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Do Politics Affect Cannabis’ Long-Term Growth Story? (Transcript)

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Rena Sherbill: Hi again, everybody. Welcome back to the show. It’s great to have you listening with us. I hope you are as psyched about this cannabis content that we have coming at you on this podcast so far in 2022. As I am to bring it to you, I really feel like we’re having some really terrific conversations, today is no exception.

We’re bringing back Julian Lin, who you know from Seeking Alpha. He runs a marketplace service there along with his other articles and other topics aside from cannabis. But he also runs a marketplace service geared towards cannabis investors called Cannabis Growth Investor. Listeners of the podcast know Julian for his sound, fundamental analysis. No different today.

He’s joined today by Jason Powers, who some of you may know from other cannabis podcasts. Some of you may know from Reddit, he writes on Reddit. He comes to us from the world of politics in Washington. And this wasn’t designed this way.

But perhaps in honor of President’s Day Week in the United States of America, we bring to you this conversation about the intersection of politics and cannabis investing. There’s an obvious intersection, because so much is dependent on legislation and the regulatory picture. But we also get into the fundamentals and timelines around how long our timelines are as investors and how much that matters to our picture.

What about the fundamentals? What stocks are we liking, but really, this is a really in-depth conversation for cannabis investors to really ask some important questions. I feel like I overuse the word salient. Some really important questions. For those of you that follow me on Twitter know that I’m trying to embrace you all. So, hope you all enjoy this one.

Julian and Jason, welcome to The Cannabis Investing Podcast. Welcome to Seeking Alpha Julian, welcome back to the podcast, one of our favorite guests. Jason, one of our favorite people to be in contact with around the podcast. But first time on the show. Thank you very much for joining us, both of you.

Jason Powers: Thanks for having us.

Julian Lin: Yes, I’m always excited to talk cannabis.

RS: Awesome. Always excited to talk cannabis with you, Julian and I think a lot of people benefit from it as well. Julian, do you want to catch listeners up, kind of updating them, and maybe giving a brief intro for people that are new to you, maybe new to your marketplace service that you have on Seeking Alpha, if you want to describe that a little bit. Just kind of catch them up on what your thesis is on the cannabis sector and what you’re like really kind of very brief at this point of view is where we stand today.

JL: Sure. So, I’m not a cannabis exclusive investor. I’m a general investor. But upon coming across the cannabis sector, I’ve found valuations to be highly compelling, and the growth story to be highly attractive so much so that I started a marketplace service on Seeking Alpha called Cannabis Growth Portfolio. There it’s a cannabis exclusive portfolio where I focus on finding the highest quality and most undervalued stocks in the cannabis sector.

RS: Awesome. Jason, I guess I would ask you the similar question if you want to introduce yourself to listeners and tell them where you’re coming from and kind of your brief overview of the cannabis sector?

JP: Sure. Yeah. So, about a decade and a half ago I started working in Washington and politics, I was a Hill staffer for an appropriations chairman. Never thought 12-13 years later that I’d be using that to help with inform the cannabis industry and all these listeners. But what ended up going through three, four or five years, getting really to see the meat and bones and how things are made, led to an understanding that I’ve noticed has been missing in a lot of these conversations.

And that’s not really just the nuance, but it’s really there’s a practical system that is working, you may think it’s not working, but there’s something that is happening in Washington that can be somewhat predicted somewhat analyzed and incorporated into investing, like an investing thesis. And what I noticed after getting into the cannabis investing world in 2020, was that there was a huge just as much asymmetry as there may have been between the investing thesis and the actual market cap of these companies, there was also an asymmetry in the investors and the understanding of what an election means, what a statement or a tweet means.

And so, I wanted to get into it and I found Reddit to be an interesting sort of first opportunity to post. So, I wrote a lengthy post or got some attention and ended up really creating a bit of a continuing saga. I call it Understanding Washington, and I’ve found quite a bit of good response from it. So, where we are now in the beginning of ’22 is I think I’ve got five posts, I promised the readers that I’ll continue to put them up as things move, but I found that doing podcast interviews also helps fill in the gaps.

