Undervalued U.S. Cannabis Operators Are on a Roll
When it comes to the legalization of cannabis, I’m neither for nor against it.
I’m 100% agnostic.
But when it comes to presenting you with the best investment ideas that I can find, well, that is where my passion lies.
And that’s why I’m writing about cannabis today.
I believe American cannabis multistate operators, or MSOs, are the fattest pitch in the stock market.
With cannabis illegal at the federal level, these companies can’t even list on American stock exchanges.
Instead, they are listed in Canada.
Hopes of progress toward cannabis legalization after the Biden election win last fall sent the share prices of these MSOs soaring.
The AdvisorShares Pure US Cannabis ETF (NYSE: MSOS), made up exclusively of MSOs (hence the ticker symbol), rose 158% in five months.
But so far in 2021, politicians haven’t made any real progress toward legalization at the federal level.
Meanwhile, as the underlying businesses of these companies have grown incredibly fast in 2021, their stock prices have crashed back to earth.
The AdvisorShares Pure US Cannabis ETF has lost half its value since peaking in February.
And that pullback has provided us with an incredibly fat pitch…
A Slow Path to Legalization Is Actually Better for These Stocks
While cannabis isn’t legal at the federal level, it is fully legal for both medical and recreational purposes in 19 states and legal for just medical purposes in another 17.
There is zero doubt in my mind that full legalization is inevitable.
Nobody knows when federal legalization will arrive, but that doesn’t matter for the MSOs already operating in states where cannabis is legal.
In fact, the longer it takes for federal legalization, the better.
This is because these MSOs are the only cannabis companies that can currently access capital at a reasonable price.
As long as cannabis is illegal at the federal level, these companies can grow and gain market share against little competition, establish brand strength, buy out smaller competitors and gain the advantage of scale.
For shareholders, this means these MSOs are going to win immediately if federal legalization comes quickly because the sector will soar on that news.
On the flip side, if federal legalization takes a few years, these MSO stocks are going to be even better investments because they will have had years to establish dominant market positions and grow at incredible rates.
Either way, shareholders are going to win – and they’re going to win big.
Outrageously Cheap Stocks Anticipating Future Catalysts
Despite being some of the fastest-growing businesses in the market, MSOs are also among the cheapest.
The chart below shows what an outlier MSOs are with respect to the rate of growth and valuation.
No sector is growing anywhere near as fast, and yet few sectors are valued less expensively.
The table below shows how American MSOs are valued relative to similar Canadian cannabis operators.
At 31.3 times EV/EBITDA (enterprise value to earnings before interest, taxes, depreciation and amortization), Canadian companies are valued four times higher than American MSOs.
The mistake here isn’t that Canadian companies are valued too high… It’s that American MSOs are valued too low.
It boggles my mind to think that companies growing this fast are valued at single-digit multiples of EV/EBITDA.
In fact, U.S. MSOs are actually growing faster than their Canadian counterparts.
The average rate of sales growth projected for 2022 is 66% for U.S. MSOs versus 42% for Canadian operators.
Eventually, I believe U.S. MSOs will trade at more appropriate premiums to Canadian operators.
There’s a long list of catalysts coming, including…
- Passage of the Secure and Fair Enforcement (SAFE) Banking Act for cannabis businesses
- Elimination of the IRS Section 280E tax code, which heavily penalizes these companies
- Legalization at the federal level
- Cannabis’s public listing on American stock exchanges
- Institutional investors who are finally able to buy these stocks.
That last catalyst is particularly driving down these stocks.
Because cannabis is still illegal at the federal level, these companies have almost no institutional ownership.
Once legalization happens, billions of dollars will flow into these stocks and drive up share prices.
And I mean billions…