Looking for New Highs: An Analysis of the Cannabis Industry and Selected Companies
December 5th, 2
This one’s a little different. Normally these reports focus on a single company. Today we’re covering a very young industry with plenty of threats and controversies. So we’ll start with an overview of the cannabis industry and then look at three possible investment options to cover the different business models and risk profiles that can be incorporated into a balanced portfolio.
Table of Contents
Executive Summary
A brief discussion of the cannabis industry and its potential appeal to value investors.Extended Summary
A more detailed explanation of the cannabis industry and possible investments in the sector.US Cannabis Industry
From the war on drugs to legalization.Industry Overview and Legislation
Legalization, remaining hurdles, and the future of the industry.A Selection of Cannabis Companies
3 different stocks to invest in cannabis.Green Thumb (GTBIF)
MariMed (MRMD)
Innovative Industrial Properties (IIPR)
Conclusion
Why the cannabis industry is worth a closer look.
1. Executive Summary
In the middle of rising geopolitical tensions and a tech stock meltdown, it is easy for investors to feel there is nowhere to hide. That would be ignoring a sector with an expected yearly growth of 25% from 2022 to 2030. I am talking about the US cannabis industry.
It is an industry still in its infancy, facing complex regulations. It is still very fragmented, even if it is consolidating rapidly. It is also mired in controversy, due to the illegal status of this product until recently in many states and until now at the US federal level. To top it all, it is also an industry famous for absurdly high volatility in valuation multiples.
These limitations have reduced the participation in the sector to retail investors only. Most institutional investors are simply unable to legally invest in the sector. This has led to extremely low valuation multiples during slumps and high funding costs for cannabis companies.
Nevertheless, ignoring a sector ready for explosive growth because it is still early can be a massive missed opportunity for investors. If you have the ability and the risk tolerance to invest in it, this could a unique opportunity to buy cheap assets before any large institutional investors can come and plow money into the sector. In this way, it is the opposite of early tech investing: only retail investors are allowed to get in early.
In this report, we will see how the industry works, what its future could hold, and 3 different ways to invest in it: a large recreational cannabis company, a medical cannabis company, and a cannabis-focused REIT (Real Estate Investment Trust).
2. Extended Summary: Why Invest in Cannabis?
The US Cannabis Industry
The US Cannabis industry has recently moved from an illegal black market to a fully legal and established line of business in almost half of the USA. This followed a massive change in the public’s perception of cannabis. It is also coming as a result of the realization of the flaws and negative impact of the so-called “war on drugs”.
Industry Overview and Legalization
Legalization is a state-by-state business, leading to an extremely complex regulatory landscape. The persistent Federal ban is a constant headache for cannabis companies and creates plenty of extra costs and inefficiencies. The hope of changes in legislation has created a very unstable market, with several cannabis bubbles rising and popping in just a few years.
A Selection of Cannabis Companies
In this section, we cover one of the largest, fastest-growing, and most profitable MSO (Multi-State Operator) in the cannabis industry, a niche medical cannabis company in protected markets, and a dividend-yielding industrial REIT catering exclusively to the cannabis industry.
3. US Cannabis Industry
From Illegal Drug to Consumer Good
You might have strong feelings about cannabis. People have widely-ranging opinions on the topic: some say it’s an evil, life-destroying drug some say it’s a miracle of nature. This is going to be a report that stirs some controversy, but we’ll try to approach it purely from an investment perspective.
Before we study the industry, let’s look at the plant itself.
Cannabis is a common plant that’s quite easy to grow, hence its moniker of “weed”. The plant is also known as hemp and consists of 2 species: Cannabis sativa and Cannabis indica. Hemp used to be a commonly grown plant all over the world for its valuable fiber, which was used to make clothing, ropes, paper, and much more.
Most of the controversy is due to some varieties having psychoactive effects. These effects have been known for millennia by cultures ranging from classic Roman and Greek to Daoist Chinese and Sufi Muslims. Its usage has been on the rise since its discovery by the hippie culture of the 70s.
The psychoactive effect is mostly due to THC molecules. Another molecule of interest is CBD, which has no psychoactive effect but is nowadays considered beneficial for some medical conditions.
The psychoactive effect is relatively strong, in the range of alcohol, but weaker than so-called “hard drugs” like cocaine. Addiction is possible but seems to be less of a factor than it is with alcohol. While debated, it is generally recognized that consumption at a young age is to be discouraged and abusive consumption has undesirable effects. Overdose is very rare, again, putting it below alcohol in terms of toxicity.
In the last decade, most Western countries have started to relax regulations around non-psychoactive cannabis-related products. Quite logically, making hemp-fiber shopping bags or anti-convulsion drugs is not that controversial. The same holds true for painkillers, cancer treatment, and anti-convulsive medications.
Full legalization, including for recreational purposes, is currently hotly debated.
The War on Drugs Debate
For many, cannabis is a drug, making it a different category than other milder substances like caffeine. I personally would put it on par with alcohol: a powerful psychoactive substance, but less dangerous and destructive than “harder” drugs like cocaine, methamphetamine, or heroin.
Prohibitionists tend to believe such substances should never be freely available. Remarkably, the same arguments were at the heart of the 1920s Prohibition period. Prohibition’s defenders argued that the destructive nature of alcohol, inducing violence, poverty, and addiction, fully justified its ban from public life.
Here I would fully agree that unlimited and unconstrained consumption of either alcohol or cannabis can be destructive to a person’s life. The problem for me with a prohibitionist stance comes with the social and economic consequences of prohibition.
The truth is that prohibition is rather inefficient at stopping the consumption of illegal substances. People seem to be ready to endure considerable personal or financial costs to keep consuming substances like alcohol or cannabis. Currently, half of adult Americans have tried cannabis in 2021. In 1985, before any sort of legalization was even on the horizon, it was already 30%.
Making desirable substances hard to find and illegal instantly creates a black market that gangsters can use to generate a high-profit margin. This is because the illegality creates scarcity, while the drug itself is cheap to manufacture, leaving a large potential margin for criminals.
The 1920 US alcohol prohibition notoriously created powerful criminal organizations like Al Capone’s. Alcohol consumption might have dropped a little, but the cost in the form of violent crimes and corruption proved to be unbearable for society as a whole.
The current prohibition is similarly funding criminal organizations, which use that money to run gang wars and other criminal activities. In recent years, it has become generally accepted that the “war on drugs“, started by Nixon in the 70s, failed.
Even if you personally disapprove of cannabis usage, it’s worth considering the possibility that moving that income stream away from violent criminals and transferring it to tax-paying legal companies might still be a good thing.