1 Cannabis Stock to Buy and 1 to Sell in 2022
Its essential to choose your investments wisely in the fast-growing marijuana industry.
The cannabis industry might be a great place to look for excellent stocks. Last year, Wall Street analyst Owen Bennet referred to the sector as a 'generational wealth opportunity.' Even so, not all marijuana companies are created equal.
While some are performing well and boast plenty of opportunities ahead, others are facing too many headwinds to be worth investing in right now. Let's look at two cannabis stocks, one in each category: Innovative Industrial Properties (IIPR -0.03%) and Aurora Cannabis (ACB -1.19%).
The stock to buy: Innovative Industrial Properties
Innovative Industrial Properties is a real estate investment trust (REIT) that focuses on the medical cannabis market. The company acquires real estate assets from marijuana players and leases the properties back to them. That allows pot growers to free up cash to invest in other areas of their operations. That's important, because cannabis companies have a hard time accessing funding and various other banking services due to marijuana being classified as a Schedule I substance under the Controlled Substances Act.
Put differently, marijuana remains illegal at the federal level. That's why financial institutions have been reticent to do business with cannnabis companies. Fortunately, Innovative Industrial Properties allows its clients a little more financial flexibility than they otherwise would have. Innovative Industrial Properties leases real estate assets to some of the largest multistate operators in the U.S., including Trulieve Cannabis and Cresco Labs.
Image source: Getty Images.
Innovative Industrial Properties has routinely reported excellent financial results. Last year, the company's total revenue of $204.6 million increased by 75% compared to 2020. Innovative Industrial Properties' net income also grew by about 75% year over year to $112.6 million. Of note, the company currently owns 105 properties across 19 states with a weighted average lease length of 16.6 years. Medical uses of cannabis are legal in 37 states and the District of Columbia, which gives Innovative Industrial Properties some room to expand its operations elsewhere.
As a REIT, Innovative Industrial Properties is legally required to return 90% of its taxable income as dividends. The company currently offers a yield of 3.50%, above the S&P 500's average of 1.27%. That makes it an excellent option for income-seeking investors. One major worry with this company is that if cannabis is decriminalized at the federal level, that would possibly allow pot growers to do business with banks more freely and make Innovative Industrial Properties obsolete.
However, this would likely also lead to significantly more competition in the cannabis industry, which would mean more potential business partners for Innovative Industrial Properties. Lending from banks has drawbacks, including high interest rates. In my view, many marijuana companies would turn to Innovative Industrial Properties even if cannabis finally becomes legal, which is by no means a sure bet.
That's why I expect this cannabis stock to continue performing well for many years.
The stock to sell: Aurora Cannabis
Aurora Cannabis has encountered a world of issues in the past few years, here are just two of them. First, due to an aggressive and expensive growth strategy, the company's goodwill famously ballooned. Goodwill is an intangible asset on a company's balance sheet when it acquires another business, it represents the premium over the fair value of the acquiree's physical assets. Too much goodwill is a dangerous thing since it can lead to write-offs that can harm the bottom line.
Second, Aurora Cannabis faces continuing share dilution. The company has routinely relied on dilutive forms of financing, which isn't good for existing shareholders.
In fairness, Aurora Cannabis has somewhat been dealing with the first problem, but not necessarily in a way that'd make investors happy. At the end of 2021, goodwill on its balance sheet stood at roughly 36% of its total assets, at 888.4 million Canadian dollars, an improvement from being nearly 58% of total assets at the end of June 30, 2019.
However, this decrease in goodwill came at the cost of expensive write-offs. The important thing to take away, though, is that the company's management team hasn't had the best capital allocation strategy in the world, to say the least. That's a legitimate worry for long-term investors. Meanwhile, Aurora Cannabis continues to be consistently unprofitable.
The company's goal is to be profitable on an adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) basis in the second half of its fiscal year 2023 (that would be during the second half of this year). But that's not the same as being profitable. And while many of its peers in the Canadian cannabis market continue to bleed red, few of them have dealt with the combination of headwinds (goodwill problems, share dilution issues, etc.) that Aurora Cannabis has encountered.
That's why it is best to stay far away from this pot stock.