Cannabis stocks have underperformed over the last two years for various reasons, including the lack of progress on federal-level legalization. Even without federal legalization, the industry as a whole continues its rapid expansion, especially outside the U.S. Current forecasts from Allied Market Research suggest the global cannabis market which stood at $25.7 billion in 2021 could reach $149 billion annually by 2031 (a compound annual growth rate of 20%).
Savvy investors know there are risks associated with any high-growth industry and volatility is typical in an evolving industry. But a long-term outlook (i.e., patience) on an investment in some select cannabis stocks can make risk-averse investors wealthy. Here are three companies with the potential to be long-term success stories.
1. Innovative Industrial Properties
Innovative Industrial Properties (IIPR -0.17%) is not a pure-play cannabis company. Rather, it's a real estate investment trust (REIT) that assists medical cannabis companies.
Because cannabis is illegal on the U.S. federal level, marijuana companies face challenges raising capital through traditional bank loans and credit lines. These companies use sale-leaseback programs with Innovative as a way to raise needed capital by selling their property to Innovative and then leasing it back.
This unique business model is a win-win for both parties. The company gets capital to fund operations and Innovative earns rental revenue in a net lease arrangement where the leasing company pays most of the fees associated with the property. Its tenants include some popular cannabis companies like Trulieve Cannabis (TCNNF 3.83%), Cresco Labs (CRLBF 5.13%), Green Thumb Industries, Curaleaf Holdings, and many more.
While the arrangement has generally worked out well, it isn't immune to worsening economic conditions. There is always a risk of tenant default, and that has occurred with greater frequency recently. Despite these headwinds, Innovative has a strong balance sheet, with $87 million in cash and equivalents at the end of 2022. It has a long triple net lease agreement with its tenants, with a weighted-average lease term of 15.3 years. This implies it has the means to keep generating revenue for a while.
In 2022, its total revenue increased 35% to $276 million and its adjusted funds from operations (AFFO) increased 34% to $234 million. AFFO (which REITs use as a more accurate representation of earnings) determines how much cash is available for dividend payments.
The tenant defaults over the past year have caused the stock price to drop 61%, which helped push Innovative's dividend yield to 9.9%. REITs in general have a higher yield, as their tax structure requires that they pay out at least 90% of their income to shareholders as dividends. Even with the economic headwinds, Innovative managed to keep paying and hiking its dividends consistently. Its recent dividend increase of 25% marked its 11th dividend increase since it went public in late 2016.
Innovative works well for risk-averse investors who want to invest in this sector without being completely exposed to the risks. If the U.S. does legalize marijuana use, it could actually hurt this REITs business model. But the current sentiment is leaning toward no change in the status quo. Until the state markets keep legalizing cannabis, domestic companies will need to expand, bringing in more business for Innovative.
2. Trulieve Cannabis
Trulieve Cannabis is a cannabis multi-state operator (MSO). It began as a small medical cannabis company in Florida and has since grown to dominate the state with 125 stores with an expanded product line, and another 56 stories around the country. The MSO has already opened three more stores in 2023, bringing its total to 184.
Trulieve's reliance solely on its home market and on medical cannabis raised some concerns about growth limitations. But it's trying to follow a wise strategy of expansion where it dominates in the markets (i.e. Florida) it does serve. That strategy helped Trulieve consistently report solid quarterly and annual results.
In 2022, revenue increased 32% to $1.2 billion. This top-line growth was attributed to "contribution from the Harvest acquisition, new market expansion, and new store openings in existing markets," according to management. Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) increased by 4% to $400 million.
While expanding, Trulieve has taken care not to overburden its balance sheet. It had $219 million in cash and equivalents at the end of the year. During the same time frame, it also had $21 million in free cash flow, which it could use to finance future growth.
Trulieve has a debt-to-equity ratio of 0.34 (total debt divided by total shareholders' equity), indicating a healthy debt level. A lower debt-to-equity ratio indicates that a company is not relying on debt to survive or grow aggressively.
3. Cresco Labs
Cresco Labs is another MSO, it owns 57 stores nationwide, and it is trying to catch up to the larger players. In 2022, it generated $843 million in revenue. Cresco's acquisition of Columbia Care (scheduled to close on June 30) will help its growth immensely. Cresco's total number of dispensaries will increase by 130, making it one of the major players in this sector.
One of Cresco's most successful strategies was to focus on limited-license markets such as Illinois, Ohio, and Pennsylvania. These state regulators are cautious when it comes to allocating cannabis licenses, giving Cresco an advantage in gaining a loyal customer base.
Adjusted EBITDA for the year came in at $174 million, a dip from $193 million in 2021. Though Cresco is not yet profitable, the Columbia acquisition may work in its favor. Cresco also had a strong balance sheet at the end of the year. Its cash, cash equivalents, and restricted cash totaled $122 million.
No risk, no reward
Over the last year, all three stocks saw their stocks price fall. Innovative Industrial Properties is down about 61%, while Cresco and Trulieve stock prices fell more than 70%. The drops can be attributed to a variety of factors, including a lack of progress toward legalization, rising interest rates, and supply-demand imbalances that are slowing revenue growth for cannabis growers.
Without a doubt, the cannabis industry, like any other evolving industry, has its share of risks. However, cannabis is also considered a consumer discretionary product, which means that demand for cannabis will not completely disappear. This is evident from the rate at which experts anticipate the industry will grow in the coming years. With some patience, these risks can yield fruitful rewards.
Average Wall Street analysts estimate that Innovative's stock might climb by up to 85% in the next year, and the stock is rated a strong buy. Analysts also rate Trulieve and Cresco as buys. Over the next year, Trulieve's stock could increase by 130%, while Cresco's stock could increase by 172%.
If you are a new cannabis investor, a small investment in these three stocks, along with a diversified portfolio of stable stocks, would be a good place to start.
