2 Cannabis Stocks to Avoid Like the Plague… And 1 to Buy

If you own Harvest Health (HRVSF), Acreage Holdings (ACRGF), or Innovative Industrial Properties (IIPR), here’s what you need to know.

Stay away from these 2 cannabis stocks if you don’t want to lose your shirt.

But buy this one stock instead…

Over the last couple of months, the cannabis industry scored some major wins and as a result, cannabis stocks have soared higher.

Of course, the first catalyst was the election.

As you probably know, one of President-elect Joe Biden’s campaign promises was to “decriminalize the use of cannabis and automatically expunge all prior cannabis use convictions”.

When he won the election in November, investors immediately recognized that a Biden presidency would move the nation one step closer towards full cannabis legalization across the country.

But it wasn’t just Biden’s win that has lit a fire under the cannabis industry.

Five additional states also passed cannabis legalization measures on November 4, 2020 as well.  

New Jersey voters approved legalized recreational cannabis, Montana approved a measure and constitutional amendment to legalize weed and set the adult-use age to 21, South Dakota voted to legalize medical and recreational cannabis, Arizona voters approved a proposition to legalize recreational cannabis, and Mississippi approved medical marijuana too.

Then in December, we had a third catalyst that pushed stocks even higher.

In an historic first, the House of Representatives voted in favor of removing marijuana from the federal Controlled Substances Act.  Although this bill will probably meet resistance in the Republican-controlled Senate, it still marks the first time the House has voted on this issue.

For many investors that are bullish about full federal legalization in the near future, cannabis stocks are looking increasingly attractive as a way to profit.

Unfortunately, not all companies are created equal – which means that there are definitely some firms that you should avoid.

Sure, some pot stocks will surge based purely on speculation, but over time the economics of the agricultural commodity business will eventually catch up – which will translate into a falling share price.

So in order to help you cut through the noise, here are 2 cannabis stocks to avoid… and 1 stock that you should buy instead.

Stock to Avoid:
Acreage Holdings Inc. (OTCQX: ACRHF, ACRDF)

Acreage Holdings is an operator of cannabis cultivation and retailing facilities in the U.S..  This includes the company’s national retail store brand, The Botanist. 

Their cannabis products include the Botanist brand, the Tweed brand, the Prime medical brand in Pennsylvania, the Innocent edibles brand in Illinois and others. Acreage also owns Universal Hemp, LLC, a hemp subsidiary markets and sells CBD products throughout the U.S.

Acreage is a bit of a confusing cannabis company, and it begins with its share structure.

For example, the company’s Class E subordinate voting shares (“Fixed Shares”) and Class D subordinate voting shares (“Floating Shares”) are listed on the Canadian Securities Exchange under the symbols “ACRG.A.U” and “ACRG.B.U”, respectively.

They are also quoted on the OTCQX under the symbols “ACRHF” and “ACRDF”, and they are traded on the Frankfurt Stock Exchange under the symbols “0VZ1” and “0VZ2”, as well.

The reasoning behind the separation of Class E and Class D shares is that their deal with Canopy Growth was recently amended.  

Originally, Canopy Growth planned to buy Acreage when the U.S. federally legalized cannabis – called the “triggering event”.  

That deal was recently amended and resulted in the creation of two new share classes. Canopy will now buy only 70% of Acreage (Class E shares) at a fixed price of 0.3048 of a Canopy Growth share per Fixed Share, but the remaining 30% will float with the market (Class D shares).  If the “trigger event” happens, Canopy will pay a minimum price of US$6.41 per Floating Share.

Of course, the question is whether Acreage is actually worth buying – even though Canopy pledged to purchase the business if the “trigger event” happens.

As of this writing, the company is bleeding cash and will continue to do so on an ongoing basis.  Over the TTM, they reported a net loss of $295 million and negative operating cash flow of $59.4 million.

The company has also taken on a ton of debt that it can’t afford.  Acreage has outstanding debt of $121.7 million and their interest expense over the TTM was $12 million.

