3 Pot Stocks That Could Soar as States Eye Marijuana Legalization – The Motley Fool

Recreational Cannabis Legalisation

Marijuana investors have seen a massive erosion of wealth over the past 12 months. Companies in the cannabis sector were expected to consolidate sales in a high-growth market in 2019; instead, they were affected by lower-than-expected growth, high inventory levels, regulatory issues, health concerns arising from the use of vaping products, and more.

Marijuana for recreational use was legalized in Canada in October 2018, but in the U.S., cannabis consumption is still illegal at the federal level. The ongoing relaxation of U.S. marijuana laws will no doubt benefit the entire cannabis industry, as several vertically integrated multi-state operators will pounce on the opportunity to drive sales and expand market share. 

Legalization efforts should resume after the COVID-19 threat subsides and governments can refocus on other economic priorities. As of April 14, marijuana is fully legal in 12 states in the U.S.; according to Fool contributor Sean Williams, states including New Jersey and Arizona might soon legalize recreational use of cannabis, while Nebraska might give the go-ahead for medical marijuana in the upcoming months. 

Here’s a look at three cannabis stocks that are well poised to benefit from the statewide legalization of medical and recreational marijuana products.

Image source: Getty Images.

A top cannabis supplier

Scotts Miracle-Gro (NYSE:SMG) is not a pure-play marijuana player. It is well known as a leader in lawn care and home improvement in the United States, and over the past few years, the company has managed to leverage its legacy operations to enter the high-growth marijuana space.

Scotts Miracle-Gro is not a licensed marijuana producer. Instead, the company supplies hydroponic gear via its Hawthorne business, which was established in 2014. This segment is focused on hydroponic growth and aims to build a solid portfolio by acquiring companies in the nutrients, ventilation, and lighting verticals, which are essential for indoor gardening. 

These services are used by both legal and illegal marijuana growers who need hydroponic equipment. Acquisition-driven growth resulted in a 95% uptick in sales for Scotts Miracle-Gro’s Hawthorne business in fiscal 2019. In the December quarter, Hawthorne sales were up 41% year over year at $198.8 million and accounted for 54.3% of the total. 

Scotts Miracle-Gro has not looked to build a portfolio from scratch to serve the growing marijuana industry. It has instead relied on acquisitions to gain traction. These acquisitions were funded by debt, and a less-than-impressive balance sheet helped to drive the stock lower by 43% in 2018.

As marijuana legalization continues to gain pace, Scotts Miracle-Gro will be one of the top beneficiaries, which will help the company drive top-line results in the upcoming decade.

A profitable cannabis player

One of the top stocks in the cannabis space is Canada-based Aphria Inc. (NYSE:APHA). It has managed to record a profit in two of the past three quarters, at a time when most of its peers are struggling with mounting losses and declining cash balances. In the quarter ended in November 2020, it reported sales of $120.6 million Canadian dollars, compared with sales of CA$126.11 million in the August quarter.

The company’s acquisition of CC Pharma early in 2019 helped Aphria establish a robust distribution network in Europe’s huge medical marijuana market. As the company said in a press release, “Through the acquisition of CC Pharma, the company obtained a leading importer and distributor of EU-pharmaceuticals for the German market.” Specifically, CC Pharma “operates a production, repackaging and labelling facility” with “over 317 active German national pharmaceutical licences, 690 active EU pharmaceutical licences, and access to approximately 13,000 active pharmacy accounts.”

Distribution revenue in the first two quarters of fiscal 2020 stood at CA$181.8 million, or 74% of total sales. Aphria should be able to leverage its huge distribution network and massive production facilities to take advantage of marijuana legalization in the United States.

Aphria is already one of the top marijuana producers in the world, with three licensed facilities and a production capacity of 255,000 kilograms per year.

A cannabis real estate play

Another ancillary cannabis player is Innovative Industrial Properties (NYSE:IIPR). This company is a marijuana-focused real estate investment trust. We know that cannabis is still illegal in several states, which makes it difficult for licensed producers to raise debt capital for expansion and growth. IIPR solves this problem with its sale-leaseback business model.

Innovative Industrial Properties acquires properties from cannabis companies and leases them back to those companies, generating revenue for Innovative Industrial Properties and reducing capital expenditure for marijuana producers. As of April 2, Innovative Industrial Properties owns 54 properties totaling close to 4 million square feet of rentable space. With a weighted average lease term of 16.1 years, the company can count on a steady stream of cash flows even during an economic downturn.

Some of Innovative Industrial Properties’s tenants are large cannabis players, including Cresco Labs, Curaleaf, and Trulieve. As marijuana laws continue to be amended, demand for Innovative Industrial Properties’s real estate services is bound to increase, making it one of the safest bets in the sector. What makes the stock more attractive is its high dividend yield of 5.5%. 

The cannabis industry is still in a nascent stage. According to a report from Research and Markets, the North American legal marijuana market is estimated to grow at an annual rate of 15.7% between 2018 and 2025 to reach $36.7 billion. This growth should drive revenue for several pot-related companies as the product is decriminalized in more and more states.