Buy This, Not That: The Marijuana Stock Edition

Sean Williams, The Motley Fool - finance.yahoo.com Posted 5 years ago
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There's little doubt that the fast-paced marijuana industry has the undivided attention of Wall Street and investors. This year alone, global sales growth in the industry is expected to clock in at 38%, with revenue expected to hit as high as $75 billion by 2030, up from less than $10 billion globally in 2017.

On the surface, it would appear as if nothing could possibly go wrong for the cannabis industry. After all, support for legalization in the U.S. is at an all-time high, and Canada became the first industrialized country in the world to greenlight recreational weed in October. This move by Canada is a blueprint that other developed nations can potentially follow.

But as investors, we're also acutely aware that not every company within an industry -- no matter how fast paced or loved by investors -- can be a winner. With that being said, let's take a look at some popular pot stocks that should probably be kept far away from your portfolio and a handful of complementary marijuana stocks that you could consider adding in their place.

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An up-close view of a flowering cannabis plant growing indoors.
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Marijuana growers

No category of the cannabis movement is arguably more polarizing than the grower segment. There are 11 publicly traded pot stocks on track for more than 100,000 kilograms in peak annual production and quite a few junior growers capable of around 50,000 kilos a year in peak output. Differentiating one pot grower from another is sometimes not very easy.

Buy this: Hands down, the most attractive grower is OrganiGram Holdings (NASDAQOTH: OGRMF). Based in the Atlantic, OrganiGram has the geographic advantage of being a key supplier to Nova Scotia, Prince Edward Island, Newfoundland and Labrador, and its home province of New Brunswick. Though these regions are less populated, early data shows these are areas of above-average cannabis use among adults.

OrganiGram also has efficiency on its side. The company's lone producing grow site (Moncton) is capable of 113,000 kilograms at peak output despite only 490,000 square feet of cultivation space. At 231 grams per square foot, OrganiGram is more than doubling the average yield per square foot throughout the industry and has its proprietary three-tiered growing system and central location in the Atlantic to thank for that. At just 24 times forward earnings, you'd struggle to find a cheaper cannabis grower.

Not that: On the other hand, Cronos Group (NASDAQ: CRON) is definitely not a buy, even with a now-closed $1.8 billion equity investment from Altria. Cronos Group's peak production simply leaves a lot to be desired, with its joint venture (Cronos GrowCo), Peace Naturals, and international sites pushing its maximum output to 120,000 kilos. That's practically the same output as OrganiGram, but Cronos Group has a market cap that's more than four times higher. 

Furthermore, Cronos has done an underwhelming job of setting itself up to succeed in international markets. With the exception of grow sites in Australia and Israel and distribution in Poland and Germany, there's little overseas presence. That's worrisome given the expectation of dried flower oversupply and commoditization within a few years in Canada. If Cronos doesn't have ample overseas channels to offload excess supply, its margins could take a hit. And should this not scare you, perhaps its forward price-to-earnings ratio of more than 400 will.

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Clear jars on a dispensary counter that are packed and labeled with different strains of cannabis buds.
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Cannabis dispensaries

Another popular means of investing in the pot industry is through vertically integrated dispensaries located in the United States. By "vertically integrated," I mean businesses that own grow farms, processing facilities, and retail stores. Essentially, they're able to control their own supply chain, as well as the quality of the product. Vertical integration is of particular importance in the U.S. since the interstate transport of marijuana is illegal.

Buy this: Although this is a niche with high upfront costs, Trulieve Cannabis (NASDAQOTH: TCNNF) has bucked the trend as one of the only profitable pot stocks in the entire industry. Trulieve's success likely boils down to its focus on Florida's lucrative medical-marijuana market. The company currently has 24 open dispensaries in the Sunshine State, which has allowed it to produce an operating and bottom-line profit.

Trulieve is also in the process of spreading its wings. Thanks to recent acquisitions, the company is expanding to Massachusetts, a market that could easily top $1 billion in annual pot sales, and California, which is expected to be the most lucrative weed market in the United States. Establishing its brand in these states could lift Trulieve's costs in the interim, but I'd be surprised if the company didn't remain profitable on a recurring basis going forward.

Not that: Then there's upscale dispensary operator MedMen Enterprises (NASDAQOTH: MMNFF), which is a stock you shouldn't be buying. Don't get me wrong -- MedMen has done a good job of maximizing its sales per square foot in its California locations. However, opening new stores and expanding to a number of new states, including Florida, costs a pretty penny. As a result, it would not be surprising if MedMen were to report a huge loss in 2019 and perhaps even lose money again in 2020, despite a nearly $1.4 billion market cap. 

The other uncertainty here is that MedMen is acquiring privately held PharmaCann for $682 million -- the second-largest U.S. pot deal in history. Sure, this deal is going to increase MedMen's presence in new states and boost its retail license count, but the company may also wind up overpaying for PharmaCann, leaving plenty of unwanted goodwill on the balance sheet. Long story short: A popular name doesn't equate to a profitable investment.

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Medical marijuana

Investors could also choose to put their money to work in the medical-cannabis space. Though the recreational market is much larger, medical pot patients are far more willing to purchase high-margin cannabis alternatives than adult-use consumers.

Buy this: Even if it's not strictly a medical cannabis company, Charlotte's Web Holdings (NASDAQOTH: CWBHF) is the pot stock you'll want to consider. Charlotte's Web produces hemp-derived cannabidiol (CBD) oil, with CBD being the cannabinoid best known for its perceived medical benefits. Therefore, even though Charlotte's Web's products have not been recognized for their medical benefits by the Food and Drug Administration (FDA), it hasn't stopped the company from offering its oils in more than 3,600 U.S. retailers. 

Just as exciting is the fact that President Trump signed the Farm Bill into law in December. The Farm Bill legalized hemp and hemp-derived CBD, which will allow Charlotte's Web easier access into retail stores. The passage of the Farm Bill should provide Charlotte's Web -- already profitable on an operating basis -- with an added boost.

Not that: Comparatively, you'll want to keep your distance from cannabinoid-based drugmaker GW Pharmaceuticals (NASDAQ: GWPH), despite the fact that its lead drug Epidiolex is the first cannabis-derived drug to be approved by the FDA. That's because GW Pharmaceuticals' lead drug could soon face competition from Zogenix in Dravet syndrome. Though neither company has pitted their lead drugs against each other, Zogenix's Fintepla has looked more impressive (at least nominally) for its seizure-frequency reduction in Dravet syndrome patients in late-stage trials. 

The other problem here is that GW Pharmaceuticals is a fundamental wreck. The company isn't expected to be profitable for another three years and its current market cap might be more than 10 times the peak sales potential of Epidiolex. Too little reward and too much risk makes this is a medical-marijuana stock to avoid.

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Sean Williams has no position in any of the stocks mentioned.

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