Thoughts On The Cannabis Sector

As an investor, hardly a day goes by without some recognition to the exciting nature and high growth prospects of the emerging cannabis industry. As I watched my morning business programs, I was captured by an interview featuring former Yahoo and Autodesk CEO, Carol Bartz.

She was speaking about her involvement in a company called Caliva Collective, a San Jose-based all-in-one cannabis dispensary, marketplace, grow facility and delivery service. They had closed $75 million in funding, in

which she was part of, and was extremely excited about the opportunity.

She called the cannabis sector, “the new tech”.

That was a profound statement for me. I can recollect back to the heady days of the late 1990’s, when the emergence of the “.com” companies traded and multi-billion-dollar market caps with minimal revenues and operating losses as far as the eye could see.

The late 1990’s was a conceptual and binary investment environment that proved to be lucrative for some but disastrous for most. I call it conceptual simply because many of these companies were trading at lofty multiples as investors attempted to justify the high price tag on the expectations of enormous market growth potential. It was also binary in my opinion because these companies were either going to thrive or die, there was nothing in-between.

I made this case in an article I had written back on June 7, 2000 entitled RealityCheck.Com. The LA Times picked up the story that can be seen by clicking on this link. The general point I was trying to make in the report was, at that time, I expected 90% of the emerging “.com” companies to be out of business within ten years and of the remaining 10%, 90% of those still will not have figured out a way to turn profitable.

Hindsight is always 20/20 but I was right in my assessment. There were large investment losses. Sure, there were the success stories. Amazon.com is up 3200% since the article, Booking Holdings (the old Price Line.com) is up 560% and EBAY is up nearly 400%. But most ended up being acquired or bankrupt.

Picking those “diamonds in the rough” took disciplined analysis in finding those companies with superior management, a proprietary approach to the industry, and a financial structure that paved the way for potential operating profits.

That said, there was another way to capitalize on the favorable industry trends back then. I like to call these the periphery investments. These are investments made in existing and established companies that had the potential to use the internet revolution to enhance their existing business lines or the cash flows to support later stage entry into the sector. Periphery companies such as Microsoft and Wal-Mart are up 360% and 150% since the article, respectively.

By adding these periphery companies to the portfolio, one could add diversification, stability and income while gaining the desired exposure to the industry.

There are five companies that we have recently targeted that offer good value with the desired periphery exposure to the industry.

The Scotts Miracle-Gro Company (SMG)

Scotts is a leading manufacturer and marketer of branded consumer lawn and garden products. Their products are marketed under some of the most recognized brand names in the industry. Their key brands include Scotts and Turf Builder lawn and grass seed products; Miracle-Gro, Nature’s Care, Scotts, LiquaFeed and Osmocote 1 gardening and landscape products; and Ortho, Roundup 2, Home Defense and Tomcat branded insect control, weed control and rodent control products. They are the exclusive agent of the Monsanto Company (“Monsanto”) for the marketing and distribution of consumer Roundup non-selective weedkiller products within the United States and certain other specified countries. They have a presence in similar branded consumer products in China and Latin America. In addition, with our acquisitions of Gavita Holdings B.V. (“Gavita”), General Hydroponics, Inc. (“General Hydroponics”), Bio-Organic Solutions, Inc. (“Vermicrop”), American Agritech, L.L.C. (“Botanicare”), Agrolux Holding B.V. (“Agrolux”), AeroGrow International, Inc. (“AeroGrow”) and Can-Filters Group Inc. (“Can-Filters”), they are a leading producer of liquid plant food products, growing media, advanced indoor garden, lighting and ventilation systems and accessories for hydroponic gardening.

They trade on the NYSE for around $70 per share. They are expected to earn $4.31 per share in the coming twelve months giving them a twelve month-forward P/E ratio of roughly 16x. Over the past several years, the company has traded on average approximately 19x. They are expected to grow their earnings by nearly 19% per year for the next three years. This potentially gets their earnings per share to $7.20 in the next three to four years. At an average multiple of 19x, we view fair value for the company near $140 per share. Our target price is 100% higher than the current level. This represents an annualized internal rate of 27% over the next three years. The company pays $2.20 in annual dividends yielding 3.2%.