RS: In terms of informing your own kind of thoughts around it?

JP: Yeah, it’s certainly a moving target. And I say it in every post, I’ll put predictions out there, I’m happy to appease the interest. But tomorrow morning, we’ll get a statement from someone, two days later, we’ll get something else. And it can have either drastic or dramatic effects on what is now a prediction, or it can have none. And you can miss read either of those two the other way. So, getting out there more routinely, I always answer comments, I answer personal direct messages. Because I’d like to keep being as useful as I can to keep the conversation honest, I think that’s really important.

RS: I agree that is really important. And I feel like that’s something that you have done a good job of in terms of being, I’ve really enjoyed being in – I know Jason because he’s been in communication with me just through the podcast, and has asked some great questions. And I feel like many times, I’ve tried to ask them, and have fumbled them. And I feel like it’s just better to get it from the source.

So, let me start there a little bit, because I want to talk a little bit that intersection of I mean, it’s an obvious intersection of politics and the cannabis industry, a very frustrating one as of late and for the most part in general. But Jason, how do you see it coming from that angle, the Washington angle, how do you view the political side in terms of investing? Like, how do you see them influencing each other or catalyzing each other? Yeah, I’ll leave it there.

JP: Yeah, I think an apt metaphor would be or just a parallel – So, if you think of investing in general, and Julian, you can comment more thoughtfully on this, it’s really just a ton of analysis to get an edge. You’re just trying simply to position your investments in a way that using information you have an angle of approach you have taken or just a thesis you’ve created, that says this is going to move in a way that is going to provide me with some alpha. It’s going to provide me with an edge over just either allowing someone else to manage my money or to manage it through an ETF.

And so, when it comes to politics, that is simply one more bucket of information that you can use to put into your thesis. And in whether you’re talking about semiconductor chips in the Competes Act, there’s an element there, right. There’s an element of how the legislation affects that industry.

Cannabis just happens to be in a very sort of an eccentric version of that, because it is completely reliant, at some level it will be completely reliant on the federal picture. And what I think has been most telling is that over the last year, we’ve seen states come online, we’ve seen New York, we’ve seen major movement, as well as a lot of federal conversations. And the truth is that we really aren’t much further in terms of the market picture.

In many ways, we’re certainly further behind than we were one year ago today. But we are also comparably not really seeing progress in any way that can show a toehold and an actual growth. And what I want to get to the bottom of in each piece that I write each conversation is what can we really predict in the next 12, 18, 24 months? And then how does that translate into the risk component of investing?

The metrics for the, you know, what is an appropriate valuation multiplier, that is something that I leave up to better thoughtful people. I’ve asked you some questions every now about that. That’s part of our conversations. But I think the political side is mostly a question of the risk and the likelihood of that big picture when these become fully capitalized, fully supported by Banking Markets. When does that happen? And that just I think that is something that has really in the last year, been hard for people to pin down.

RS: Julian, do you have any different ways of thinking about that intersection between the political picture and the industry and the sector as investors?

JL: Yeah, I mean, let’s start off, I’m very familiar with Jason’s work. I mean, he’s been spot on. And I think he also mentioned in one of his Reddit posts that he even bought puts a couple months ago, I mean, so he’s done very well. I’m gauging the political climate here. And I think I do agree with a lot of his previous commentary, especially cautiousness in terms of hoping for legalization. I think if I had to add anything regarding the politics side of cannabis and investing, it would be that cannabis stocks have traded.

So, in line with the legalization hype over the past few years that it’s easy to think that they only can go up. If cannabis stocks are legalized – sorry, if cannabis is legalized federally. I mean, make no mistake if federal legalization happens, it kind of strengthens the story mainly because institutional capital will be able to come in. But it’s not the only way to create fundamental value in the sector. Right.

