Things did not go as planned in 2019 for marijuana stock investors. It was supposed to be the year pot stocks put it all together and proved to Wall Street that they deserved their lofty valuations. But visions of industry maturation and profitability were quickly dashed by persistent supply issues in Canada and a resilient black market throughout North America. In other words, the blazing-hot start to 2019 for cannabis stocks quickly turned into a nightmare for investors.
However, this precipitous decline in marijuana stocks has some folks questioning whether now is the time to invest in this fast-paced industry. The buzz surrounding cannabis stocks has been especially notable in the United States, where 33 states have legalized weed in some capacity and a majority of residents support medical and/or recreational legalization.
But should you consider putting your money to work in U.S. pot stocks? Below, you'll find three reasons in favor of such a move, as well as three catalysts that could cause your investment capital to go up in smoke.
The pros of investing in U.S. pot stocks
Arguably the top reason to invest in U.S. marijuana stocks is the fact that they're operating in the most lucrative market in the world. Although Wall Street estimates vary considerably (which we'd expect given that there's no precedent for legalizing pot in the modern era), the general consensus is that the U.S. will account for anywhere from a third to half of all marijuana sales by 2030. In fact, one analyst went so far as to suggest $100 billion in annual weed sales are possible in the U.S. a decade from now. This makes the U.S. a market that cannabis investors are almost certain to want exposure to.
A second reason to consider U.S. pot stocks is that they likely have an easier path to profitability than their Canadian counterparts. Even though Canada has legalized recreational marijuana at the federal level, and the U.S. federal government continues to classify cannabis as a Schedule I (i.e., illicit) substance, the vertically integrated multistate operator (MSO) model gives pot stocks easy access to billion-dollar markets. Plus, it doesn't hurt that only a small number of markets (ahem, California) have experienced supply problems, whereas supply issues have been a constant in Canada since adult-use weed sales began on Oct. 17, 2018.
Third and finally, U.S. cannabis stocks are considerably cheaper than their Canadian counterparts. For example, Canopy Growth and Aurora Cannabis, the two most popular marijuana stocks to our north, are valued at roughly 28 and 8 times their respective sales in fiscal 2020. This compares to large-scale vertically integrated MSOs like Curaleaf, Cresco Labs, and Green Thumb Industries, which are valued at roughly 3.3, 1.6, and 4.5 times their respective 2020 full-year revenue.
However, there's another side to this argument.
Three cons of investing in U.S. marijuana stocks
On the other side of the aisle, one of the biggest reasons investors might consider avoiding U.S. pot stocks is the high tax rates being assigned to legal-channel product. While this isn't typically a problem in states where only medical marijuana is legal, it is a big problem in certain states where recreational cannabis is sold. California, for instance, has seen its weed sales stagnate for two years, primarily because it's taxing the daylights out of its consumers. The Golden State's already high sales and local taxes, coupled with an excise tax and wholesale tax, could have consumers paying north of 45% extra for the final product. This makes it increasingly difficult for legal operators to compete with the black market on price, and it's a big reason California-focused pot stocks disappointed in 2019.
Second, there are serious financing concerns associated with U.S.-focused marijuana companies. Since weed isn't legal at the federal level, banks and credit unions have somewhat avoided providing basic banking services to cannabis businesses. If financial institutions decide to provide basic banking services, they could be exposing themselves to criminal and/or financial penalties. For U.S. pot stocks, this means capital raising is typically done by either issuing common stock, which is dilutive to shareholders, or executing sale-leaseback agreements. Either way, financing remains a huge question mark for American weed companies.
Last, investors should understand that U.S. cannabis stocks will be swimming in goodwill by the end of 2020. Since cannabis is illegal at the federal level, the interstate transport of marijuana isn't allowed. This means having to set up redundant growing and processing operations in multiple states or, in many instances, MSOs simply buying their way into new markets. Unfortunately, these acquisitions appear to be grossly overpriced, with goodwill representing a significant portion of total assets for some U.S. pot stocks. This goodwill could easily result in writedowns in the not-so-distant future.
Two U.S. cannabis stocks that offer intrigue
With the understanding that the U.S. is full of opportunity but also that all cannabis stocks have risks, here are two U.S. pot stocks that have me particularly intrigued.
The first is Florida-focused MSO Trulieve Cannabis (TCNNF -1.05%). Whereas most MSOs are busy acquiring new businesses and stretching their balance sheets thin by trying to establish a presence in as many legalized states as possible, Trulieve has quietly gobbled up a lot of market share in medical marijuana-legal Florida with its 40 open dispensaries. Because it's kept its focus on one state, Trulieve has been able to effectively build its brand and keep its operating expenses considerably lower than those of its peers. In just the third quarter alone, Trulieve's $70.7 million in sales outpaced its cost of goods sold and operating expenses combined by more than $23 million. There's not a marijuana stock generating more no-nonsense operating income right now than Trulieve Cannabis.
The other intriguing name here is KushCo Holdings (KSHB) in the ancillary space. KushCo has been pummeled in recent months due to the fact that it generates the bulk of its revenue from selling vaporizers. Sales of vaporizers and vape accessories have taken a hit after more than 2,600 cases of lung illness were tied to vaping. However, KushCo is now valued at less than 1 times its forecasted sales for 2020 and has two other puzzle pieces to lean on: a hydrocarbon gas business that's instrumental in creating cannabis oils and a branding and packaging solutions division. Although KushCo is unlikely to turn the corner to profitability in 2020, it's one of the few U.S. pot stocks to hold firm on its revenue projections.
Ultimately, opportunity does exist in the U.S., but pot stock investors will have to be picky.