If you think investors have had a tough time staying the course in the stock market over the past three-plus months, take a gander at the cannabis industry. Following a blazing-hot first quarter in 2019 that saw more than a dozen popular pot stocks gallop higher by more than 70%, marijuana stocks have spent the majority of the past 14 months stuck in a vicious downtrend. Many have seen between 50% and 95% of their market value evaporate before shareholders' eyes.
And yet, cannabis remains an intriguing long-term opportunity. Even though the industry has suffered from some expected growing pains, we're seeing tens of billions of dollars in sales conducted annually in the black market. With Canada being the first industrialized country to legalize adult-use weed in the modern era, and numerous U.S. states legalizing cannabis to some extent, it wouldn't be difficult to steadily transition these North American black-market consumers over to legal channels.
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The big question is, what marijuana stock should you buy to take advantage of this long-term growth opportunity?
After perusing dozens of potential candidates, my top marijuana stock for the month of June is U.S. multistate operator Cresco Labs (CRLBF 2.50%).
Here are the risks Cresco Labs' shareholders need to be mindful of
While I believe there are a number of reasons to be excited about Cresco's future, it's important to understand the reasons behind its struggles in recent months. Therefore, let's begin by looking at some of the risks investors will be taking on if they choose to invest in Cresco Labs.
First of all, there's going to be some degree of operational inefficiency when purchasing a U.S. MSO. Since marijuana remains a Schedule I drug at the federal level (i.e., it's entirely illicit), MSOs like Cresco are only allowed to operate in states where pot has been legalized to some degree. Further, the interstate transport of pot products isn't allowed. This means the need to set up potentially redundant cultivation, processing, and retail operations in multiple states in order to keep costs down and quality up while controlling the seed-to-sale process.
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A second issue to take into consideration is that, due to this Schedule I classification for cannabis, many U.S. MSOs are struggling to gain access to nondilutive forms of financing. Short of selling their own stock and diluting their existing shareholders, MSOs have not had an easy time finding a bank or credit union that's been consistently willing to provide them basic financial services. That's because, under a strict interpretation of the law, banks and credit unions that assist cannabis companies could be hit with criminal and/or financial penalties.
Third and finally, investors need to understand that Cresco Labs is intricately tied to the health of the California market via its Origin House acquisition. Although California is the largest marijuana market in the world by total sales, it's had significant issues contending with the black market. A combination of inefficient dispensary licensing and high levels of taxation on legal pot products has made California a disappointing cannabis market in the early going.
Now that you have a better idea of what challenges Cresco could face moving forward, let's take a look at why it's the marijuana stock to buy in June.
Here's why Cresco Labs should be on your buy list
The most obvious reason to consider Cresco Labs is the company's position as a major player in the U.S. cannabis space. While most eyes have been focused on Canada, there's no question that the U.S. has become and will remain the leading marijuana market in the world, by total sales. If you're an investor who's following the money, then it makes sense to focus your attention on the clearly superior U.S. weed market.
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Another reason to be really excited about Cresco Labs' future is the company's aforementioned all-share acquisition of Origin House. While the transaction was completed under less-than-ideal circumstances (i.e., cannabis stock share prices were imploding around the time the deal closed), Origin House adds indoor cultivation and, more important, broad-scale wholesale distribution. Origin House is one of a select few companies that possesses a cannabis distribution license in California, the largest pot market in the world by sales. This means Cresco Labs instantly gained access to more than 575 licensed Californian dispensaries with which to market its products when it closed this deal.
Investors can also take solace in the fact that Cresco Labs isn't in a cash crunch like some other U.S. MSOs. To begin with, the company closed a $100 million senior credit facility in early February offered by a consortium of investors, with a mutual option to double this credit facility in size (to $200 million). Cresco is among a small handful of cannabis stocks that hasn't had to solely lean on selling stock to raise cash.
What's more, Cresco Labs has been willing to enter into sale-leaseback agreements with Innovative Industrial Properties (IIPR -2.31%) to bolster its balance sheet. In a sale-leaseback agreement, an MSO like Cresco sells a cultivation or processing asset to Innovative Industrial Properties in exchange for cash. Innovative Industrial then leases the property right back to the seller for an extended period of time (usually 10 to 20 years). By doing this, Innovative Industrial gains a long-term tenant and hearty rental income, while Cresco receives an instant cash infusion.
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This is a company that's also demonstrating better fiscal prudence. In late April, Cresco paid $1.25 million in equity consideration to Tryke Companies to terminate a previously announced acquisition in September 2019. Terminating this $282.5 million deal saves the company the $55 million in cash it was to have paid as part of this acquisition.
Lastly, Cresco Labs looks to be on the cusp of operational profitability. It's still in the process of incorporating Origin House into the fold, and is liable to face some growth disruptions in the short-term tied to the coronavirus disease 2019 (COVID-19). However, it's also on track to be one of the first U.S. MSOs to reach $1 billion in annual sales, and could reach recurring profitability by as early as next year.
Patient long-term investors looking for the green in the cannabis industry probably can't go wrong with Cresco Labs.
