Why investors should be enthusiastic about cannabis stocks

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April 15, 2019 3:32pm NYSE:MJ

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From Wayne Duggan:

Marijuana stocks are soaring in 2019.

The bullish 2018 momentum in cannabis stocks has continued in 2019, with several popular U.S.-listed stocks hitting new highs this year. Canopy Growth Corp (ticker: CGC), Aurora Cannabis (ACB) and GW Pharmaceuticals (GWPH) are just three examples of cannabis stocks that are each up more than 55% already in 2019. Roth Capital Partners analyst Scott Fortune recently took a deep dive into the cannabis business. Despite huge gains in cannabis stocks, Fortune still has plenty of reasons to expect additional upside in the long term. Here are 13 reasons investors are buying cannabis stocks.

The U.S. cannabis market is huge.

The cannabis industry offers investors a rare opportunity to gain exposure to a high-growth industry with a massive addressable market that is virtually untapped. Roth Capital Partners estimates the U.S. cannabis market at roughly $11 billion today, but Fortune says it will double to $23.4 billion by 2022. Over time, he says that market could expand further to between $59 billion and $78 billion, up to seven times its current size. BDS Analytics estimates the U.S. cannabis market is growing 23% annually, and Roth Capital Partners says it represents at least 25% of the global cannabis market.

The U.S. will decriminalize cannabis.

The biggest long-term cannabis stock catalysts will be federal decriminalization of marijuana in the U.S. Experts are divided on if and when U.S. federal decriminalization will happen, but Fortune says it will open the floodgates for cannabis investors. The tide is slowly turning in favor of federal legalization among U.S. politicians. The Democratic Party voted in 2016 to add removing marijuana as a Schedule I substance to its party platform. President Donald Trump has said he is in favor of state-by-state legalization, although he has not indicated he is in favor of federal legalization.

The States Act could provide a near-term boost.

Federal legalization could be years down the line, but cannabis investors may not have to wait that long to get some major legislative relief. The States Act is a bill with bipartisan support that would block the federal government from interfering in the cannabis business in states where it is legalized. The States Act would provide cannabis companies in certain states with access to banking, freeing them from the astronomically high tax rates they currently pay. Fortune says even Trump may be forced to support the States Act if cannabis becomes a major issue during the 2020 campaign.

Marijuana stocks should get access to institutional investors.

A major reason why the States Act could provide explosive upside for cannabis stocks is because it would provide them with much-needed access to capital. Operating a federally banned cannabis business in any U.S. state today is a gamble for cannabis entrepreneurs. However, providing credit to these companies is also a big risk for banks. Fortune says cannabis companies are starved for banking and will need massive amounts of capital in coming years. If the States Act is passed, banks and institutional investors that have shied away from the marijuana business would have federal protections for the first time.

States are embracing cannabis.

With or without changes to federal law, individual U.S. states are welcoming the cannabis business. In the 2018 midterm elections, Michigan voters fully legalized recreational marijuana and voters in Missouri and Utah legalized medicinal marijuana. In total, 10 states have now legalized both medicinal and recreational marijuana and 22 other states have legalized medicinal cannabis. These state votes don’t impact federal laws and they don’t reassure concerned banks and institutional investors. However, they do create opportunities for cannabis companies already operating in the U.S. to expand their businesses and build their brand while waiting for federal legislation.

Public sentiment trends are positive.

Given the success of state-by-state initiatives in recent years, it’s no surprise nationwide public support for federal legalization is on the rise. Fortune says it’s rare to see a political movement gain so much momentum in such a short period of time. As recently as 2003, only a third of Americans supported federal legalization of marijuana. Today, roughly two-thirds of Americans are in favor of legalization, up from 54% in 2016. Among adults under age 35, a whopping 85% now support federal legalization. According to Pew Research, 74% of American millennials support legalization.

Marijuana stocks are becoming mainstream.

In recent years, U.S. retail cannabis investors were limited to buying shares on the thinly regulated, over-the-counter market or finding ways to purchase shares on a Canadian exchange. However, the demarginalization of cannabis stocks began in February 2018 when Cronos Group (CRON) began listing its Canadian shares on the New York Stock Exchange. Cronos was followed by Tilray (TLRY), Canopy and a parade of other U.S. listings in 2018. Today, there are more than a dozen cannabis stock listings on major U.S. exchanges and the stigma associated with investing in cannabis is disappearing rapidly.

The U.S. infrastructure is already being built.