Constellation Brands, Inc. (STZ)

Constellation Brands is an international producer and marketer of beer, wine and spirits with operations in the U.S., Mexico, New Zealand, Italy and Canada and more than 100 brands in their portfolio. In the U.S., they are the largest multi-category supplier (beer, wine and spirits) (“Multi-category Supplier”) of beverage alcohol. They are the third-largest beer company in the U.S. market and the world’s leading premium wine company. Many of their products are recognized as leaders in their respective categories. This, combined with their strong market positions, makes them a supplier of choice to many of their customers, who include wholesale distributors, retailers and on-premise locations.

They trade on the NYSE for around $165 per share. They are expected to earn $9.67 per share in the coming twelve months giving them a twelve month-forward P/E ratio of roughly 17x. Over the past several years, the company has traded on average approximately 22x. They are expected to grow their earnings by nearly 9% per year for the next three years. This potentially gets their earnings per share to $12.40 in the next three to four years. At an average multiple of 22x, we view fair value for the company near $270 per share. Our target price is 64% higher than the current level. This represents an annualized internal rate of 18% over the next three years. As an added benefit, the company pays $2.69 in annual dividends yielding 1.8%.

AbbVie Inc. (ABBV)

AbbVie is a global, research-based biopharmaceutical company. AbbVie develops and markets advanced therapies that address some of the world’s most complex and serious diseases. AbbVie’s products are focused on treating conditions such as chronic autoimmune diseases in rheumatology, gastroenterology and dermatology; oncology, including blood cancers; virology, including hepatitis C virus (HCV) and human immunodeficiency virus (HIV); neurological disorders, such as Parkinson’s disease and multiple sclerosis; metabolic diseases, including thyroid disease and complications associated with cystic fibrosis; as well as other serious health conditions. AbbVie also has a pipeline of promising new medicines in clinical development across such important medical specialties as immunology, oncology and neurology, with additional targeted investment in cystic fibrosis and women’s health.

They trade on the NASDAQ for around $86 per share. They are expected to earn $8.80 per share in the coming twelve months giving them a twelve month-forward P/E ratio of roughly 10x. Over the past several years, the company has traded on average approximately 12x. They are expected to grow their earnings by nearly 12% per year for the next three years. This potentially gets their earnings per share to $12.41 in the next three to four years. At an average multiple of 12x, we view fair value for the company near $150 per share. Our target price is 75% higher than the current level. This represents an annualized internal rate of 21% over the next three years. The company pays $4.28 in annual dividends yielding 4.8%.

Zebra Technologies Corporation (ZBRA)

Zebra Tech is a global leader in the Automatic Identification and Data Capture (“AIDC”) market. The AIDC market consists of mobile computing, data capture, radio frequency identification devices (“RFID”), barcode printing, and other automation products and services. The Company’s solutions are proven to help their customers and end-users achieve their mission critical strategic business objectives, including improved operational efficiency, optimized workflows, increased asset utilization, and better customer experiences.

They trade on the NASDAQ for around $175 per share. They are expected to earn $11.73 per share in the coming twelve months giving them a twelve month-forward P/E ratio of roughly 15x. Over the past several years, the company has traded on average approximately 15x. They are expected to grow their earnings by nearly 28% per year for the next three years. This potentially gets their earnings per share to $24.66 in the next three to four years. At an average multiple of 15x, we view fair value for the company near $355 per share. Our target price is 103% higher than the current level. This represents an annualized internal rate of 26% over the next three years.

Innovative Industrial Properties, Inc. (IIPR)

Innovative Industrial Properties, Inc. targets medical-use cannabis facilities for acquisition, including sale-leaseback transactions, with tenants that are licensed growers under long-term, triple-net leases. They believe this industry is poised for significant growth in coming years, and their highly experienced management team is focused on being a creative capital provider to this industry through the long-term ownership of cultivators’ mission-critical facilities.

They trade on the NYSE for around $58 per share. They are expected to earn $2.02 per share in the coming twelve months giving them a twelve month-forward P/E ratio of roughly 29x. Over the past several years, the company has traded on average approximately 29x. They are expected to grow their earnings by nearly 15% per year for the next three years. This potentially gets their earnings per share to $3.08 in the next three to four years. At an average multiple of 29x, we view fair value for the company near $90 per share. Our target price is 55% higher than the current level. This represents an annualized internal rate of 16% over the next three years. The company pays $1.40 in annual dividends yielding 2.5%.

Joseph S. Kalinowski, CFA