The road to federal cannabis legalization

Vivien Azer, Cowen Managing Director and Senior Research Analyst joins the Yahoo Finance Live panel to discuss the wave of state level legalizations and the future of the cannabis industry.

Video transcript

ZACK GUZMAN: Welcome back to Yahoo Finance's Business of Cannabis special. As we've been discussing, not only are more states here in the US moving to legalize cannabis, but also marijuana products are rapidly changing. Come a long way from just pre-roll joints or flower in the space. Drinks and edibles also becoming important as well. And all those things led to one of Wall Street's most watched cannabis analysts to increase their size of the total addressable market for legal cannabis here in the US, up to $41 billion by 2025.

When you look at the legal recreational side of the business from $40 billion, that number is even larger when you factor in illicit purchases on the black market. But growth is still quickest in that legal recreational use piece of the market. So what are the best ways for investors out there to play that? Well, let's bring in a closely watched cannabis analyst today. That would be Cowen managing director, senior research analyst Vivien Azer joins us once again.

Vivien, good to be chatting with you. Happy 4/20. When we look at this, obviously, the states, the big ones that we've been talking about and waiting for, New Jersey and New York seem to be the largest there. But talk to me about how those states coming online and the timeline there really boosts the overall market here in the US.

VIVIEN AZER: Yeah, tremendous momentum at the state level. And good to be back with you, Zack. So since the general election, we've actually raised our TAM by $11 billion cumulatively. So that does factor in Arizona, New Jersey, New York. And then we raised an incremental $1 billion with New Mexico and Virginia coming online. From a timing perspective, we're trying to be conservative.

On a market like New York, we're assuming the start of 2023. But by 2025, we think that will be very close to $3 billion. Same thing with Pennsylvania. We think there's a chance that maybe Pennsylvania takes up adult use legislatively at the state level in 2022. That could be another $3 billion. It's already a billion dollar medical marketplace. And for the rest of the year, we think Connecticut and Rhode Island could pass as well.

ZACK GUZMAN: Yeah, what's interesting is, you know, we've heard some critics talk about maybe Virginia's expedited rollout of allowing legal cannabis without the sale there. We've seen that in some other states, too. But interestingly, I mean, in your chart, the black market doesn't necessarily see the same growth as the recreational side. So, talk to me about maybe what we're seeing in this evolution of where the market is relative to where it was before when more states still had cannabis be illegal.

VIVIEN AZER: So the illicit market has been tough to disrupt in California because that's where a lot of the illicit cannabis comes from. And, you know, enforcement arguably could be better. There's kind of an unknown number of illicit dispensaries that are currently in operation. So it's not just kind of individual drug dealers, if you will. The further east you go, the easier it's been to disrupt the illicit market. And that's why you're seeing markets like Illinois, which just legalized cannabis last January, generating a billion dollars in sales. So the revenue is being displaced. But it's easier to do on the East Coast.

ZACK GUZMAN: Yeah, when it comes to choosing which one of these companies, or I guess, number of companies, are leading the way in capitalizing on these new states, obviously, some of them have a leg up, because they're operating there medically in some of these states. But when I look at your top picks, we've talked a lot about Green Thumb, multistate operator based in Chicago.

But another one, you updated your price target on Trulieve or initiated coverage on Trulieve there. A $65 price target, so some pretty big upside there when you look at that stock based in Florida. We're going to be chatting with the CEO of Trulieve later in the show. But why do you like that one? And what really stands out when you look at the ones that are best poised to win, moving forward?

VIVIEN AZER: So for Trulieve, it's their market share leadership and underlying fundamentals of the Florida marketplace, which drive best in class margins. And Kim is doing an exceptional job with that. Trulief has a 50% share roughly of the Florida market. And the market is actually accelerating. So over the last two years, Florida was adding about 3,000 patients a week. It crossed half a million patients already. But in 2021, those new patient adds have actually been accelerating. In the most recent weekly period, it was over 6,000 patients got added in just a one-week period.

So when you're Trulieve and you've got six times the amount of cultivation capacity that fuels a 50% market share, you're going to drive a big piece of the benefit of that accelerating growth. And in turn, it drives best in class margins, where last quarter, they generated over a 46% adjusted EBITDA margin.

ZACK GUZMAN: Yeah, and what's interesting is, you know, I think we've come a long way in the cannabis sector. This special is on 4/20. It's kind of tongue in cheek maybe a little bit. But it's a established piece of business now, an established sector. And when you look at it maybe relative to others, some people might point out valuations still have a ways to go, given some of these names people don't even know. We talk so much about the Canadian companies that are listed on major exchanges. These ones can't. So talk to me about where valuations here in the marijuana space in the US operators fit in to maybe the Canadian peers, and then also just general sectors you follow as well.

VIVIEN AZER: Sure, absolutely. So the exchange or the venue where the US stocks are trading certainly is depressing the multiple. And it's having a negative impact on liquidity. So it would be huge if the US operators could regress to the NASDAQ or the NYSE. But in the interim, from a top line growth perspective, if you benchmark where the US operators are trading relative to my core coverage in beverages or tobacco, you know, these companies are going to grow their top line at a mid-teens to high 20s compound annual growth rate over the next five years, which is multiples faster than anything that I cover in beverages and tobacco.

And impressively, the adjusted EBITDA margins are very, very attractive for a CPG. So you've got a issue with the venue. You also have an issue with the cash flows because of the onerous tax code in the US called 280E, which essentially prohibits most, if not all, operating expense deductions.

ZACK GUZMAN: Yeah it's important. I know we've talked about it before. We're going to dig into that a little bit later on in the show. But for now, Vivien Azer, I wish we had more time here. I'm going to have to do this more often than just on 4/20, but Cowen managing director, senior research analyst, appreciate you coming back on to chat with us to--