America investors have been mostly focused on the major U.S.-listed Canadian cannabis stocks previously mentioned. However, a group of American companies is working under the radar to establish major market presences in U.S. states where cannabis is legal on a local level. In fact, Fortune says these multistate operators, which are still relegated to the OTC market, offer investors the most upside in the near term. The largest U.S. MSOs include Curaleaf Holdings (CURL), Medmen Enterprises (MMNFF) and Green Thumb Industries (GTBIF). These companies each operate cannabis retail and wholesale operations in more than 10 different states.

There are deals and mergers.

One of the biggest drivers of upside for cannabis stocks in the past year has been investment deals and partnerships with huge international companies. American companies can’t operate cannabis businesses outright because of the federal ban. However, they can certainly invest in Canadian cannabis companies. Tobacco giant Altria Group (MO) took a 45% ownership stake in Cronos last year. Alcohol leader Constellation Brands (STZ) also announced a 38% stake in Canopy. In addition to those two blockbuster investment deals, dozens of smaller cannabis investments and partnerships have been announced. Fortune says mergers and acquisitions among marijuana stocks will likely continue.

Investors will close their short positions.

Cannabis stocks have been on fire in the past year, but there’s still a healthy level of skepticism out there on Wall Street. According to financial analytics firm S3 Partners, combined short interest in Canopy, Aurora and GW Pharmaceuticals alone is more than $2.5 billion. Given the extremely high borrowing fees many of these short sellers are paying, it’s only a matter of time before they close out their positions regardless of whether or not the trades are profitable. This short covering buying volume will either help support falling cannabis stock prices or help fuel their next leg higher.

Wall Street is paying attention.

Until recently, cannabis stocks were mostly ignored by most Wall Street firms. Few analysts covered or discussed cannabis stocks, and few investors paid attention to them at all. However, that dynamic has changed dramatically in the past year. Big-name firms like Jefferies, Cowen, Piper Jaffray have all initiated coverage of cannabis stocks. According to CNN, 13 different analysts now cover Canopy alone, up from eight analysts back in August. The more analysts cover cannabis stocks, the more comfortable investors will become and the more “buy” initiations will drive share prices higher.

High penetration rates are possible.

Fortune says there are four major industries that are ripe for cannabis disruption: alcohol, food and beverage, tobacco and pharmaceuticals. Assuming federal legalization, Roth Capital Partners estimates U.S. cannabis penetration rates will likely eventually reach 20%, or about one in five adult Americans. However, if cannabis eventually becomes as popular as alcohol in the U.S., that penetration could approach 50%. Alcohol was once federally banned in the U.S. under Prohibition, but has been legal since 1933. An estimated 160 million Americans consume alcohol and spend an average of $100 per month on booze, according to Roth Capital Partners.

There are potential new medicinal applications to be discovered.

Cannabis has a potentially unlimited number of undiscovered medicinal uses. GW Pharmaceuticals made history in 2018 when its Epidiolex drug became the first-ever cannabidiol drug approved by the U.S. Food and Drug Administration. Epidiolex was approved for the treatment of epileptic seizures. Medical cannabis is already being prescribed to treat chronic pain, anxiety, inflammation and sleep disorders, but research of medicinal cannabis applications is still in its infancy. At more uses emerge, medicinal demand could grow significantly. An increase in mainstream medical prescriptions could help further alleviate the stigma associated with cannabis and drive recreational use as well.

Reasons to invest in marijuana stocks

  • The U.S. cannabis market is huge.
  • The U.S. will decriminalize cannabis.
  • The States Act could provide a near-term boost.
  • Marijuana stocks should get access to institutional investors.
  • States are embracing cannabis.
  • Public sentiment trends are positive.
  • Marijuana stocks are becoming mainstream.
  • The U.S. infrastructure is already being built.
  • There are deals and mergers.
  • Investors will close their short positions.
  • Wall Street is paying attention.
  • High penetration rates are possible.

There are plenty of reasons investors are excited about cannabis.

The ETFMG Alternative Harvest ETF (MJ) was trading at $33.96 per share on Monday afternoon, down $1.13 (-3.22%). Year-to-date, MJ has gained 4.41%, versus a 9.07% rise in the benchmark S&P 500 index during the same period.

MJ currently has an ETF Daily News SMART Grade of C (Neutral), and is ranked #59 of 75 ETFs in the Global Equities ETFs category.

This article is brought to you courtesy of US News & World Report.

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