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Rob Fagan is one of the few analysts anywhere who covers the stocks of U.S. cannabis chains like Green Thumb Industries or Curaleaf Holdings. The 39-year-old researcher at Canada’s GMP Securities believes that the U.S. operators have better growth prospects than their better-known counterparts in Canada, like Canopy Growth. But even after this year’s selloff of Canadian producers, U.S. weed operations sell for a fraction of the Canadians’ multiples. Fagan explains why he thinks the U.S. stocks will take investors higher. An edited version of our conversation follows.

Barron’s: How did a nice Canadian boy end up covering cannabis?

Fagan: I got a job at GMP Securities in 2011, working as a research associate for the consumer products analyst, Martin Landry. We were introduced to Canopy Growth (ticker: CGC) and led their public offering. They had a hard time just getting a meeting with other investment banks, but GMP goes after niches where they can have a good market share. Cannabis was one of them.

When we were marketing, Martin would say he didn’t want to be the pot guy. But I said, “I always wanted to be the pot guy!” I’m a big fan of cannabis. It’s something I’m passionate about. And I have a certain knowledge base that could give me a competitive edge.

Knowledge base?

Experience base…I don’t know how else you would like me to describe it. An eye for quality, perhaps?

You focus on the U.S. multistate operators, instead of Canadian producers like Canopy or Aurora Cannabis (ACB). Why?

To be super honest, it just was a greenfield opportunity, where there was less competition for an up-and-comer like myself.

It’s true that very few analysts cover U.S. operators. And they are Canadian stocks. Why?

Because of the federal illegality of cannabis in the U.S., these operations have not been able to list their securities on federally-regulated U.S. exchanges. One of the smaller exchanges in Canada—the Canadian Securities Exchange—did let them sell stock. It was the only place that these U.S. companies could access public markets, although they’ve since cross-listed on the OTC [over-the-counter] market in the U.S.

How can a U.S. resident go about buying one of these stocks?

The easiest way is to have a brokerage account that can access the OTC Markets Group in the U.S., or the Canadian Securities Exchange. Last I checked, there were a handful of self-directed brokers that could access the Canadian Securities Exchange for U.S. residents. But it’s broadening out. There’s now an ETF listed on the NYSE, the AdvisorShares Pure Cannabis exchange-traded fund (YOLO) that has exposure to the U.S. multistate operators through an equity swap arrangement.

Are stocks of these U.S. operators underpriced?

I strongly believe so. Just compare the market capitalizations of the U.S. and Canadian pot sectors, and the sales opportunity of each.

What are those numbers?

For most of Canada’s licensed producers, you’ve got an aggregate market cap of 50 billion Canadian dollars [$31 billion], even after the group’s selloff. They have a C$5 billion sales opportunity in Canada that they can readily address in the next few years. So that is a price-to-sales multiple of 10 times.

The U.S. operators have a market cap of $20 to $25 billion. Counting only the states that already have some form of medical or recreational access, their sales opportunity is around $22 billion within the next three to four years. So that’s one-times sales.

Not only is the U.S. a larger opportunity, but it has a better economic model. In most states, you’re allowed to go direct to your customer—from production right up to retail—cashing in on more of the value chain. There are also fewer restrictions on product forms and advertising than in Canada.

When will more states approve recreational sales?

In 2020, you might have an Arizona ballot initiative, a Florida ballot initiative. Connecticut has a chance of passing legalization. Maryland and Pennsylvania, too. New Jersey couldn’t get enough votes in the legislature, but they will try again. That will put pressure on New York.

Read more: Marijuana Company Harvest Health Is Bullish on a Legalization Vote in Arizona

The markets where these companies operate are fantastic. Massachusetts converted from medical to recreational sales and is growing above a 500% annualized clip right now. Even a mature market like Arizona is still growing at a better than 30% annual rate.

Which of the U.S. operators interest you?

Green Thumb Industries (GTII.Canada or GTBIF). It is one of the best operators. They get things done, quickly and efficiently. They expanded their footprint across 10 states, while generating positive Ebitda [earnings before interest, taxes, depreciation, and amortization]. That’s much better than many Canadian operators, some of whom have large Ebitda losses every quarter.

And they are known for having high product quality. Their product was tested by High Times magazine—an authority in the space—and certain of Green Thumb’s proprietary strains tested at a total THC level of 38%. It was the most potent cannabis strain ever tested by High Times. That product is in such high demand in Massachusetts that some stores limit your purchase quantities.

How do you value Green Thumb?