Without an additional infusion of cash through debt or a share offering, the company will likely burn through its remaining cash of $46.3 million very quickly – especially when the company reported compensation expense of $30.7 million over the last 3 quarters.

Based on debt levels, cash burn, and the uncertainty of the future of this business, it’s best to steer clear of Acreage Holdings for the foreseeable future.

Stock to Avoid:
Harvest Health & Recreation Inc. (OTCMKTS:HRVSF)

Founded in 2011 and headquartered in Tempe, Arizona, Harvest Health & Recreation Inc. is a vertically integrated cannabis company that has 11 cultivation and processing locations, 38 retail locations, and over 1,075 employees spread across multiple states in the U.S.

At first glance, the company seems to be heading in the right direction.

Revenues are growing very fast and reached $61.6 million in their most recent quarter ended September 30, 2020.  Stockholder equity has soared as well, reaching $376.9 million.

But take a peek under the hood, and you’ll start to see some of the problems that are building at HRVSF.

For starters, the company has $243.6 million in outstanding debt.  The interest payment alone was $13.2 million in the most recent quarter and the company reported a net loss of $2.1 million.

Of course, this debt (along with the proceeds from their original public offering in 2018) was used for a massive buying spree where they purchased a ton of various businesses and assets over the last 2 years and invested a total of $283.5 million in cash (the company still had a cash balance of $66.2 million as of September 30, 3030).

Now, I don’t know about you, but you would think that if you invested $283.5 million of cash in any business, you would generate some sort of profit.  

With HRVSF, that is definitely not the case.  What’s more, operating cash flow was negative by $51.7 million over the TTM as well.

However, because of these acquisitions, the company’s intangible assets (which mainly consists of cannabis licenses and permits) also soared to $384.6 million of which $120.7 million was goodwill.  Their ratio of intangibles to total assets is a whopping 44.4% as of September 30, 2020.

If Harvest Health continues to lose money at a rapid pace, then investors will begin to question whether their assets are really worth what they’ve stated on the books.

There is a strong possibility that the company will have to admit that they overpaid for these acquisitions and overstated their assets, which could lead to massive write-downs in the future.

Even if they don’t, the company would still need to grow earnings significantly to justify its current market cap of $710 million.

There is a possibility that HRVSF may prove the doubters wrong and achieve spectacular and profitable growth in the weeks and months ahead, but the risk in owning the stock is great – especially at current valuations.

Stock to Buy:
Innovative Industrial Properties (NYSE:IIPR)

Innovative Industrial Properties, Inc. is a real estate investment trust that began operations in 2017.  The company targets medical-use cannabis facilities for acquisition, including sale-leaseback transactions, with tenants that are licensed growers under long-term, triple-net leases.

(A triple-net lease is where the tenant is responsible for paying all the expenses of the property including real estate taxes, building insurance, and maintenance.)

As of September 30, 2020, the company had net real estate assets of $885 million after depreciation and total assets of nearly $1.5 billion.  In terms of liabilities, the company only had $229.9 million and their stockholders’ equity was $1.27 billion.

And because IIPR signs long-term leases with their tenants, revenues and profits were virtually unaffected by the coronavirus pandemic.  

For the 9 months ended September 30, 2020, the company had $79.8 million in revenue versus $27 million the previous year, and they had $43.3 million in net income versus $12.6 million the year before.

Of course, because of the REIT structure, IIPR must pay out the majority of its profits in the form of dividends, which have grown significantly over the last 3 years.  Q3 dividends were $1.17 per share, up steadily from just $0.15 per share in Q2 2017.

Over the last year, the stock has performed very well.  However, even though it was one of the bright spots in the cannabis industry in 2020, I believe there is still plenty of upside for investors today.

Because of IIPR’s unique business model, its strong balance sheet, and its proven and profitable operations, this is a cannabis stock that is head and shoulders above the competition that will continue to grow in the future.

IIPR is a company that should be in your portfolio today.

-Investing Insider Magazine

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