I mean, even in spite of the lack of federal reform, these companies are still growing very rapidly. They are taking market share. They are benefiting from every new state that is coming online. So like, it’s very curious to see how when new states come online, the stocks are still not benefiting, because it seems like investors right now they only care about federal legalization, they think that is the one or the be all end all for cannabis stocks. But that’s not really the case.

RS: Jason, anything to kind of point out before I kind of ask my next question?

JP: So, I’d love to dig into that a little bit, which is sort of the why and understanding I’ve had some really great conversations with a lot of people that I respect in the market around just the market dynamics, the actual inflows and outflows and how these things are actually working, because of the fact that we have this systemic barrier to investing from the institutional side.

So, how do we rectify if Ohio and Pennsylvania come online this November? How do we look at a growing green map and growing revenues and all of these things happening? And like you said, Julian, the market isn’t responding to that. And the conversations in the last couple of years have sounded like this coiled spring approach that it’s just it’s even further and further as a metric and therefore when something passes, it’s just going to 500x in a moment.

I wonder if maybe there’s more going on there. And if we want to look at it like a CPG, if we want to look at it, thoughtfully I do wonder if maybe we’ve almost put too much into this idea that there’s an explosive to rerating. I think there is a – certainly there is a rerating but is it as explosive as we thought 12 months ago, 24 months ago? And what happens if we’re two three years away from any kind of federal legislation? Does the rewrite keep shrinking?

JL: As I mentioned earlier, I mean cannabis stocks make up a large, large allocation on my portfolio. But I’m a generalist investor, so I invest across most sectors. In particular, I like to focus on the growth stocks. So, what really attracted me to the cannabis sector was when I compared the valuations to undervalued tech stocks that I was also covering. I mean, no, I’m not going to compare them to the bubble of valuation tech stocks that would – obviously that would be quite unfair.

But I’m just talking about it in regards to undervalued tech stocks. And this is important, because the way that investors treat cannabis stocks versus tech stocks is very different. When in reality, longer term, I expect the sentiment to be more in line with how investors treat tech stocks, mainly because digital tech stocks, it’s one of the more attractive long-term stories that you could find.

So, with cannabis stocks, it almost seems like if legalization does not happen, then 280E taxes will not be removed. And these companies will not produce much profits. So, it’s, some people think, Oh, they’re just dead money. But when you look at how tech stocks trade, a lot of tech stocks, they don’t have profits, even though but it’s very clear that they will have profits in the future, just based on their high gross margins, their operating leverage, it’s very clear that they’re over investing in growth.

But if they wanted to, they could show profits very quickly. But nonetheless, Wall Street tends to value these tech stocks not based on current lack of profits, but they tend to value them based on what they believe the long-term profit margins will be. So, you see how with the tech stocks, Wall Street or in any stocks, in general, Wall Street tends to be very long term, very forward looking. They’re not going to focus just on the lack of profits today, they’re going to look at how much profits they’re going to make in the future. But that just doesn’t really happen with cannabis stocks. And I think that is the underlying reason why a big rerating should happen.

I think some of my targets tend to be on the optimistic side of things. I think when I looked at the fintwit universe of price targets, it does seem like a lot of investors, they are looking to sell after maybe a 100% or 200% move upward. But that doesn’t quite cover it. Just to give an example, a very commonly used valuation metric would be to compare the growth rates. Basically, if something is growing at a 40% rate, you might expect a 15x prices sales multiple in the tech stock world.

And cannabis stocks, I think, have one of the more attractive growth stories, just because I mean, this is a whole economy coming online. So, my idea is like if you thought video streaming was an attractive growth story, cannabis is even more attractive. Consider that even in a state like California, where cannabis is legalized, about 20% of adults use cannabis. That’s astonishingly low when you think about just what cannabis is.

