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Sin stocks are a category of stocks from companies involved in “immoral” activities, like gambling, alcohol, tobacco, or weapons manufacturing. Many investment funds and individuals will refuse to invest in these sectors, causing an artificially low price for these stocks. Distillate Cartridge
But these are also highly profitable activities, leading to these companies generating over time massive cash flows that can be used for acquisitions, share repurchases, or dividends.
As a result, sin stocks significantly and consistently outperform the overall markets.
Cannabis is still considered at the US federal level as a fully illegal drug. Meanwhile, almost half of the US states have fully or partially legalized the production, sale, and consumption of cannabis. This should be a very profitable business line, like most other “sin stock” activities.
This creates a strange situation for cannabis companies. While legal, cannabis companies encounter a lot of problems with anything related to national-level regulation and laws.
They are, for example, often forced to operate only with cash, which carries significant costs. They are also paying a lot more taxes than “normal” businesses. Most brokers will refuse to buy cannabis stock for their clients, and most investment funds are forbidden to invest in the sector. The interstate trade of cannabis is a big no-no, even between 2 contingent states where cannabis is legal in both states.
A lot is expected to change when a new set of laws, the SAFE Act (Secure And Fair Enforcement), is finally voted on. But this is a law stuck in the legislative process for years now. This has caused some despair among cannabis investors, with federal decriminalization or legalization seemingly endlessly out of reach.
As the normalization of cannabis has been delayed, the sector experienced a brutal crash, with the leading ETF for the sector declining by as much as 90% from the top. This also creates an opportunity, as 88% of adults in the US want cannabis legalized. So, even if it is a lot slower than expected, it is likely that the political process will move on and slowly allow cannabis to be commercially sold in the whole of the USA.
IIPR is an industrial REIT (Real Estate Investment Trust) specializing in building facilities for cannabis companies, like greenhouses, oil extraction plants, etc…
The first reason why cannabis companies chose to work with IIPR is that cannabis companies suffer from a very high cost of capital. IIPR, as an industrial REIT, can finance the greenhouses at a much lower rate, de facto providing capital to an industry that desperately needs it.
Another reason is that by building a massive amount of greenhouses, IIPR achieves a scale able to reduce costs on materials, construction, designs, etc. It can also provide expertise in multiple fields, like plant strain selection, oil extraction, humidity management, etc.
IIPR has massively grown its real estate portfolio since its inception in 2016, reaching 108 in 2023.
The capital committed was $2.4B, slightly higher than the current market capitalization. Considering the trend of inflation that has occurred since these facilities were built, it is clear that any new competitor would have to pay more to build a similar asset base.
The tenant base is diversified, and IIPR facilities are present in 19 US states, or almost all states where cannabis has been fully or partially legalized.
The debt schedule is manageable, with no significant repayment before 2026, on a $300M bond at 5.5%.
As an industrial REIT, IIPR can potentially be easier to buy than a cannabis stock. It also offers an almost double-digit dividend yield.
The stock price is highly correlated to the overall cannabis market, meaning it can, at times, trade way above NAV (Net Asset Value) and at times below that. Considering the current despondent mood in the cannabis space, this can make IIPR a good entry point while providing a solid dividend until things turn around for the cannabis industry.
Curaleaf is one of the world's largest cannabis companies, with a presence in 19 states, operating 152 dispensaries, with a total cultivation capacity of 4.2M square feet.
The company also expands in Europe, with a presence in the UK and Sweden, and opening in Germany, Czech Republic, Italy, Portugal, and Switzerland. The company is offering a full range of cannabis products along multiple brands, including drinks, edibles, and vaping, on top of more “classic” cannabis products like dried flowers.
The company has steadily grown its revenues and AEBITDA (Adjusted Earnings Before Interest, Taxes, Debt, and Amortizations).
Source: CuraleafCuraleaf is a typical growth stock aiming to become the industry's dominant player, focusing on expansion over immediate profitability. The presence in the European markets is also a relatively unique feature of Curaleaf, making it potentially a future global player in cannabis instead of a solely US company.
Tilray's strategy is to build solid brands, first in the cannabis segment but also in beverages.
It is very strong in Canada, ranking first in adult market share across all major Canadian markets.
Due to the delays in US legislation change, Tilray is also pursuing opportunities in alcoholic beverages. It notably acquired Breckenridge Distillery for $103 million in 2021, followed by several craft beer brands and, more recently 8 beer & beverage brands from Anheuser-Busch.
Tilray’s expansion into beer and spirits matches its focus on branding. The company aims to become a household name in “cool/relaxing” products causing mild intoxication, aiming for cross-selling between cannabis, beer, energy drinks, and whiskey.
