Cannabis stocks are, once again, at the top of investors' minds. U.S. states continue to legalize pot in a piecemeal way, with four states (Montana, Arizona, New Jersey, and South Dakota) passing measures for recreational marijuana in the 2020 election. Once these markets open, adults will be able to use marijuana recreationally in 15 states and medically in 36 states, a staggering change from 10 years ago when it was completely illegal in every part of the country. Of course, marijuana remains federally illegal, but President-elect Joe Biden has said he plans to decriminalize the substance.
Even with all this momentum, investors who want a piece of the pot market should consider buying stocks with proven concepts. Two companies that fit this bill are Planet 13 (PLNH.F 2.13%) and Curaleaf (CURLF -10.07%). Here's why.
1. Planet 13
Based in Las Vegas, Nevada, Planet 13 plans to operate high-end dispensaries (what it calls "superstores") in large markets across the U.S. It's a young company with just one open dispensary located near the Vegas Strip. This 112,000-square-foot complex (the largest cannabis store in the world, if you were wondering) is not yet finished, but it already brings in meaningful revenue.
Over the first nine months of 2020, Planet 13 had $50 million in sales and generated $6 million in free cash flow. This means that in the middle of the COVID-19 pandemic and before the site is completed, the business has a 12% free cash flow margin. A big reason it was able to sustain these cash flow levels was its pivot in the spring to 100% delivery to local residents once dispensaries had to shut in-person operations. Staying cash flow positive should allow Planet 13 to fund new locations without adding debt or diluting shareholders with equity raises.
One risk with Planet 13, outside of the potential for strict government regulation, is that its superstore concept hasn't proved it can succeed outside of the Vegas Strip, a tourist destination. Las Vegas is unlike any other urban center in the U.S., and investors shouldn't think other locations are guaranteed to repeat the first store's profitability. The second superstore is slated to open in Santa Ana, California, and will be a big test to see whether the concept can work in a typical urban environment.
Two of the four states that legalized recreational use (Arizona, New Jersey) have either a large metropolitan area (Phoenix) or tourist destination (Atlantic City), where Planet 13 could probably do well in. To sustain or grow its current $1.3 billion market cap, the company will eventually need to open more superstores nationwide.
Unlike Planet 13, Curaleaf is further along in its business life and is more focused on the medicinal side of the industry. In other words, while Planet 13 wants to build cannabis facilities focused on entertainment, Curaleaf locations are for wellness. The company has 93 dispensaries in 23 states and over 350,000 registered patients who can buy its products. With medical cannabis sales legal in 36 states, it has 13 untapped markets it can grow into, including Virginia, Minnesota, and recently legalized Mississippi.
Last quarter, revenue grew at a blistering 195% rate to around $182 million. Some of this was inorganic due to Curaleaf's acquisition of Grassroots, a private cannabis company with a similar business model, but even without this boost the company likely would have grown sales in the high double-digits. The acquisition was a $700 million stock and cash deal, which is large, but not crazy big compared to Curaleaf's $10 billion market cap. It is part of Curaleaf's "growth by acquisition" strategy as it tries to vertically integrate the medical dispensary market. The deal makes the combined company the largest cannabis business in the world measured in revenue, according to the company.
Curaleaf isn't profitable under generally accepted accounting principles (GAAP) and doesn't generate free cash flow, but it does have a 50% gross margin and generated $42.3 million in adjusted EBITDA last quarter. While adjusted EBITDA isn't necessarily "real" profitability, it shows Curaleaf is on the right track to generating free cash flow, hopefully within the next few quarters. However, investors should start to get worried if the company struggles to translate EBTIDA profits to free cash flow or net profits. This would indicate Curaleaf's business model is not as sound as it looks.
Finally, Curaleaf trades at what one might call a reasonable valuation. At 7.5 times the next 12 months sales and 25.5 times adjusted EBITDA, investors are not paying an absurd price as long as Curaleaf keeps growing over the next few years.
Pot stocks to profit on
Overall, investors should be cautious when looking at cannabis companies. It is a young industry, with lots of potential legislation that could negatively impact its prospects. However, if you are looking for exposure to cannabis but don't want to buy a lottery ticket on unproven business models, Planet 13 and Curaleaf could be two ways to do it.
Both Planet 13 and Curaleaf have outperformed the Horizons Marijuana Life Sciences ETF (HMMJ -1.44%) this year, up 203% and 93%, respectively. With strong business strategies and growth opportunities in new markets, investors should still be confident in these two stocks heading into 2021.