Cannabis stocks haven't been kind to investors. Shares of the eight largest American-based multi-state operators (MSOs), by revenue, have fallen by an average of 72.5% over the prior five years.
Canadian cultivators have been even less friendly to shareholders. Since the country legalized marijuana for recreational purposes among adults on Oct. 18, 2018, the eight largest publicly traded Canadian cannabis companies (by revenue) have generated an average return on capital of negative 89.5%.
The industry's value destruction phase may be near an end, however. In 2023, the pace of bankruptcies, distressed asset sales, and mergers is expected to pick up in both Canada and the United States.
This consolidation phase ought to provide some much-needed relief on the supply side of the value chain in oversaturated markets like Colorado, Oregon, and the whole of Canada. In short, cannabis wholesale and retail prices could start to bottom by the end of the year.
Which cannabis stocks are the best buys as the industry slims down? Cresco Labs (CRLBF -2.50%) and Green Thumb Industries (GTBIF -2.16%) are two top-shelf MSOs that have what it takes to survive the industry's early growing pains. Here is why investors might want to buy these two cannabis stocks in February and hold them for the long term.
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Safety and deep value
Even though U.S. cannabis sales are forecast to grow at an exponential rate over the balance of the decade, the challenging financial environment has kept most cannabis companies from reaching their full potential. The long and short of it is that cannabis's Schedule 1 status under the Controlled Substances Act creates a legal liability for financial institutions who might serve businesses selling cannabis and/or cannabis-related products.
This key hurdle was supposed to be overcome by the passage of the SAFE Banking Act late last year. But this landmark bill has so far failed to pass in the Senate, despite public support from top Democrats and Republicans. So, until MSOs have access to mainstream financial services, investors ought to stick to companies that are capable of making it through the industry's early lean years. In effect, the name of the game in cannabis investing right now is survival, pure and simple.
The top MSOs Cresco Labs and Green Thumb Industries check this all-important box. Cresco is gearing up to merge with another large MSO, Columbia Care. Upon closure of this deal later this quarter, Cresco will become the largest MSO in terms of annual revenue.
It will also create several important cost-saving synergies, and give the new entity a commercial presence in every major cannabis market in the United States. This transformational deal should cement Cresco's competitive position as a leader in the high-value U.S. cannabis market, making it one of the safer cannabis stocks to own in this challenging operating environment.
Green Thumb is a unicorn of sorts. The MSO is one of only a handful of U.S. cannabis companies currently generating a profit on an annual basis. It also has a fairly strong balance sheet, evinced by its industry-low debt-to-equity ratio of 30.2. Most MSOs, by contrast, sport debt-to-equity ratios well north of 60. Green Thumb thus qualifies as one of the best-managed and most successful cannabis companies operating in the U.S. right now.
Bottom line: Green Thumb has already proven it can weather the slow crawl toward cannabis banking reform, the ongoing price compression across all categories of cannabis products, and the challenges inherent in operating across multiple states with varying rules and regulations. The same simply can't be said for many of its competitors.