This strategy can be good, with strong brands a known method to generate higher margins in commodified sectors like food and drink.
So, investors in Tilray should see the stock as a potential consumer brand conglomerate similar to Coca-Cola, Mars, or Hershey.
Green Thumb has a range of cannabis brands focused on wellness, including medical cannabis. It operates in 15 US markets, with 84 retail locations. Green Thumb operates mostly in states with limited licenses, allowing for a higher sale price of cannabis products.
It produces all types of cannabis products, including pre-rolls (pre-made cannabis “cigarettes”), edibles, candies, balms, etc…
Contrary to many of its competitors, Green Thumb has managed to grow revenues and turn profitable with positive free cash flow in 2020. Since then, free cash flow has been negative due to high capital expenditures, fueling a quick revenue rise. EBITDA has been stable in 2022 despite depressed wholesale cannabis prices.
The focus of Green Thumb on higher margin markets and positive operating cash flow will be reassuring to some investors. It should also provide the company with enough ammunition to manage any prolongation of the current downturn or further delays in changes in legislation, like the SAFE Act or federal-level legalization.
Verano is another one of the largest cannabis companies in 14 markets with 132 retail locations. While most of the company's revenues come from retail sales, it also makes 32% of its income from wholesale, leveraging its massive production facilities.
Verano focuses on quality, with special attention brought to plant genetics, with 160+ proprietary strains and strict quality control on dosage and concentration.
This allows the company to display exemplary EBITDA margins, above all of its peers. The company is now forecasting a free cash flow of $65M-$75M for 2023, which would be remarkable compared to the rest of the industry.
There is still an open question of what a mature cannabis market will look like. Will it be a fully commoditized sector, where only the price/gram matters? Or will it be one when premium quality and/or brand will be important?
Verano is a bet on the cannabis market, becoming a market segregated by product quality. Good cash flow should also allow Verano to thrive even in a difficult environment and maybe to buy assets from less cautious or profitable distressed competitors.
This Israeli company is also active in Canada and the USA through partnership and partial ownership of local companies (respectively, Cronos GrowCo & Pharma Cann).
Cronos is backed by the tobacco giant Altria, which bought a 50% stake in 2019 for $1.8B, or more than twice the current valuation following the recent severe decline in prices of all cannabis stocks. The relation with Altria is overall a plus but also implies the risk of the company looking to fully acquire Cronos to reinforce its entry into the cannabis market.
Initially, the company's focus was on medical cannabis, a sector where it is still very active. Since then, it has diversified in consumer product selection, including edible vape cartridges, smoking, and candies.
Another sector of activity is rare cannabinoids, molecules present in low concentration in cannabis plants, besides the more well-known THC and CBD. The company has developed a program to mass produce these rare chemical compounds through fermentation in partnership with the synthetic biology company Gingko Bioworks.
Investors interested in Cronos will be looking at a very original portfolio with a focus on medical cannabis, including rare cannabinoids that might be useful for a wide array of new therapies, from mental health to glaucoma and cancer. The diversification of revenue streams in Israel and Canada also makes it less sensitive to US political and legal reforms.
Cresco is the number 1 wholesaler of cannabis products, using 900,000 square feet of cultivation to supply its clients. This means the company's cannabis is sold at Cresco's 69 retail locations and third-party resellers (1,600 dispensaries).
It sells a wide array of products, including vaping liquid, smoking products, gummies, edibles, marshmallows, resin, popcorn, etc. Cresco is present in 9 US states, of which 8 are in the top 10 by market size, representing more than $1B of annual sales.
This focus on wholesale places Cresco in the cannabis landscape in a position similar to a company like Kraft in the food industry. It produces its own brands and counts on resellers to assume the distribution. This can be a lower margin strategy but also one less reliant on acquiring limited dispensary licenses and less capex intensive.
The company has recently been focusing on improving its margin by closing low-margin cultivation sites in California, Maryland, and Arizona. With a focus on cultivation and production instead of selling directly, Cresco has been developing 400 unique plant strains and has become the #1 seller in flowers and concentrates.
The more cannabis is normalized, the more sell points will be authorized and opened. It is possible that, in the long run, cannabis will be as accessible as tobacco.
In that context, a preexisting infrastructure for wholesaling might become an asset, and investors in Cresco will be well-positioned to benefit from it. Cresco's focus on limited markets and efficient production could also benefit from lifting the inter-state trade ban.
Glass House is a cannabis-growing company looking for the maximum economies of scale and lowest production costs. The company manages a massive 6M square feet of greenhouse, of which only 3M are currently in use. The rest of the greenhouse is expected to be retrofitted by the end of 2024.
