Investing in Cannabis Has Become More Nuanced

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It wasn’t that long ago that investing in the cannabis space was mainly about choosing between Canadian operators, American operators and CBD companies. Today, those choices still exist, but none of them are the largest part of the New Cannabis Ventures Global Cannabis Stock Index, which currently has 42 members that qualified as of the end of September. Instead, it is the ancillary sub-sector, which includes 12 names and represents 29% of the index currently.

The Ancillary Sector Is Now the Largest

We introduced the Ancillary Cannabis Index at the end of March due to the proliferation of publicly traded names following several recent IPOs and SPAC mergers in order to help our readers better follow this sub-sector. Ancillary stocks benefit from being able to trade on higher exchanges, not being subject to 280E taxation and the ability to scale their businesses across state lines. As we suggested when we launched the index earlier this year, we aren’t surprised to see the increasing popularity of the sub-sector given that investors can gain access to the growth of the American market with liquid securities. After ancillary, American cannabis operators are next at 25% and Canadian LPs at 17%. The balance consists of biotech (12%), CBD (9%), international (6%) and Canadian retailers (3%).

Companies Are Increasingly Crossing Into New Sub-Sectors

While we have precisely broken down the sector by these categories, there are several companies in the index and beyond that operate in multiple sub-sectors. A great example is Canopy Growth, which has international, retail Canadian, CBD and ancillary operations. Recently, we have seen other companies enter the CBD space as well, such as Village Farms. High Tide, a Canadian retailer of cannabis, has beefed up its ancillary retail business with acquisitions and has also been buying CBD companies. TerrAscend is the only index member that has cannabis production in both Canada and in the U.S. Curaleaf is primarily focused on its American operations, but it is now positioned in the European market as well through an acquisition earlier this year.

Several Companies Have Substantial Non-Cannabis Businesses

We have also seen a number of companies with substantial cannabis operations that operate in non-cannabis markets as well. In fact, looking at the current index, Canadian LPs Canopy Growth and Tilray have significant non-cannabis operations. Canopy owns the majority of a sports drink manufacturer, BioSteel, and skincare company This Works, while Tilray has operations in pharmaceutical distribution, craft beer and hemp food. Within the ancillary space, several companies are involved in other markets as well, including AgriFORCE, Turning Point Brands and urban-gro. Of course, ancillary goods provider Scotts Miracle-Gro derives the majority of its sales and earnings from its lawn and garden business. Biotech Jazz Pharma has only modest exposure to cannabis after acquiring GW Pharma earlier this year but is still an important company in the space.

Investors Need to Be Careful When Valuing Diverse Companies

With cannabis companies increasingly diversifying within and beyond the industry, investors will need to give more thought to valuation. Businesses within and beyond the cannabis industry have different growth rates, profitability and capital requirements. We have discussed the challenges of analyzing companies that have significant exposure outside of the cannabis industry in the past, suggesting that investors need to use sum-of-the-parts analysis to assess valuation. Companies that are diversifying their businesses within the cannabis industry also make using this analytical tool necessary. Taking Canopy Growth as an example, the valuations for Canadian retailers, ancillary devices and CBD companies are very different than for Canadian LPs.

As the cannabis industry matures, we are likely to see more companies look to expand beyond their initial area of focus. Investors could benefit from having companies with exposure to different geographies and different parts of the supply chain, but they need to spend time and effort understanding the potential synergies, if any, and to make sure that they are using the correct multiple when looking at the overall revenue or profits of the company.

Get the facts with a subscription to Alan Brochstein’s 420 Investor, the longest running cannabis stock due diligence platform trusted by investors for over 8 years. The primary goal of 420 Investor is to provide professional, real-time, objective information about the top cannabis companies in the market in order to help investors Capitalize on Cannabis™.

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Alan & Joel

Exclusive article by Alan Brochstein, CFA
Alan Brochstein, CFA
Based in Houston, Alan leverages his experience as founder of online community 420 Investor, the first and still largest due diligence platform focused on the publicly-traded stocks in the cannabis industry. With his extensive network in the cannabis community, Alan continues to find new ways to connect the industry and facilitate its sustainable growth. At New Cannabis Ventures, he is responsible for content development and strategic alliances. Before shifting his focus to the cannabis industry in early 2013, Alan, who began his career on Wall Street in 1986, worked as an independent research analyst following over two decades in research and portfolio management. A prolific writer, with over 650 articles published since 2007 at Seeking Alpha, where he has 70,000 followers, Alan is a frequent speaker at industry conferences and a frequent source to the media, including the NY Times, the Wall Street Journal, Fox Business, and Bloomberg TV. Contact Alan: Twitter | Facebook | LinkedIn | Email

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