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Will Cannabis Stocks Revive in 2022?

There's plenty of opportunity for these stocks after a rough 2021.

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Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Cannabis stocks took it on the chin in 2021. Does that mean there may be opportunities here? Joining me with his perspective is Kris Inton. Kris is a strategist in Morningstar's equity research team.

Hi, Kris. Thank you for being here today.

Kristoffer Inton: Thanks for having me.

Dziubinski: After doing pretty well in 2020, cannabis stocks really struggled in 2021, with the names we cover ending the year anywhere between 20% to 70% in the red. What happened?

Inton: First, I'd make a distinction between what happened for American cannabis stocks, which are Curaleaf and Green Thumb and the Canadian cannabis stocks that we cover, Canopy Growth, Aurora Cannabis, Tilray, and Cronos. Every cannabis stock fell as optimism for federal legalization reached a fever pitch after Democratic wins in the Senate and the White House early last year. But the drop was much bigger for the Canadians in general as the cannabis market there has been incredibly hard compared to the robust American market. Oversupply, price competition, and lack of dispensaries are all challenges the Canadian producers faced that Americans didn't. Furthermore, U.S. federal prohibition has kept the Canadians out of the more attractive American market.

Dziubinski: Kris, what do you expect on the legislative front in 2022 and beyond?

Inton: We expect more states to advance legalization for medical and recreational cannabis, and for states that have previously legalized to formally open their recreational markets. On the federal front, we still think it's going to be a year or more until significant progress is made for changes to federal prohibition.

Dziubinski: Do you see a catalyst in 2022 that may help these stocks turn around?

Inton: Sure. First, if we see some firmer progress on federal legalization, we think market worries would alleviate a bit. And second, we think that if cannabis companies could turn in some solid financial results with fewer hiccups that we saw in 2021, like unexpected declines in revenue or margins, that we could see some better stock performance.

Dziubinski: Kris, most of the cannabis stocks that Morningstar covers are undervalued today. There's one exception, which is, Aurora Cannabis. We think that one is fairly valued given its extreme uncertainty. Tell us a little bit about why that stock in particular is different from the rest.

Inton: The American cannabis companies like Curaleaf and Green Thumb had been turning in strong financial results. So, their trajectory is a lot better. Canada has been a challenging market with oversupply and price competition plaguing producers. And as such, it's been a harder path to profitability there. Tilray, which includes legacy Aphria, has generally been more on a path to profitability than its peers, helping deal with that challenging market. Canopy and Cronos have access to deep pockets through investments by Constellation Brands and Altria, respectively, and that's helped them handle those market challenges. Aurora has yet to reach positive EBITDA, nor has it gotten a big check from a strategic investor. So, there's been a real risk of value destruction through dilutive equity issuances necessary to keep the lights on.

Dziubinski: Kris, given that many of the cannabis stocks that we cover are undervalued, are there one or two in particular that are sort of the highest on our list today as far as opportunity goes?

Inton: Yes, we like the American stocks. So, we like Curaleaf and Green Thumb. Both U.S. multistate operators trade in 5-star territory, offering meaningful risk-adjusted upside. The market has been overly focused on federal legalization, but in the meantime, both companies have been building large footprints and seeing robust profit growth even without federal law changes.

Dziubinski: Well, Kris, thank you so much for your perspective today and for your picks. We appreciate it.

Inton: Thank you, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.

Kristoffer Inton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.