Kamikaze Cash

How to Buy the Dankest Kush Stocks

Added 2020-10-20 14:43:21 +0000 UTC

Legalized weed in North America has hit a number of snags. Weed companies in Canada suffer from price competition from black market sales ($5/gram vs. $10.50/gram) and poor distribution. As a result, the Green Rush darlings like TLRY, CRON, ACB, and APHA have suffered since the 2017-2018 boom.

Despite the setbacks in the industry, the 2020 US election offers fresh stimulus for the marijuana industry. 4 more states will vote on legalized marijuana this year, and Democratic candidate Joe Biden indicated he intends to pursue decriminalization at the federal level. If he is elected and the Democratic Party maintains control of the House, we are likely to see a push toward full legalization. This would allow US marijuana companies to flourish.

On the other hand, if the Republican Party maintains control, weed stocks will likely take a hit due to the belief weed will remain illegal under conservative leadership.

There are right ways and wrong ways to play the marijuana push. Canadian companies like CGC, TLRY, and APHA may see a quick price bump due to excitement and the belief that the US market will be open for these companies to sell to. However, there are more promising candidates for long-term growth of the marijuana industry in the US. There is also no need to hunt the needle in the haystack by investing in single companies when you can buy the whole haystack through an ETF.

This post will focus on 4 ETFs and their holdings: MJ, YOLO, THCX, and TOKE. It will also discuss opportunities for tobacco companies to benefit from the marijuana push, and how TOKE can provide exposure to this.

tl;dr: Buy MJ if you expect US companies to buy Canadian weed companies to quickly fill demand. Buy YOLO if you desire an actively managed ETF that can change quickly to adjust to changes in the industry and want a more stable group of companies. Buy THCX if you want to own a balanced risk/reward ratio. Buy TOKE if you expect tobacco and alcohol companies to benefit from marijuana legalization. Note: of these, MJ is the only ETF not well-postured for growth in the US without buyouts or trade deals, but is also the most likely to rapidly increase in price based on legalization specifically.

Positions: 100x shares of each TOKE and YOLO.

Comparison of Weed Industry ETFs

1) MJ is suitable for investors who are looking for a quick bump on legalization, or for those who anticipate Canadian weed growers to get access to the US market. It is not clear what relationship US and Canadian weed companies will have, or how protective the US will be of its own growers. Any buyouts of struggling Canadian pot companies will also benefit MJ.

As of this writing on 19 Oct, 2020, the mostly Canadian weed stocks listed on MJ are having a great day, with some names up 14%. This is likely due to excitement over the election and prospects of legalization in the US. I caution that this bump is likely temporary as the companies themselves are not in a strong position to benefit from legalization long-term. Their exposure to the US market is minor, with CRON having the most exposure to the US via its 55% ownership by Altria (MO). Also, none of the companies within its holdings have had much financial success and have been unable to produce regular profit, although some of the companies have had the occasional profitable quarter.

This does not mean MJ is necessarily a poor investment. If MJ's holdings like CRON, APHA, and ACB receive greater access to US markets, then their businesses can easily turn around. Further, US tobacco company Altria (MO) has demonstrated interest in Canadian marijuana companies, which may indicate the possibility of buyouts. American companies would benefit from acquiring the developed Canadian marijuana production infrastructure, especially if they desire the ability to rapidly bring product to the US to fil demand.

MJ was not established as a marijuana ETF, but a revised South American real estate ETF. This allowed it to avoid regulatory scrutiny as it entered the US. As the first marijuana-focused ETF, it legally cannot carry the word "marijuana" in its name because it did not originally have 80% of its holdings in marijuana stocks, and due to its status as a converted real estate ETF.

MJ also pays a dividend of around 8%. Much of this comes from dividend from its tobacco holdings like VGR, which the ETF passes to shareholders.

2) YOLO is well-postured to benefit from the wholesale development of the marijuana industry in the US and is most suitable for investors who believe the US will be protective of its marijuana companies. YOLO's top holdings include several well-established companies that are already entrenched in the fledgling US weed industry and will almost certainly boom if legalization occurs.

Of note, IIPR, an REIT that specializes in owning properties that marijuana growers use for production, is YOLO's largest holding at 9.3%. IIPR has increasing revenue and profit, offers a 3.5% dividend, and appears to be fully sustainable. It's greenhouses will benefit from increased growth demand, and it will almost certainly expand its properties. YOLO also holds VFF, a Canadian vegetable grower/distributor with a marijuana segment. These two companies are firmly established and form the backbone of a stable portfolio of holdings.

YOLO's most interesting segment is their chain of vertically-integrated marijuana growth and distribution companies. Green Thumb, Curaleaf, and Trulieve operate growth, production, distribution, and retail sales locations, and together make up a sizeable portion of the small US market. Although there will be plenty of space for more dispensaries in the US, these companies have first-mover advantage and stand to benefit immediately from legalization.

