put their foot down on CBD as an additive to food and beverages, potentially limiting the company's reach, the Farm Bill provides an easier means for Charlotte's Web to get its branded CBD products into retail stores.
Mind you, the company wasn't exactly struggling to find retail outlets prior to the Farm Bill's passage. As of late 2018, it had its products in more than 3,600 stores, and through the first nine months of fiscal 2018, it racked up $48 million in revenue, $37 million in gross profit before fair-value adjustments, and $24.4 million in operating expenses. It's worth noting that Charlotte's Web was also profitable on an operating basis through the first nine months of fiscal 2017, too, meaning it's continuing to trend in the right, and profitable, direction.
With CBD products expected to generate robust sales growth over the next five years, it would be surprising if Charlotte's Web didn't stick to its profitable ways going forward.