While cannabis stocks such as Cronos Group Inc. (CRON), Green Thumb Industries Inc. and Aurora Cannabis (ACB) have pulled back as much as 50% over six months on profit and supply concerns, many cannabis industry suppliers have seen their stocks rise as much as 100% this year. These suppliers look poised to rise higher as they expand their share in the burgeoning cannabis market, as outlined in a recent Wall Street Journal report.
Growers Struggle, Suppliers Take in Profits
Companies directly involved in the growing and distribution of marijuana products continue to face a myriad of challenges. Most notably, the plant remains illegal in the key U.S. market on the federal level, making it even more difficult for cannabis producers to navigate unchartered territory without access to things like traditional banking services.
These headwinds have led shares of the big Canadian producers to tumble, with tobacco giant Altria Group Inc.’s (MO) stake in Cronos Group now worth 10% less than the $1.8 billion it paid at the end of last year. That said, the Journal notes that the most popular names are still trading at a premium, with Canopy’s stock reflecting a multiple of 13 times estimated 2020 revenue.
On the other hand, firms that provide supplies and property to cannabis companies have been beating the market. These names are also ideal for more cautious investors that want to bet on the growth of the cannabis industry, but remain wary of the regulatory risk.
Fertilizer company Scotts Miracle-Gro Co. (SMG), for example, has soared as much as 60% by supplying cannabis companies in legalized markets with the equipment they need for indoor growing. The 150-year-old company makes a wide variety of products for cannabis companies, such as horticultural lights, plant-growing trays and air-filtration systems.
In the quarter ended June, Scotts Miracle-Gro saw its business with cannabis clients increase by a whopping 138% over the same period last year. Shares of the Marysville, OH-based company have gained near 76% year-to-date (YTD) through Monday.
Cannabis Real Estate Providers
Meanwhile, the stock of cannabis REIT Innovative Industrial Properties (IIPR), which specializes in facilities for growing cannabis, has risen more than 89%, despite a recent pullback. Nearly 60% of the company’s shares are owned by institutional investors, an anomaly in an industry known for its popularity among retail investors. BlackRock Fund Advisors and Northern Trust Investments are top shareholders.
Another play on companies that provide property to cannabis companies are Cannabis REITs, which have seen business soar. They are expected to continue to gain on the fact that pot companies are unable to receive traditional mortgages while the drug remains federally illegal.
“The REITs are filling a current void in capital markets where banks would traditionally be,” explained Harrison Phillips, vice president of cannabis investment bank Viridian Capital Advisors, per the Journal. These REITs are also exempt from paying corporate taxes, as long as they distribute at least 90% of earnings directly to shareholders in the form of dividends.
In these particular real estate deals, a sale and lease-back of the real estate on cannabis companies’ balance sheets offers a means for them to free up cash and support growth. IIP estimates a rental yield of 15% on such deals, more than double that of the national average for industrial property.
To be sure, the same structure that favors IIP stock may also cause shares to fall if changes to the federal law facilitate cannabis growers in getting regular mortgages. This would take a bite out of IIP’s above market average yields and therefore weigh on profits.
While the long-term outlook for the cannabis industry looks promising for the major producers, the current risks may lead investors to consider companies on the sidelines. Until issues faced by the growers themselves ease up, those less vulnerable to short-term fluctuations may look like a better bet.