2 ways to invest in U.S. Cannabis legalization

The U.S. states of Arizona, New Jersey, South Dakota and Montana, passed legislation Tuesday decriminalizing possession of cannabis.

It brings to 15 the number of states that have legalized pot for recreational use. Mississippi voted to allow medical marijuana to be sold, bringing to 36 states, the number which allow distribution of medical cannabis.

The legal cannabis industry is in its early days and the global movement to legalize pot is an unstoppable force. This is even though on the second anniversary of the legalization in Canada, most of the billions invested in the industry have vanished. Shares of the 100 or so publicly traded cannabis companies peaked in the run-up to legalization on Oct. 18, 2018 and are now down between 66% and 90%, the Globe & Mail reported recently.  

All eyes are on the U.S., which is the single biggest potential market, but lacks a federal law. It presents complications for companies listed here and doing business there and vice versa as I wrote in an article this week. But that may change.

Canadian cannabis sales are about C$2 billion a year with an expected peak of $6 billion. The U.S., with its patchwork of state legalizations, is already a US$15 billion market.

 “The global cannabis market is really about the U.S. consumer. It’s about retail, adult use in the United States,” says Mark Noble, executive vice president of ETF Strategy at Horizons ETFs Management Ltd. in Toronto.

Investors are hoping for quick federal cannabis legalization with a Joe Biden victory.  

Here are a two ways to take advantage of U.S. cannabis industry growth. One is Scotts Miracle-Gro, a conservative, dividend-paying stock with a growing business selling greenhouse hydroponics and nutrients to grow pot. The other is the Horizons U.S.-focused ETF (HMUS), which is a speculative bet on growth and coming U.S. federal legislation.

Scotts Miracle-Gro Company (NYSE: SMG)  Closed Thurs. Nov 5. at $171.16. (Figures in U.S. dollars.)

Background: With sales of $3.2 billion, Scotts is one of the world’s largest marketers of lawn and garden care products. It was founded in Ohio in 1888 to sell grass seed and now sells weed and pest control, potting and garden soils, bird seeds, and mulch. Miracle-Gro is a best-selling water-soluble plant food.

Since 2014, Scotts has been building a business as a supplier of hydroponic growing systems for the North American cannabis industry. Its Hawthorne Gardening Co. is the leading source of liquid nutrients, growing media, and lighting for hydroponic growing.

Performance: Scotts  shares have doubled from their mid-March low of $76.50 and are up  60.9% year-to-date.

Recent developments:  Scotts Miracle-Gro reported a record fourth quarter and yearend Wednesday on the strength of pandemic nesting trends and its growing cannabis industry. The year was so good that 3,000 hourly paid employees, who are not part of other incentive plans, were paid a $3,000 bonus.

For the 12 months ended Sept. 30, revenues were a record $4.13 billion, up 31% year-over-year. Net income rose 40% to $585.2 million, a 40% jump. Adjusted for one-time expenses, earnings per share were $7.24 a share were 62% higher. 

 In its fourth quarter, traditionally the weakest, consumer product sales of $497.2 million were 90% more than 2019.  Its Hawthorne division also had a banner quarter. Fourth quarter sales increased 68 percent to $351.9 million. 

Looking ahead to next year, the company sees Hawthorne driving growth, with revenues rising 15 to 20 percent. The company expects home and garden sales to be flat to down 5 percent.

“For cannabis growers, greenhouses are the lowest cost and most efficient way to grow a lot, quickly, especially in places like California,” says Mr. Noble “So this company is uniquely situated. As the U.S. market grows, they get a lot more leverage from Hawthorne.” 

 Dividend: Scotts paid a special $5 per share dividend in September and also  raised its regular dividend by 7% to $0.62 quarterly. It yields 1.52%. The stock carries a high p/e ratio of 29.9 but the business stands to gain from the prospects for cannabis legalization in the U.S. and ongoing COVID-related demand for its home and garden products.

Horizons US Marijuana Index ETF (NE: HMUS) Closed Thurs. Nov 5. at $19.04.

Background: This fund was launched in April 2019 and is listed on the NEO exchange. It is Canadian dollar-hedged, has $24.1 million in assets, and replicates the U.S. Marijuana Companies Index, net of expenses. It is designed to provide exposure to the US cannabis industry.

The holdings are mainly listed in Canada but are American companies. They cannot get listings in the U.S. without federal legislation but can get listings on the TSX and the NEO Exchange in Canada.

Performance: This ETF is down 39.9% since its launch 18 months ago, mirroring the Canadian industry’s sell-off. Year-to-date it is flat.

Holdings: There are 30 companies in the fund, of which the top four account for 44% of the assets. Only one is profitable, although all show strong revenue growth.

The largest holding Curaleaf Holdings Inc., (12%) is based in the Boston area. It operates 93 dispensaries in 23 states and is one of the largest multistate cannabis operators in the U.S. It has a market capitalization of C$6.3 billion, trailing 12-month sales of US$238 million and a loss of US$46 million.

Cresco Labs Inc. (11%) is based in Chicago. It has 15 production facilities, operates in nine states, and owns 19 dispensaries for medical marijuana. It sells a variety of consumer products including gels, fruit chews, chocolates, vape pens, and popcorn. It has a market capitalization of C$1.9 billion, sales of US $232.8 million in its latest 12 months, and recorded a loss of $61 million.

Trulieve Cannabis Corp. (11%) is the dominant medical cannabis grower and distributor in Florida with 55 stores and 51% of the market. It has other licenses in California, Massachusetts, and Connecticut, where it plans to expand. Trulieve had revenues of US$216.8 million in the first half of 2020 and a net profit US$20.5 million.

Columbia Care (10%) is one of the original American medical cannabis producers with licenses in 18 U.S. jurisdictions and the European Union. It reported a record second quarter revenue, has US$100 million in annual sales, and a loss of US$88 million over that period.

Key metrics: The fund is rebalanced quarterly and has a management fee of 0.85%.

This ETF is a bet that the next phase of industry growth will come quickly, driven by U.S. legalization.

This is an edited version of article that appeared in the Internet Wealth Builder on November 2, 2020.