2 recreational pot stocks to buy

Haywood Securities analyst Neal Gilmer picks two US-based marijuana stocks to buy for their pent-up recreational demand.

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There is a yawning gap between valuations of marijuana companies in Canada and the USA.

Toronto-based equity analyst Neal Gilmer observes that although the United States Controlled Substances Act continues to classify cannabis as a Schedule 1 controlled substance (the most restrictive category of drug), “There is growing momentum across the US on the acceptance of cannabis, particularly for medical use, and competing factors with a high level of bipartisan support for cannabis, no federal funding for enforcement and laws that protect existing medical markets.”

Mr. Gilmer is responsible for special situations research at Haywood Securities. Accordingly, he leads its coverage of US and Canadian marijuana stocks. His beat also leads him to companies in such realms as e-sports.

Initiating coverage of the US cannabis stocks in May 2019, the analyst had recommended that investors look there instead of in Canada for portfolio additions given the yawning gap between valuations of marijuana stocks operating south of 49 degrees and those operating north of it.

Mr. Gilmer conceded then that this was the natural result of marijuana’s still-illegal status in the United States, but added, “We believe this disparity should narrow over time.”

The analyst also noted that “certain key, highly populated, states” that had already approved medical marijuana were considering legal frameworks for adult recreational use, including Illinois, New Jersey, Arizona, and New York.

“All of this leads us to state the obvious, which is that we remain in the early stages of the overall cannabis opportunity in the US,” he said in May 2019.

Marijuana legalization expanding in the USA

The analyst’s thesis appears to be playing out. Since then, Illinois legalized recreational marijuana use on Jan. 1 of this year, and both New Jersey and Arizona (along with South Dakota and Montana) voted for legalization on election day, Nov. 3. Bringing up the rear, in a Nov. 5 interview with public radio station WAMC, New York Gov. Andrew Cuomo said that he continued to support fully legalizing adult use, and that 2021 was “ripe” for the changeover to go ahead. (The previous state budget, unveiled last April at the height of pandemic restrictions, omitted any legalization legislation but since then, COVID-related government budget shortfalls have drawn new attention to marijuana’s potential as a revenue generator.)

However, rather than favouring cannabis stocks preparing to make inroads into the Empire State and its Big Apple, Mr. Gilmer underlines two firms headquartered in the Windy City and operating in the Land of Lincoln, among other states, Green Thumb Industries Inc. (CSE—GTII) and Cresco Labs Inc. (CSE—CL), both trading on the Canadian Securities Exchange in Canadian dollars so they are easy for domestic investors to access.

Mr. Gilmer considers Cresco and Green Thumb to be “buys” and says they posted very impressive results in the third quarter of 2020.

Cresco and Green Thumb growing fast

According to the analyst, Cresco is rapidly expanding its footprint in the US, especially in Illinois, California and Pennsylvania. Its portfolio of branded products includes Cresco, Reserve, Mindy’s, Good News, and others. “Cresco reported sequential revenue growth of 63 per cent, totalling US$153.3 million, significantly above our US$120.4-million estimate and consensus at US$116.3 million,” he says. Meanwhile, adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) of US$46.4 million far outstripped his US$26.4-million prediction. In fact, the numbers even exceeded his 2020 fourth-quarter forecasts, leading him to raise those estimates. “Cresco has taken a consumer packaged goods approach to the market and has developed a house of brands designed to meet all consumer segments,” explains Mr. Gilmer.

“The company has exposure to some of the high-growth states in the US, with the largest presence in Illinois and significant exposure to the strong medical market in Pennsylvania. Furthermore, Cresco has demonstrated strong growth in California following its acquisition of Origin House in early 2020.”

Meanwhile, Green Thumb Industries’ third-quarter results included net revenue of $157.1 million and an adjusted operating EBITDA of US$53.2 million, up 31.3 per cent and 50.2 per cent quarter-over-quarter, again far exceeding Mr. Gilmer’s expectations.

The company is swiftly expanding its presence in Illinois and holds licences for up to 96 retail locations and 13 manufacturing facilities across 12 states. Green Thumb’s core business plan is to distribute its brands (such as Rhythm and The Feel Collection) at scale in the markets where it operates, which include Pennsylvania, New Jersey, and Ohio.

This is an edited version of an article that was originally published for subscribers in the December 4, 2020, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.

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