I Like a Certain Type of Cannabis Stock

I have been cautious on cannabis stocks since late 2022. I shared a post here recently that discussed this binary event now hanging over the sector, rescheduling, on January 1st. I said then that the stocks are cheap but with a lot of risk, and this remains the case.

The binary issue is rescheduling, and some of the stocks are priced as though it is happening. It may happen, and this would be very good if it plays out as some expect. Why? If cannabis is rescheduled from Schedule 1 to Schedule 3, as the Department of Health & Human Services has requested to the DEA, then the onerous tax, 280E, will be wiped out. This would be great, as I discussed previously.

I run two model portfolios at 420 Investor, and they have a lot of cash in them currently. I don't try to time the markets. My goal is to pick the best stocks and do better than the index. I have done a pretty good job of this over the past decade.

For those that want to get a taste of my thinking, I write a piece at New Cannabis Ventures each week. You can access all of the past issues of the weekly newsletter. You can also read my contributions to Seeking Alpha, where I write an article each week.

I started 420 Investor in 2013, and I moved it to Seeking Alpha in 2023. Earlier this year, I began offering a version of it that is less intense, The Big Picture. I explained the differences in a blog piece. I am pleased that a few have subscribed to this new sub-service.

With The Big Picture, I began offering "top picks" and have shared six. I closed one out already. The first three all shared a theme, which I am addressing in this piece. Each of my first three top picks, which included WM Technology (MAPS), Hydrofarm (HYFM) and Village Farms (VFF), was facing potential delisting by the NASDAQ.

Delisting sounds horrible! I think that many investors avoid stocks like this, as they fear a potential reverse-split of the stock. I don't share this negative view of reverse splits. For those that have followed my work, they can look to one that I liked a lot but didn't go well for me at first, Organigram (OGI). It did the reverse-split and fell below $1. I wrote it up recently, sharing why I don't like it any longer. The piece was written in late February, when the stock was $2.02. I sold all of it from my model portfolio last week. The stock closed at $2.72 on Friday and is up 107% so far in 2024!

While these three stocks that I initially made "top picks" as part of The Big Picture all shared this trait of facing delisting risk, it wasn't the driver for me to include them. I added each of these stocks that are part of my Focus List because I thought at the time that they were cheap. Cannabis investors seem overly excited about the very largest American cannabis companies and entirely agnostic to other sub-sectors. MAPS and HYFM are ancillary companies, and VFF is a Canadian licensed producer.

Hydrofarm closed Friday at about $0.93, up just 1% year-to-date. It has substantial debt, but it's not due until 2028. The date by which it needs to have traded 10 straight days above $1 is in September. The company did an IPO on the stock in late 2020, and the stock soared close to $100 per share. If 280E goes away, I think that it will see its business pick up a lot. Why? Customers that will be doing better financially. The stock is not drop-dead cheap, as it trades at 3X its tangible book value and is well above the all-time low set last summer. There are just 2 analysts, and they project that the company will generate $3 million of adjusted EBITDA this year and $12 million next year. The current enterprise value is $129 million, which is just 11X the projection for next year.

Village Farms closed at $1.03. It has rallied a lot recently! The stock is up 35% year-to-date. It has a small amount of net debt. Unlike Organigram, it has not outside investor (yet!). What stands out most to me is that it trades at just 54% of its tangible book value. The company does a good job in Canada, and there are international markets in which it participates. I don't like that their core business is produce. I also don't like their efforts to get into the CBD market. My view, though, is that just the Canadian LP is worth more than the entire market cap of $117 million. 5 analysts project that the company will generate $12 million of adjusted EBITDA this year, and 4 analysts estimate that it will grow to $19 million in 2025. The enterprise value, which adds the net debt of $22 million to that market cap, is just 7.4X the projected adjusted EBITDA for 2025. This is a NASDAQ-listed federally legal operator! I am not just a fundamental analyst, and the chart looks very good here. The stock plunged in early 2023 when the company sold stock. I think it can get back to where it was then, which is about $1.50.

I have a lot of HYFM (19.7%) and VFF (9.9%) in my main model portfolio, and neither is in the index I am trying to beat. Neither is MAPS, but I own none of that one now. I had a lot. The stock closed Friday at $1.15, and it is up 60% year-to-date. The company has no debt and a chunk of cash. The company hasn't yet reported its Q4 and will be late due to having a new CFO. I do think that this company is cheap still for longer-term investors, and it will fundamentally improve if 280E goes away. With that said, it's up a lot! I shared a piece this weekend with subscribers at 420 Investor that explains why I have no position currently. My year-end target is $2.58, which is up more than 100%. This is based on achieving an enterprise value to projected 2025 adjusted EBITDA of 15X.

Here is a look at these three stocks over the past three years:

Just because a stock is down does not mean it's a buy! I manage an index, and the New Cannabis Ventures Global Cannabis Stock Index is down about 84% over this period.

It's very difficult to have confidence in cannabis stocks right now despite the low prices. If cannabis is rescheduled to Schedule 3, they should do a lot better. If not, look out below, especially for the American operators. Each of the companies I have shared here already trades on the NASDAQ and is not exposed to the onerous 280E tax. They all seem cheap to me, especially Village Farms.