These facilities are located in California, considered as having an almost ideal weather for cannabis cultivation. The advanced greenhouse design and climate advantage allow Glass House to claim a 95% lower CO2 emission than the average indoor growth.
While California is by far the largest cannabis market in the US and in the world, it is also the one where bulk cannabis prices are the lowest due to the massive number of 5,600 cultivators.
The company has managed to consistently decrease its production costs when compared year-to-year (to take into account seasonality and weather). This allowed Glass House to consistently produce Californian cannabis below its selling price, something very few in the state have managed, with a lot of Glass House’s competitors getting out of business.
Thanks to its razor-focus on cost control and efficiency, Glass House is one of the rare companies able to successfully compete in California, the largest but toughest cannabis market. With many competitors leaving the industry and Glass House's production expected to grow by 70% by 2024, the company is well positioned for a rebound in Californian cannabis prices and to grow revenues and profits quickly.
A long-term potential for Glass House is in inter-state trade. If or when this happens, California-grown cannabis is likely to out-compete local producers dealing with a smaller scale, poorer weather, and generally less favorable conditions. Considering California's cannabis prices can often be 5-10x lower than in other US states, this would represent a large opportunity for Glass House to export its production to the rest of the country.
Village Farms is a 30-year-old vertical cultivator that reconverted into cannabis cultivation. One of Village Farms subsidiaries, Pure Sunfarms, is one of Canada's largest cannabis producers. The company operates 2.2M square feet for cannabis production, as well as 8.3M of produce (berries, tomatoes, lettuces. etc.), and works with 13.2M square feet of production capacity through various partners for more produce.
It entered the cannabis market early in 2017 in Canada and in the USA in 2018. Its installations are estimated to be able to supply 1/3 of the total forecasted Canadian market and with an ever larger capacity by surface in Texas, also for the US market.
It also owns 12% of Altum, a platform for large-scale import of cannabidiol products to the Asia Pacific Region, and has launched its cannabis products in Germany. It also acquired Leli Holland and exported for the first time to Israel from Canada in 2023.
Village Farms is able to convert into cannabis cultivation a lot of its produce greenhouses, allowing it to scale up quickly in case of expanding legalization, higher demand, or higher prices.
A depressed cannabis market had pushed the company into negative income, but it managed to get back to a positive EBITDA in Q2 2023, with a net income loss of $1.4M on $77.2M of revenues.
Village Farms still registers more of its revenues from produce than cannabis, but this might change soon. As a well-established expert in indoor cultivation, Village Farms has the potential to compete on costs with newcomers to the industry who might be more knowledgeable about cannabis but not about indoor cultivation.
From craft and illegal cultivation, the cannabis sector is now a very industrialized and optimized indoor farming sector. A key supplier to the whole industry is Hydrofarm.
It is the leading manufacturer of hydroponic cultivation systems. The company owns outright 70 brands and also distributes 80 others. It sells through many retailers and distribution channels, including online and offline, B2B and B2C.
Two-thirds of sales are consumable products, and one-third are durable equipment. The company has expanded sales through organic growth and a large acquisition in 2021. Its revenues have overall grown over time, but with a strong cyclicality, with 2022 the first down cycle since 2018.
The company is counting on cannabis to keep growing in the long term and for Hydrofarm to be a successful supplier to the industry, riding out the speculators and volatility:
“Like the Gold Rush, the path to stabilization is wiping out some speculators. But the surviving picks and shovels suppliers should thrive“.
Hydrofarm saw net sales decrease in 2022, compared to 2021, from $479M to $344M. This turned the 2021 net income of $13.4M into a net loss of -$285M in 2022. Net income in Q2 2023 was -#12.8M, reflecting the stabilization of the situation for Hydrofram. Free cash flow is positive in Q2 2023 at $8.3M and is expected to stay so for the rest of the year.
Hydrofarm is a stock for investors looking for a “pick and shovel” stock in the indoor growth market, with a lot of the industry now driven by cannabis cultivation. The sector is highly cyclical, which can play both in favor and to the detriment of Hydrofarm shareholders.
On the plus side, consumable sales depend on the volume grown, while equipment depends on capex spending. So, with legal cannabis consumption growing, Hydrofarm products should stay in relatively high demand, especially once the current crash in cannabis prices is over.
The company could also, at some point, benefit from a rebound in demand from vertical farming, a sector that suffered severely from rising rates and inflation in 2022-2023.
Jonathan is a former biochemist researcher who worked in genetic analysis and clinical trials. He is now a stock analyst and finance writer with a focus on innovation, market cycles and geopolitics in his publication 'The Eurasian Century".
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