Cannabis As A Consumer Staple - Part 2

Editors Note: This was republished with permission from Bengal Capital.

Last week we looked at cannabis as an emergent consumer staple – something that a significant portion of the population regularly purchases regardless of economic conditions. But cannabis is currently an outlier among consumer staples for two reasons, both of which are potentially significant to investors: growth of state-legal cannabis outpaces even the fastest-growing consumer staples, and the stocks of cannabis companies are much more volatile and are valued differently, than other consumer staples companies.

Most staples tend to have stable, regular demand but also not have very high growth rates – usually, growth rates are not too far off of GDP growth (as people get richer, they might eat more expensive food but are unlikely to suddenly start having three dinners) or population growth (for fairly obvious reasons). But, state-legal cannabis sales are growing much faster currently, and estimated to grow at 19% per year for the next five years straight.

As a multiple of forward earnings, consumer staples companies tend to trade roughly on par with the S&P 500, but at a much higher relative multiple when you factor in the estimated forward growth rate of earnings (the PEG Ratio below, an imperfect measure we are not endorsing but just using as quick shorthand for this article) – investors pay up for the certainty of earnings vs. growth of earnings. Plus, with the stable underlying demand, they tend to be less volatile than other sectors.

Source: Yardeni Research, www.yardeni.com
Alcoholic beverage companies are one of the hottest subsectors of consumer staples because its projected growth is higher than most others. But it still isn’t in the same league as cannabis: some optimistic estimates put total alcohol revenues growing 7% to 2022, with a 14% bump in EBITDA, implying a 2022 EBITDA multiple of 16x while major U.S. cannabis companies trade for under 13x.
Source: Stoic Advisory 4/16/21 update, NYU Stern industry multiples compilation, and Bengal research
And cannabis stocks are much more volatile. Below is a graph showing the relative price moves of MSOS (blue line, a decent proxy for U.S. MSO cannabis stocks), and XLP (orange line, a popular consumer staples ETF), and XLY (turquoise line, a popular consumer discretionary ETF). Despite the surging underlying demand, cannabis stocks are significantly more volatile than staples, and even put consumer discretionary stocks to shame.

So, cannabis companies sell a staple that’s growing faster than any other, and they trade at a discount to companies that sell slower-growing staples while having more volatility.

Make no mistake: there are many reasons that cannabis would trade differently from other consumer staples or be valued differently. But when you see the magnitude of negative difference in valuation/volatility matched with the magnitude of positive difference in underlying growth, we think it’s a good idea to take a step back and take a broader look.

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