Hedge fund manager Whitney Tilson has his eye on three cannabis stocks, or rather he is high on three cannabis stocks, and whenever Tilson expresses interest in the company, it's a good idea to take a look. He's got a very strong track record. We'll…
Hedge fund manager Whitney Tilson has his eye on three cannabis stocks, or rather he is high on three cannabis stocks, and whenever Tilson expresses interest in the company, it’s a good idea to take a look. He’s got a very strong track record.
We’ll get to those picks in a moment, but first, keep his picks in context with the challenges faced by cannabis companies.
There are really only two types of cannabis products. The first is marijuana itself. Canada has legalized marijuana for both recreational and medical use. A few states here in the US have also legalized recreational marijuana, while several more have approved it for medical use.
The marijuana lobby in the United States is very powerful. They’ve long been able to control the narrative in downplaying the dangers of regular marijuana usage. For example, despite the fact that legalized marijuana has led to an increase in drivers wrecking their vehicles while under the influence, a lot of that news gets buried.
The real problem for companies that sell marijuana, beyond legalization and regulation, is that the product will very quickly become commoditized – much like electronics.
Whenever there is new television technology, such as 4K, and as screens get bigger and bigger, manufacturers will put out new models that are very expensive. All the nerds and tech-obsessed consumers rush out and buy the latest model.
Then all the competitors come out with their version of the same thing, and prices fall through the floor. That’s a great example of the commoditization of a product.
The big problem with a commodity is that there is nothing to distinguish it from its competition. Consequently, competitors get into price wars, which cut their margins to almost zero.
There will be the same problem with marijuana. There are only so many fantastic ways to grow the best weed. Eventually, everyone is going to figure them out. It seems unlikely that any truly groundbreaking process will occur and get patented.
That means the market will focus on the rush to establish the preeminent marijuana brand. Branding is virtually all that matters in a commoditized business.
The same goes for the second category of cannabis products, items which are derived from hemp and do not contain THC. They’re commonly known as “CBD products” and include everything from tinctures to oils to proteins, creams and lotions, capsules and pills, edibles, and vaping.
This category will also be commoditized, much like the herbal supplements that you see in various stores. This is also going to come down to a matter of branding.
But there is one advantage that these products may have over marijuana.
You may notice that many herbal supplements are expensive, considering they are commodities. In some cases, that’s because they are costly to produce. It’s not like extracting oil from grapeseed is terribly easy.
Some of these supplements have earned reputations as being “cure-alls” for certain types of ailments. Although the vast majority of these claims are nonsense and not supported in the medical literature, they have still gained broad public acceptance. That allows for pricing power.
This is likely to be how CBD products end up hitting the market as well. I can certainly imagine a future in which these products start taking up shelf space in your local pharmacy, Whole Foods, or vitamin store.
With all of this in mind let’s turn to Whitney Tilson’s cannabis stocks.
The first is Charlotte’s Web. That’s right, the company name is the same as the famous children’s book. I have to admit I am surprised that the company is doing rather well for a relatively new and small operation.
Charlotte’s Web just reported earnings and enjoyed a 45% increase in year-over-year sales to $25 million. The company is also seeing enough demand for its products that it tripled the acreage of cannabis plants it grew this year.
I’m already seeing the company’s products in some pharmacies and grocery stores, and I see the same pricing pattern as I do with herbal supplements. It seems to me that Charlotte’s Web might just have gained a beachhead in this arena.
Most impressively, the company is actually making money, with a market cap of $840 million. Whitney Tilson may be onto something; he calls it a “must-own.”
Next up is Green Thumb Industries. I’m not as high on this choice as Whitney Tilson appears to be.
The company manufactures, distributes, and sells cannabis products for both medical and adult use in the United States. It has 28 of its own stores and licenses for about another hundred stores across 12 other markets.
In its latest earnings report, it also showed significant revenue growth. Sales increased 34% year-over-year to $28 million.
The company has a different approach than Charlotte’s Web, which only produces products for retail sale.
Green thumb Industries is actually taking the same approach that General Nutrition has, in that it wants to open its own stores with its own branded merchandise. In some cases, it is acquiring other brands.
This is an intriguing play. It is more expensive than Charlotte’s Web on an enterprise value-to-revenue basis, trading at 25x versus 18x for Charlotte’s Web. Yet taking the General Nutrition route could prove to be an interesting strategy, as long as it is able to become a dominant brand.
Whitney Tilson’s last cannabis stock pick is Trulieve.
This is a straight-up medical marijuana company that is based in Florida and works the Florida market. Why Florida? There are a lot of senior citizens in that state, and many of them are starting to turn to medical marijuana for various ailments.
Trulieve has 181,000 users in that state alone. The company is now moving into other states with populations that would find medical marijuana to their liking.
What I love about this company, more than the others, is that its sales growth is not only increasing, but it’s actually a very profitable business – and very few earn that status.
In its most recent quarter, sales grew 30% sequentially to $58 million, and that also represents a whopping 149% increase over the same quarter last year.
I was amazed to see operating income of $163 million over the trailing 12 months, and net income of $100 million. Perhaps even more astounding is the market cap is only $1 billion, giving the company a P/E ratio of only 10.
Whitney Tilson suggested that the company would be a target for acquisition, and I have to agree with that. As one of the few pure-play and profitable marijuana companies out there, I would expect someone to snap it up. Of even greater interest is whether it will be another cannabis startup, or a huge pharmaceutical company like Pfizer or Johnson & Johnson.
The key to investing in the cannabis markets is to find a company that is actually making money and growing, and is less likely to face commoditization.
Disclaimer: The views expressed in the article are solely those of the author and do not represent those of, nor should they be attributed to, CCN.