Cannabis stocks recently rallied on news that the House of Representatives would vote on a cannabis legalization bill. The House eventually passed the bill, called the Marijuana Opportunity Reinvestment and Expungement (“PLUS”) Act, but stock prices have since stagnated. then, because we still do not know if the Senate will follow. In this report, I discuss how two names could benefit from the legalization of cannabis. One is from Canada and the other from the United States. While how they benefit varies, both have everything to gain and their market valuations are cheap right now.
Cannabis legalization 2022
As we can see below, many cannabis stocks like Tilray (TLRY), Canopy Growth (CGC), Aurora Cannabis (ACB) and Sundial (SNDL) saw their prices soar when the Chamber announced that she would vote on the MORE Act. .
Investors should keep their expectations in line with the prospects for cannabis legalization in the near term. Of course, the MORE Act would remove cannabis as a Schedule 1 drug and erase criminal records of previous cannabis convictions. However, the Senate is unlikely to pass the bill. For starters, Senate Majority Leader Chuck Schumer is seeking to pass his own Cannabis Administration and Opportunity Act (“CAOA”), which is expected to be revealed later this month. Additionally, the filibuster means the Democrats would need 60 votes of support, which is highly unlikely given that Republican senators have not shown any interest in supporting a vote on the MORE Act. While I and many others have no doubt that legalizing cannabis would be positive for society and the economy, many senators do not share the same opinion. Only time can tell if the opinions of our politicians will change.
What might the path to cannabis law reform look like? There are positive signs that some sort of legislative reform may be taking place. As Marijuana Moment reported, White House press secretary Jen Psaki told reporters that President Biden agrees that “our current marijuana laws aren’t working.” President Biden had previously signaled his intention to seek the decriminalization of cannabis and grant clemency to people with drug convictions. So far, he has failed to deliver on any of those promises, although he still has just over two years left in his term. Senate Democrats like Cory Booker have said they don’t want to pass legislation like SAFE Banking until there are guarantees of social fairness and criminal justice reform. If Biden were to grant clemency to those convicted of cannabis drugs, that could pave the way for the Senate to pass SAFE banking. The SAFE bank would not decriminalize cannabis, but it would provide access to the banking system for cannabis operators. US cannabis operators had to haul cash in armored trucks and had limited access to capital markets, driving the cost of capital into double digits, even for major operators. SAFE Bank may not be the biggest catalyst for US cannabis stocks, but it may be the most investors can hope for in the near term.
Now let’s talk about two choices that will benefit if and when the country finally legalizes cannabis federally.
Legalization Choice 1: Village Farms
My top cannabis pick for possible legalization is Canadian operator Village Farms (NASDAQ: VFF). As seen below, VFF has a footprint spread across Canada and the United States.
In Canada, VFF is a cannabis operator through its subsidiary Pure Sunfarms. Pure Sunfarms is one of the strongest operators in the country with adjusted EBITDA margins around 20% in recent quarters.
Unlike other Canadian names like Canopy Growth (CGC) or Aurora Cannabis (ACB), VFF has better managed costs with significantly less annual cash burn. How would US legalization benefit VFF? For starters, VFF could use its Canadian operations to sell into the US market. A big issue for Canadian operators has been that of supply, as the larger operators all have large greenhouses that so far have only been able to sell to the smaller Canadian market. Access to the US market would allow Canadian operators like VFF to make full use of their facilities, which should translate into better margins.
Additionally, VFF currently owns 5.5 million square feet of cultivation assets in the United States, primarily located in Texas. These assets currently produce tomatoes, which are a lower-margin commodity than cannabis. VFF has indicated that it can and will convert these facilities to grow cannabis upon federal legalization. This can happen if the country legalizes interstate commerce or if Texas legalizes the factory at the state level. Since VFF is listed on major stock exchanges, it would not be allowed to make its proposed conversion in the latter case, as laws currently prohibit US plant operators from listing on major stock exchanges. VFF would only be able to use these cultivation assets for cannabis after full federal legalization.
VFF has a strong balance sheet with $53 million in cash versus $62 million in debt. The stock trades for 5.5 times net cannabis sales (this does not take into account any upside from their tomato operations), which is a very reasonable valuation for one of the major operators in Canada.
Legalization Pick 2: Trulieve
VFF is a solid choice, but Trulieve (OTCQX:TCNNF) is a better choice. Unlike VFF, TCNNF already operates in the United States, with a footprint spanning 10 states.
One of TCNNF’s crown jewels is in the state of Florida, where it has about a 50% market share of the medical market (I note that TCNNF has since grown its footprint in the state to 112 stores – the slide is from an old presentation).
Unlike operators in the north, TCNNF has been able to maintain attractive profit margins. TCNNF’s adjusted EBITDA margin of 33% in the last quarter was well above that of all Canadian carriers and the company forecast adjusted EBITDA margin to return to the 40% level of historical norms.
Since TCNNF is a plant-touching trader in the United States, its stock is not listed on major exchanges and is instead traded over-the-counter. It’s ironic that Canadian cannabis operators are allowed to list on major US exchanges, but the largest cannabis operators in the United States are not. As a result, institutional capital is low in US stocks like TCNNF, as most institutional mandates prevent companies from investing because cannabis is federally illegal, even if those companies only operate in jurisdictions where cannabis is legal at the state level. Cannabis legalization would allow institutional capital to flow into the sector, leading to stronger multiples for operators like TCNNF.
From a financial point of view, TCNNF should benefit from an increase in the profitability of its net result. In 2021, TCNNF generated adjusted net income of $123 million. Yet the company paid $146 million in corporate income taxes, far more than the typical 21% tax rate for a typical US corporation. The company is also indebted with interest rates north of 8%. Federal legalization would lower interest rates and reduce their corporate tax rate, which would dramatically increase their bottom line. Even based on adjusted net income of $123 million in 2021, the stock is trading at 33 times earnings. That’s an incredibly low multiple for one of the most profitable names in cannabis in the United States and one that stands to benefit from continued growth, among other states, from the inevitable future legalization of sales for adult use in Florida.
Investors may have gotten a little too excited about the prospects for cannabis legalization in the near term. But SAFE bank’s prospects remain bright, as it is a bill with more bipartisan support in the Senate. In this report, I have discussed how VFF and TCNNF would benefit from cannabis legalization and both of these stocks look very buyable at current prices. Although it may be many years before full legalization or any legislative reform takes place, cannabis remains an attractive long-term secular growth story, with legislative reform only being a catalyst. potential for the sector (although obviously very important). My opinion is that the best way to invest for US cannabis legalization is to invest in the stocks of US cannabis operators, with TCNNF being one of my top picks.