Whether you realize it or not, mid-May a special time of the year for investors — and I’m not talking about the barrage of earnings reports that have hit the newswires over the past couple of weeks. No, I’m talking about May 15 being the deadline for primetime money managers and Wall Street institutions to file Form 13F with the Securities and Exchange Commission.
Put simply, Form 13F is a required disclosure of investment holdings for investment funds and hedge funds with more than $100 million in assets under management. Within 45 days of the end of the previous quarter, investment and hedge funds must disclose their holdings, which in turn allows Wall Street and investors to see what the brightest minds on Wall Street have been up to over the previous quarter. Although the data can be a bit dated — after all, we’re getting a bird’s-eye view of holdings that are more than six weeks old — it’s nevertheless a rare look at what’s going on behind the scenes with the biggest investment funds in the world.
While most of Wall Street has been focused on what these investment funds did with regard to FAANG stocks in the first quarter — Facebook, Amazon, Apple, Netflix, and Alphabet, which was originally known as “Google” — I was surprised by the fact that Wall Street added, in aggregate, to their positions in three marijuana stocks in the first quarter.
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The first pot stock that saw modest buying in the first quarter from institutional investors was Aurora Cannabis (NYSE:ACB). According to 13F aggregator WhaleWisdom, a little more than 1 million total net shares were purchased by funds that are required to file a 13F during the first quarter, which equates to increase of almost 1.2%.
Why would Wall Street be more excited about Aurora Cannabis than it was in December? First of all, Aurora’s production and efficiency are doing a lot of the talking. On April 10, the company provided a construction update on its largest facility, known as Aurora Sun, in Medicine Hat, Alberta. Previously expected to span 1.2 million square feet and yield more than 150,000 kilos a year, Aurora Cannabis announced that it would be boosting capacity to 1.62 million square feetto produce at least 230,000 kilos a year. That’s more than 140 grams per square foot at peak capacity, which is about 40% above the industry’s average yield at peak production.
As a whole, Aurora projects for more than 625,000 kilos of annual run-rate output by the midpoint of 2020, which is far and away more than any of its peers. I suspect that modest capacity upgrades from its ICC Labs acquisition in South America could easily put the company over 700,000 kilos on an annual basis. With so much cannabis being produced, Aurora looks to be shoo-in to receive long-term supply deals domestically and abroad.
There’s also the growing likelihood that Aurora Cannabis will land itself a brand-name partnership at some point in 2019. In March, the company hired billionaire activist investor Nelson Peltz, the founder of Trian Fund Management, as a strategic adviser. With his expertise being in the food and beverage space, these institutional investors might be trying to jump in prior to a big, but at this point expected, brand-name partnership announcement.
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Innovative Industrial Properties
Another stock that institutional investors couldn’t seem to get enough of in the first quarter was cannabis real estate investment trust (REIT) Innovative Industrial Properties (NYSE:IIPR). As of March 31, 2019, institutional funds required to file a 13F owned just over 6 million shares, which is up 13.1% from Dec. 31, 2018.
A cannabis REIT like Innovative Industrial Properties runs a very low-cost, high-success-rate business model. It seeks to purchase land and/or facilities that can be used for growing or processing medical marijuana in the U.S., then leases the land and facilities over very long periods of time to its tenants, locking in predictable levels of cash flow. Innovative Industrial Properties also passes along a 3.25% annual rental increase, as well as requires its tenants to pay a 1.5% property management fee, which is based on the rental rate, thus providing itself with a modest pathway to organic growth from its existing portfolio.
Right now, IIP, as the company is known in shorthand, has 19 properties in 11 states, and has aggressively acquired eight new properties since the year began. More importantly, the average length of its remaining leases is 15.2 years (again, predictable cash flow), with an average return on invested capital of 14.8%. This last figure suggests a complete payback of its invested capital in less than five years’ time.
Wall Street’s love affair with IIP has been well rewarded, as evidenced by the REIT’s first-quarter operating results. Rental revenue rose by 146% in Q1 2019 from the prior-year quarter, while adjusted funds from operations (AFFO) soared 275% to $0.54 per diluted share. AFFO is what determines the company’s quarterly dividend payout, and it’s a big reason why its dividend has tripled over the past two years. In terms of per-share profit, IIP is the king of all pot stocks right now.
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A third marijuana stock that saw significant buying in the first quarter by institutional investors is Cronos Group (NASDAQ:CRON). Data from WhaleWisdom shows that an aggregate of 2.5 million shares was added by funds that are required to file a 13F, a 9.9% increase from the end of 2018.
Why Cronos Group? Arguably the biggest reason to jump into Cronos is the now-closed $1.8 billion equity investment from tobacco company Altria (NYSE:MO). Altria announced in early December that it planned to invest the $1.8 billion in return for a 45% nondiluted stake in the company. Altria also received warrants that could allow it to up its equity stake in the company. With tobacco cigarette shipments falling in the U.S., and the adult smoking rate hitting at least a 50-year low, Altria needs new channels of revenue, and partnering on vape products and pre-rolls might just be the answer.
As for Cronos, the money it received from Altria put some serious pep in its balance sheet, which had less than $25 million in cash as of the end of the fourth quarter. With a boatload of cash at its disposal, Cronos can, presumably, work toward building out its capacity, further expand its product portfolio, lay the foundation to move into foreign markets, and make earnings-accretive acquisitions that fit with its long-term growth strategy.
Of course, of the three pot stock Wall Street gobbled up in the first quarter, this is the biggest head-scratcher. While the cash pile provides some reasonable downside support, Cronos Group isn’t even considered a top-10 cannabis company when it comes to producing and/or retailing marijuana products. It has a long way to go before it merits what’s currently a frothy valuation.
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