Over the next decade, cannabis is expected to be one of the fastest-growing industries. After more than tripling worldwide sales to $10.9 billion between 2014 and 2018, Wall Street is looking for the marijuana industry to generate a minimum of $50 billion in global annual sales by 2030. This offers plenty of long-term upside for the industry, as well as opportunistic pot stock investors.
The big question is, should investors consider putting their money to work in Canadian pot stocks, which are operating in the only recreationally legal developed country at the moment, or U.S. pot stocks, which are operating in the largest weed market in the world by annual sales?
While there is a clear-cut answer, one thing is for certain: Both U.S. and Canadian pot stocks are set for serious growing pains.
No matter the choice, growing pains are a given
To our north, Canadian marijuana stocks have been stymied by regulatory problems. Health Canada, which oversees the Canadian weed industry, has been slow to review cultivation and sales license applications, and was responsible for delaying the launch of high-margin derivatives by two months. Derivatives, such as edibles, infused beverages, vapes, topicals, and concentrates, finally began hitting dispensary shelves in Canada in mid-December.
Provincial holdups have also been a problem. Ontario, the most-populous province in Canada, had been working with a lottery system for assigning dispensary licenses until the end of 2019. As of the one-year anniversary of adult-use sales commencing (Oct. 17, 2019), only 24 retail stores have been opened in a province that could probably support around 1,000 dispensaries. This has led to supply bottlenecks in perhaps the most lucrative province of Canada.
The end result for Canadian pot stocks has been scaled back production and some serious belt-tightening. For example, Aurora Cannabis (ACB -2.42%) announced in November that it would halt construction on two of its largest grow farms, and then, in January, put a 1-million-square-foot greenhouse up for sale that it had originally planned to retrofit for cannabis production. Meanwhile, Canopy Growth (CGC -4.82%) recently announced plans to close approximately 3 million square feet of licensed production capacity in British Columbia, and hold off on opening its 350,000-square-foot Niagara on the Lake facility in Ontario. All told, Aurora Cannabis reduced its peak production by close to two-thirds, while Canopy Growth may have slashed its peak output potential by up to 45%. Aurora and Canopy also each let go of 500 employees.
On the U.S. side of the equation, high tax rates on legal cannabis and licensing delays are taking their toll, with California providing the perfect example.
California is expected to be the largest pot market in the world by annual sales. However, the Golden State is taxing the daylights out of its consumers. Aside from already high state and local taxes, California tacks on an excise tax and a wholesale tax. This makes it virtually impossible for legal producers to compete with black-market product.
We're also witnessing licensing delays in California. For instance, the Los Angeles City Council has challenged the awarding of 100 dispensary licenses within the city. The Council claims that some applicants may have had early access to the online process and wants to redo the awards. With many jurisdictions also denying retailers a presence, California has far too few dispensaries for a state its size. This, too, gives black-market operators a chance to thrive.
It should also be noted that financing remains a concern in the U.S. and Canada. In the U.S., where marijuana remains federally illegal, banks and credit unions remain shy about assisting marijuana businesses with basic banking services. Meanwhile, Canadian banks have cracked down on their lending standards to cannabis companies given the deterioration in the industry's fundamentals in recent months.
U.S. or Canadian pot stocks? The better buy is...
While there are a slew of short-term problems for the marijuana industry, the long-term outlook remains bright, especially for U.S. pot stocks, which look to have a much clearer path to success.
As noted, U.S. cannabis stocks are operating in a much larger market than Canada. With the understanding that analyst estimates are really all over the place, most analysts are counting on Canada to generate in the neighborhood of $5 billion in sales by 2024. By comparison, U.S. pot sales could soar to $30 billion by 2024, according to the State of the Legal Cannabis Markets report in 2019 from Arcview Market Research and BDS Analytics.
The issues plaguing the U.S. market are also, arguably, more easily fixable that those in Canada. We've witnessed Canadian pot sales stagnate badly since August, while new state-level legalizations and organic growth continue to add nicely to the total revenue being generating from marijuana in the United States. Growing pains will continue for all North American pot stocks, but the ramp-up in sales and the push toward profitability will be considerably easier for U.S. cannabis stocks than their Canadian counterparts.
So, what U.S. pot stocks look intriguing? Among vertically integrated multistate operators (MSO), Trulieve Cannabis (TCNNF 0.51%) is raising some eyebrows. Whereas most MSOs have chosen to operate in as many legalized states as possible, 45 of 47 operational dispensaries for Trulieve are located in medical marijuana-legal Florida. By focusing nearly all of its attention on the Sunshine State, Trulieve has successfully built up its brand with relatively minimal recurring marketing expenses. The company currently controls the lion's share of the medical pot market in Florida, and has been generating the mot operating income (without the help of one-time benefits or fair-value adjustments) of any cannabis stock... period!
Another way to play the budding U.S. pot industry would be with real estate investment trust (REIT) Innovative Industrial Properties (IIPR 2.30%). With access to financing somewhat challenging, Innovative Industrial Properties has stepped in as a sale-leaseback agreement provider. In return for buying growing and processing assets from MSOs and providing them with cash, Innovative Industrial lands longtime tenants. IIP now has 51 owned assets with a weighted-average lease length of 15.6 years and an average return on invested capital of 13.3%. IIP is going to get its money back in a little over five years, with everything else being gravy.
If you're torn as to where to put your money to work within the cannabis space, the United States is where you should be focusing your attention.