To say that the stock market has been volatile would be a brutal understatement. The week prior to last, the CBOE Volatility Index, or VIX, which measures the expected volatility of S&P 500 (^GSPC -0.32%) index options over the next 30 days, hit an all-time record high. If you though the stock market was volatile during the financial crisis, the coronavirus disease 2019 (COVID-19) panic has blown that previous mark out of the water.
It took just over three weeks for the benchmark S&P 500 to push from an all-time closing high to official bear market territory, then one additional week for losses to push beyond 30%. Both figures are records for the quickest 20% loss and 30% loss in the history of the S&P 500.
But it's been especially harsh for the cannabis industry, which was already struggling mightily well before COVID-19 became a pandemic.
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Nothing was going right for marijuana stocks before the coronavirus pandemic
In our neighbor to the north, regulatory issues have mostly been to blame. Health Canada delayed the launch of high-margin derivatives by two months, while provincial regulators in Ontario had were working with a lottery system to assign retail licenses until the end of 2019. The result being that only two dozen dispensaries were open in Canada's most-populous province by mid-October 2019, a full year after recreational weed sales commenced. These regulatory problems have created everything from shortages to supply gluts, depending on the province.
Comparatively, the United States has been done in by the sky-high taxation of legal marijuana and, to a lesser extent, a lack of legal retail channels. California, the top-selling cannabis market in the world, just happens to be the posterchild for both of these issues. It's hitting consumers with state, local, excise and wholesale taxes that can add well over 40% to the per-gram price of legal pot, and roughly 100 dispensary licenses remain in limbo within the city of Los Angeles. Both of these problems are allowing black-market producers to thrive.
Additionally, marijuana stocks throughout North America have struggled to gain access to traditional forms of financing. In the U.S., cannabis remains a federally illicit substance, meaning many banks and credit unions won't provide basic banking services. Meanwhile, in Canada, banks have become more critical of struggling marijuana balance sheets and have been unwilling to provide loans or lines of credit.
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These cannabis stocks have soared over the past week (but most are worth avoiding)
And yet, something of a miracle happened last week. For the first time in about a year, cannabis stocks showed signs of life. Following the noted 30%+ decline in the S&P 500 over a more than four-week stretch, five pot stocks have rallied well over 100% off of their intraday lows in the span of about a week:
- MedMen Enterprises (MMNFF): up 266%
- Tilray (TLRY): up 225%
- HEXO (HEXO): up 201%
- Innovative Industrial Properties (IIPR -2.28%): up 109%
- Harvest Health & Recreation (HRVSF): up 104%
These are eye-popping moves that are reminiscent of the golden days for pot stocks... from 18 months ago. But they're also really surprising given the ongoing issues listed above that North American cannabis stocks are still working through.
For example, U.S. multistate operator (MSO) MedMen Enterprises isn't even a sure thing to survive. Despite concerted efforts to reduce its general and administrative expenses, MedMen lost almost $232 million on an operating basis last year and has racked up $103 million in operating losses through the first six months of fiscal 2020. With the remaining $115 million of $280 million in capital offered by private equity company Gotham Green Partners no longer accessible and MedMen angling to pay vendors with its common stock, it would certainly appear that its judgment day is rapidly approaching.
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Tilray, which we've witnessed rocket higher before, recently announced a $90.4 million registered direct offering that was well below its prior-day closing price. Then again, this was much needed after Tilray's cash position sunk from north of $500 million at the end of 2018 to less than $100 million by the end of 2019. With the company completely shifting its focus to the U.S. and Europe, neither Wall Street nor Main Street is exactly sure what to expect at this point, other than continued losses.
HEXO, a one-time darling, has also been a bona fide dumpster fire. Two weeks ago, the company announced that it would delay the filing of its interim financial statements because it plans to book a significant impairment loss on its assets of between $265 million Canadian and CA$280 million (by the company's own estimate). Late last year, HEXO also cut 200 jobs and reduced its annual peak production potential by about a third.
Even Harvest Health & Recreation, a U.S. MSO, is a mess. Last week, Harvest Health announced that it and privately held MSO Verano Holdings were mutually terminating their combination. This deal was expected to make Harvest Health a real challenger among the top dispensary operators in the United States, but it was done in by a lack of working capital and other regulatory hurdles.
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This pot stock has doubled, but it's still worth buying
On the other hand, cannabis real estate investing trust (REIT) Innovative Industrial Properties has given Wall Street and investors every reason to believe in this company, and to continue buying this stock, even after a more-than-doubling off of its lows.
Innovative Industrial Properties (IIP) is a company that acquires medical marijuana-growing and processing sites, then leases these assets out for a long period of time (10 to 20 years). It's able to reap the reward of rental income, as well as pass along annual rental increases to stay ahead of the inflationary curve. IIP also collects a 1.5% property management fee that's based on the prevailing rental rate, meaning there's a modest organic growth element built into this REIT.
What's made IIP so special is that it's played a key role as a source of financing for cash-strapped U.S. MSOs. Through sale-leaseback arrangements, IIP acquires growing or processing assets from MSOs, providing them with valuable cash, then leases these same assets back to the MSOs, thereby locking in a long-term tenant.
To date, Innovative Industrial Properties has acquired 53 assets in 15 states, with a weighted-average lease length of 15.9 years and an average return on invested capital of 13.2%. Put simply, IIP should net a complete payback on its invested capital in about 5.5 years, with everything else being gravy.
As the only dividend-paying pure-play pot stock, it remains a solid choice for investors.