I project the companies’ revenues and Ebitda. Not too far in the future—I use a 2020 estimate. Then I apply a fair multiple. In the case of Green Thumb, it’s 20 times Ebitda.

Yikes!

Yes, that could be considered elevated. But there are factors that argue for a strong valuation multiple on a U.S. cannabis stock. There’s the huge market growth opportunity from disrupting other consumer categories like alcohol. Another area where cannabis can be very disruptive is in treating opioid addiction.

OK. What Ebitda do you project for Green Thumb?

I estimate the company will generate $485 million of revenues next year, from organic growth and already-announced acquisitions. The company can go from a 13% Ebitda margin now to a 35% margin and $172 million in 2020—driven by what I expect will be scale benefits and vertical integration. I also include some contribution from future M&A.

So that’s how you get to your target price of $24, for this $9 stock. Can they earn 35% Ebitda margins?

The benchmark for fully-integrated cannabis businesses is a company called Trulieve Cannabis (TRUL.Canada or TCNNF). It operates almost exclusively in Florida, where vertical integration is mandated. Trulieve just reported a quarter with 55% Ebitda margins.

So you like Trulieve?

Yes, that’s another favorite. It was one of the first companies to open dispensaries in Florida in 2016, so it had almost 90% market share. Even after competitors have opened over 100 stores, Trulieve still has more than a 50% share on a dollar basis.

Does Trulieve operate outside of Florida?

They have acquired the holder of a provisional license in Massachusetts, where they plan to open three stores in the recreational channel. Given the kind of growth coming from the Massachusetts recreational market, it’s going to be a nice state for Trulieve. They’ve also got a small footprint in Connecticut and a retail store in California.

Trulieve’s last quarterly results were incredibly strong. I forecast $400 million in revenue for 2020. They’ve not gotten a fair valuation. The stock is trading below 6 times their 2020 Ebitda of $146 million; other large players are 9 to 11 times. The stock is $8 today. My target for Trulieve is $22.50, using a 17½ multiple.

Who else do you like?

I would direct you to Curaleaf Holdings (CURA.Canada or CURLF). After some recent M&A, Curaleaf is by far the largest player in the U.S. cannabis industry. This year alone they deployed $2 billion on a number of transactions. They are under contract to acquire a company called Cura Partners, which manufacturers the Select brand of vaporization products—it’s the biggest-selling vape brand in California, Nevada, Arizona and Oregon. They have the potential to be a huge vertically-integrated player that can spread its products across the entire nation.

Curaleaf could exceed $1.1 billion in revenue next year, with a 34% Ebitda margin generating $390 million. That gets me to an $18 target for a stock that sells below $7 today.

Got another?

I would call out Cresco Labs (CL.Canada or CRLBF). It’s a mix of retail and wholesale, and will be an interesting way to play California once it completes its acquisition of one of the largest distributors in the state—a business called Origin House.

Like Green Thumb, Cresco was started in the Midwest and has solid platforms in Illinois and Pennsylvania. Cresco did a series of acquisitions at the end of last year, to get a national presence. Origin House touches nearly all the retail outlets in California. That compliments Cresco’s earlier acquisition of a large wholesale cultivation operation there. They also have some pending M&A in Massachusetts, Florida, and New York.

Leading to sales and Ebitda of what?

We think Cresco Labs can generate in the area of $735 million in revenue next year. We assume an Ebitda margin of 34%, generating about $250 million of Ebitda. Our target price for this $8.25 stock is $16.

Anyone else you like?

Valuations are very attractive, so it is hard to not be positive. Another notable name is Harvest Health & Recreation (HARV.Canada or HRVSF). They hope to be one of the biggest in the industry. They are the leading participant in the Arizona market, which is only medical, but generates about $550 million of industry sales from a population of just seven million. Roughly 3% of the Arizona population uses medical cannabis, compared to a national average of about 1%.

Last year Harvest went on a kind of acquisition spree, acquiring a big Midwest operator called Verano Holdings and an East Coast player called CannaPharmacy with a good presence in New Jersey. They’ve also acquired assets in Florida and California. Their goal is to have 120 retail stores open by the end of next year. It’s just a matter of getting them open.

The company has guided for a revenue range between $900 million and $1 billion, including their planned acquisitions. We’re a little more conservative, at $785 million. The company will be more retail focused, so we expect an Ebitda margin of around 31%. That would translate to about $250 million of Ebitda next year and a price target of $13, compared to a $4.50 stock price now.

Thanks, Rob.

Write to Bill Alpert at william.alpert@barrons.com