Better Cannabis Stock: Cresco Labs vs. Harvest Health & Recreation

The rise of legal U.S. cannabis is one of the most promising growth trends in the market today. Over two-thirds of Americans now believe cannabis use should be legalized. In the recent November election, pro-cannabis ballot measures won five out of five state elections.

Unsurprisingly, U.S.-based cannabis stocks rose, though their companies still operate under a cloud of federal prohibition. Still, the best-run players should still have tailwinds well into the future, as more regulations are rolled back.

Two promising U.S. cannabis operators are Cresco Labs (CRLBF -0.95%), one of the larger U.S. MSOs today, as well as the smaller Harvest Health and Recreation (HRVSF). Which of these two cannabis upstarts is the better way to play this "high" growth market?

Image source: Getty Images.

The current asset base

The first criterion to understand about each U.S. cannabis company is the location of its respective assets. Each state is its own closed ecosystem since it's illegal to transport cannabis across state lines. Each state also has its own licensing regulations. Knowing where each company has set up shop is crucial. The retail breakdown for each company looks like this:

Data source: Company websites and filings. Chart by author.

As you can see, Cresco has established 21 retail stores across six states, with a big concentration in Illinois. Harvest has 38, with a focus in Arizona.

However, these retail numbers don't tell the whole story. Cresco has concentrated most of its efforts on large-scale cultivation and processing, which it then wholesales to other dispensaries, rather than focusing solely on its own retail stores. In fact, Cresco has a large cultivation presence not only in the states where it operates, but also in California, where it doesn't even have any retail stores. Its wholesale operations actually make it a much bigger company.

Recent revenue and profitability

Both companies performed exceedingly well last quarter. Past growth investments, along with cost controls, allowed each to grow revenue handsomely as well as profits. Yet Cresco is clearly hitting its stride:

Data source: Company Q3 earnings releases. Chart by author. YOY = Year over year.

While both companies are posting terrific year-over-year growth, Cresco's results are really impressive. The company has benefited from new cultivation and processing centers in the highly attractive, limited-license states of Illinois and Pennsylvania, which both came online in 2020. The new facilities enabled Cresco to earn a whopping $90 million out of its $153 million in revenue from wholesaling to others -- making it the largest wholesale player in the industry.

On the recent conference call, CEO Charlie Bachtell said:

We started off 2020 by completing the construction on two transformational expansions of our cultivation facilities in Illinois and Pennsylvania. We knew that focusing on the build-out of wholesale operations would be a less linear path to revenue growth than prioritizing new retail stores, but we also knew that by focusing on the middle two verticals of the value chain, we would gain leading market positions in the largest key markets, drive sustainable growth on the top and bottom line and have a more versatile and scalable business model long term.

While that wholesale segment was important, even the remaining $63 million in retail revenue outdoes Harvest, although Cresco has fewer locations.

In fact, Harvest has actually been divesting certain assets in noncore markets like Arkansas and the highly competitive California market. The company has also executed a recent cost-cutting initiative, taking out some $30 million in operating costs, which has helped profitability.

That's encouraging in the sense that the company has been able to right-size its cost structure and grow profits. Yet the fact that Harvest is already having to divest assets and cut costs in what should be a high-growth market is not a good sign. Its management team may be correcting for past strategic errors. Harvest is smaller and therefore may have bigger upside, but it's clearly in more of a transition phase than Cresco, which appears to be firing on all cylinders. 

Still an uncertain industry, so stick with the biggest and best

Although the U.S. cannabis industry has tantalizing prospects, it's also subject to uncertainties of a young, growing, and (technically) illegal industry. For those looking to play the space, I'd go with the larger and stronger player in Cresco Labs. Cresco is a bit more expensive than Harvest, at 5.3 times sales versus Harvest's 3.2 price-to-sales ratio. Still, Cresco has demonstrated more success with its differentiated strategy to focus on cultivation and processing. As such, it's the choice to make today.