The most risky aspect of YOLO is the prospect of Canadian companies accessing the US market and using their larger production capability (and stockpiles) to overshadow US producers. It is unclear if this would be allowed under US law even if marijuana becomes legal, as import/export of cannabis will likely remain a gray area.

YOLO is actively managed and the composition of its holdings can change at any time. This will allow it to change rapidly as the industry develops. YOLO also has a dividend of 5.8%, a significant portion of which is derived from IIPR.

3) THCX has a balanced mix of long-term and short-term prospects and is suitable for the investor who wants to invest in stable companies without sacrificing the fast-moving benefits of owning speculative weed companies.

THCX's largest holding is APHA, a cash-heavy vertically-integrated weed company that handles cultivation through distribution. It serves the Canadian market, but like all the other Canadian companies, APHA will benefit tremendously if it can access the American market as well. However, APHA has had a difficult time turning a profit, and without access to new markets, will likely stay a laggard.

Likewise, some of its other holdings like CRON, CGC, and TLRY are likely to require access to US markets as well. Some companies on its holdings list, like FireFlower (FAF.TO) are literal penny stocks and unlikely to gain traction without expansion. If allowed to access US markets, however, their growth prospects will likely turn around quickly.

This contrasts with some of its other holdings, which include cultivator GRWG, VFF, and Scott's Miracle Grow (SMG), all of which are established companies that form a more solid foundation for the rest of its holdings. Although much of THCX is dependent on the Canadian weed industry expanding, these profitable companies will help the ETF as the marijuana industry takes shape.

THCX offers a 10% dividend.

4) TOKE offers arguably the most conservative method of playing in the weed industry because most of its largest holdings are large and established companies. It is most suitable for investors who anticipate large tobacco players and alcohol brands to enter the marijuana industry. It is also suitable for investors who want to avoid having their investment squashed if marijuana does not become legal.

Of TOKE's top 10 holdings, 3 are primarily tobacco companies with prospects of entering the marijuana field. Altria (MO) has already demonstrated interest in the weed industry by taking a 45% stake in Cronos (CRON). Converting from tobacco to marijuana is simple enough, and tobacco companies already have the distribution networks to make it happen. Likewise, TOKE holds Constellation Brands (STZ), best known for beers like Corona and Modelo, which can stabilize the ETF as the marijuana industry finds its footing. It also holds Scott's Miracle Grow which cultivators may use. If weed does not become legal, these companies will survive better than the other marijuana-only companies.

For its weed-centric plays, TOKE holds IIPR, APHA, and CGC. It also holds Greenlane (GNLN), which focuses on cultivation but not distribution. Resultantly, TOKE is well diversified across the different avenues in which the weed industry may go.

Importantly, TOKE's holdings of the British American Tobacco Company (BATS), PM, and MO will allow the ETF strong exposure to the most likely direction I believe the industry will go. For better or worse, I anticipate large tobacco companies to shift gears and beginning stuffing their cigarettes with marijuana instead of tobacco. They have well-developed distribution networks, and all they need to do is modify their sourcing and production. MO has sought other avenues for revenue besides tobacco, most notably JUUL, and would almost certainly expand their revenue stream further on marijuana legalization.

TOKE offers a 7% dividend, largely from IIPR.

Promising ETFs: Mikey's Moves

I intend to purchase shares of both YOLO and TOKE ahead of the 2020 election in anticipation of a Joe Biden victory setting a pathway toward weed legalization.

I am drawn to YOLO's focus on US-based companies and vertically-integrated holdings. YOLO holds access to much of the marijuana retail sales network, which I expect to flourish. I also love IIPR and its dividend.

I am likewise interested in TOKE's focus on holdings in large companies that will likely move to take a large share of the US marijuana market. I like their focus on tobacco companies because I expect them to shift production to marijuana, and I believe their distribution networks are strong enough to fill consumer demand.

I am distrustful of MJ because its focus on Canadian companies will prevent it from adequately accessing the US market. I expect these companies to run into regulatory issues with export to the US due to strong lobbying from US companies. I recognize that US companies are interested in buying stake in Canadian companies as part of their supply chains, and if that does happen, MJ will probably outperform other ETFs. However, I am disinterested in the risk and prefer other plays.

I do not dislike THCX and believe it is a suitable alternative to YOLO and TOKE. However, I am not satisfied their limited access to US markets. I prefer YOLO for access to US markets instead of THCX, which has too much exposure to Canada for my taste.

Final Warning

Most of this analysis depends on one key assumption: weed becoming legal in the US. Unless weed is legalized at the federal level, these companies are almost certain to continue lagging, and investors would be better off buying key profitable companies (IIPR, for example) instead of buying the whole mostly-illegal haystack with a weed ETF.