But anyway. So, if you assume like a 40% growth rate will lead to a 20x price sales multiple, I mean, you just think about the long-term growth projections for these cannabis stocks. They’re roughly around 30% annually. So, you could expect them to trade around 15x sales once institutional capital will come in. And right now, I think they’re trading around 3x 4x next year’s sales price, next year’s revenue estimates.

So, just based on a two-year horizon, there is this at least 3x to 4x rerating just on multiples. And then you got to take into account the growth over the next 10 years. And then you get some really fancy numbers that can be exciting and scary to think about. So, I mean that’s just kind of how I think about why that rerating should happen once institutional capital coming in. And sorry for the long run. But this is not unprecedented.

It’s important to note that Canadian cannabis stocks have been trading uplisted for many years. Institutions have had access to invest in the Canadian names for many years, and to represent a really good indication of what we could expect when the U.S. cannabis companies uplist or when they’re able to add institutional capital flow in. And you can see with Canadian names, I mean, they’ve been hit recently.

But even at the current valuations, they’re trading very richly based on the low growth, they have very minimal growth, they have no profits. They’re still trading at really rich multiples, because you could tell Wall Street really, really likes that cannabis growth story. So, it is very – it makes a lot of sense to assume that when U.S. cannabis names can have institutional investment, they’re going to be treated in a similar manner as those Canadian.

JP: Would you say then that, and we’re talking about all of the different sort of vectors for growth, right. We’ve got more states, we’ve got more clientele, we’ve got deeper pockets, then we’ve got new products. We’ve got sort of – just sort of a full breadth of how this one particular product really can be hundreds and hit many, many different markets, is that unfolding sort of like, how Apple (NASDAQ:AAPL) 15 years ago was making computers but in reality, what they do today is 400 different things. And so, you think that analysts should be sort of like Tesla’s (NASDAQ:TSLA) not a car company, Tesla is a tech company. This is the tech company of CPG, in your opinion?

JL: I think at least the growth side is very similar. I’m not going to pretend that there’s going to be so much innovation. I mean, at the end of the day, we’re kind of selling some CPG products. It’s not going to be entirely different, I guess, 10 years ago from now. But I think in terms of growth, I mean, we just think about how in the near term, we’re going to see so much growth just from states coming online. And that’s so easy.

You’re just going to see growth from even where states have already come online, there’s that large illicit market that the legal market will continue taking market share from, that’s big growth. And just regards to like the states coming online and think about in Florida, right, a lot of people think, oh, Trulieve’s (OTCQX:TCNNF) tapped out, right? Trulieve’s 50% market share prices will go down, they’re in trouble.

But in reality, they’re just, there, it’s only a medical market, and only about 3% of the population are registered medical patients. So, I mean, Trulieve’s generating all this profits. And I mean, I like a lot of companies I’m not trying to say only about Trulieve, but Trulieve is generating a ton of profits, while only addressing 3% of the population.

But we know that on average 20% of adults use cannabis. So, upon when recreational sales began in Florida, it’s basically their total addressable market just increased to 6x overnight. And but that’s the thing. This is only, that’s all near term. This is like when states come online recreational that’s all near term. That’s basic stuff.

But the longer-term growth story here is where the average person starts using cannabis, where the person who’s not so open to cannabis right now I mean, I know plenty of people who as long as cannabis is illegal on the federal level, they’re not even going to consider thinking about cannabis. They still think cannabis is like going to kill you or going to get you addicted or, you know, has no medicinal benefits. But there still needs to be that tipping point where normal valuation will happen, where cannabis becomes more normal and becomes something like alcohol, becomes something like Tylenol. That is the longer-term story here.

And I think that that’s the thing that kind of Wall Street will like pick up on and that will be cannabis stocks – U.S. cannabis stocks will eventually trade at a premium multiple to even tech stocks I think.

RS: Jason, do you have any follow ups there? Do you feel satiated?

JP: Well, I feel I think you’ve got the right two people here because I often get called a bear lately. And I think what Julian and I bring to the table is it really is truly about your timeline. I just feel a heck of it pulled up…

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