3 Marijuana Stocks I'd Genuinely Consider Buying
By Sean Williams | April 06, 2018 |

When we think of the fastest-growing industries on the planet, our minds likely gravitate to artificial intelligence or cloud computing, or perhaps they even wander all the way to the cryptocurrency market. However, at or near the top of that list is the legal marijuana market.

In North America, according to cannabis research firm ArcView, in partnership with BDS Analytics, the legal weed market is expected to grow by a compound annual rate of 28% through 2021. Mind you, this comes after 33% growth in 2017, which wound up topping most expectations. By 2021, we could be looking at nearly $25 billion in annual North American sales.

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At the heart of this growth is the expectation that Canada will become the first developed country in the world, and the second overall behind Uruguay, to legalize recreational marijuana for adults. Doing so would open the door to $5 billion or more in sales on top of what the industry is already generating from domestic medical cannabis sales and exports.

With no true precedent for a developed country greenlighting the sale of adult-use pot, the imaginations of investors -- and even, to some extent, Wall Street -- have been left to run wild.

These pot stocks may be worth buying
Over the past few years, marijuana stock valuations have shot into the stratosphere, and while they've cooled a bit over the past three months, they're still pricey. There isn't a single pot stock that I'd consider an intriguing buy at the moment.

However, assuming Canada does sign the Cannabis Act into law -- which seems like a near-certainty -- and demand builds up as expected, then there are a handful of pot stocks that I'd genuinely consider buying. Understandably, a lot needs to go right for me to buy into the cannabis craze, but consider these marijuana stocks on my short list of potentially attractive companies.

1. OrganiGram Holdings
In terms of smaller Canadian growing operations, I'm attracted to OrganiGram Holdings (NASDAQOTH:OGRMF), which recently revised its fully funded production guidance to 113,000 kilograms a year by 2020. Though growing capacity is highly fluid, this would likely rank OrganiGram anywhere from, say, fifth to seventh in annual domestic production.

There are a couple of factors that I really like about OrganiGram. To start, all of its operations are at its Moncton, New Brunswick, location. Rather than focusing on multiple facilities, it's centralizing its costs. Presumably, that should help lower its costs and boost its margins.

Along those same lines, OrganiGram recently discovered that its yield calculations were way off, and that it was generating far more from its grow operations than expected. This is why OrganiGram recently increased its fully funded production from just 65,000 kilograms of dried cannabis a year to 113,000 kilograms. Yet, Wall Street and investors haven't rewarded OrganiGram for this boost in production at all. But this investor is paying attention.

Fundamentally, OrganiGram might be a bargain as well. Though earnings-per-share estimates are also very fluid, OrganiGram is currently valued at less than 29 times next year's profit projections, and is sporting a price/earnings-to-growth ratio of below 0.5, by my best estimate. That's ridiculously cheap if it can hit all of its production targets.

Why aren't I buying now? I worry about domestic oversupply wrecking cannabis margins in Canada. There could be, by some estimates, a 1 million kilogram surplus of dried cannabis in Canada that exporting simply won't fix.

A potentially bigger concern is that it'll take OrganiGram until April 2020 to complete the capacity expansion that'll allow it to reach 113,000 kilograms in annual production. By then, major long-term supply agreements will likely have been reached, potentially leaving the company on the outside looking in.

Yet, even with these risks, I'm intrigued.

2. Cannabis Wheaton Income Corp.
Another unique small-cap marijuana stock that has my attention is Cannabis Wheaton Income Corp. (NASDAQOTH:CBWTF). What makes Cannabis Wheaton unique is that it isn't a traditional grower. Instead, it's a first-of-its-kind publicly traded royalty stock in the cannabis space.

One of the bigger issues cannabis growers face is finding capital for capacity expansion. Since pot is still illegal at the federal level in every country but Uruguay, most banks won't offer access to loans or lines of credit. Further, most cannabis businesses aren't currently profitable; or if they are, they're generating just a few million dollars in positive operating cash flow, at best. That's nowhere near enough to fund projects and acquisitions that are costing, in some cases, well beyond $100 million.

This is where Cannabis Wheaton steps in. It supplies up-front capital allowing these growers to expand. In return, it receives a percentage of its partners' production, and pays a below-market rate for that marijuana. Cannabis Wheaton then turns around and sells this received weed at market rates, and pockets the difference as profit. The business model is pure genius -- and if it sounds familiar, that's because it's designed after Wheaton Precious Metals in the precious-metals industry. Cannabis Wheaton has intimated that its internal rate on return should be at least 60%, giving it what could be the juiciest margins in the pot industry.

With more than a dozen licensed production partners, this royalty stock has found a way to diversify its revenue stream geographically across Canada, as well as ensure that production issues at one company, should they arise, won't wreck its top or bottom line.

Why not buy now? The biggest issue is the concern about domestic oversupply. Whereas growers have the potential to use economies of scale to push their growing costs lower, many of Cannabis Wheaton's costs are fixed, since it's agreed to buy a certain amount of production each harvest or year. That would suggest that no company would be hurt more, should per-gram cannabis prices tumble, than Cannabis Wheaton Income Corp. In other words, I'd first need strong evidence that cannabis prices are stable.

The other concern here is that the royalty business is a highly capital-intensive model in the early stage. This often translates into a lot of dilution to investors via bought-deal offerings to raise capital. I'd rather not be on the receiving end of ongoing bouts of dilution for the time being.

I am, however, very excited to see if this high-margin model can function in the cannabis space.

3. Aphria
Among the biggest traditional growers, my preference continues to lie with Aphria (NASDAQOTH:APHQF), even though its peers offer a compelling investment argument.

Aphria is projected to produce around 230,000 kilograms of dried cannabis annually, which is outpaced (for the moment) only by Aurora Cannabis and Canopy Growth Corp. (NASDAQOTH:TWMJF) which are expected to yield 283,000 kilograms and perhaps more than 300,000 kilograms, respectively. Canopy Growth's distribution channels are absolutely unmatched, with the ability to sell cannabis in physical retail outlets and through its online operations. Canopy also sold a 9.9% equity stake in its company to Corona beer maker Constellation Brands last year, forging a partnership that could yield global benefits. And yet, I still prefer Aphria.

One of the most intriguing aspects about Aphria is its management team's focus on profitability. It's one of just two cannabis stocks (along with MedReleaf) to have produced a full-year profit in each of the past two years. Even though acquisition-related costs may stop this streak from entering a third year, Aphria's execs understand how important it is to maintain profitability for its investors, and that's something I can appreciate.

Aphria's strategic partnership with Double Diamond Farms was also a smart move. This partnership should produce roughly 120,000 kilograms a year and, more important, it expedites the timeline for Aphria to double its production. Originally, Aphria was expected to organically build out a 100-acre grow site, which likely wouldn't have been complete until well into 2020. However, given its tie-up with Double Diamond Farms, Aphria moved its production-doubling timeline forward by a year.

What's not to like? Among the big growers, Aphria will be the latest to really ramp up production -- its organic four-phase expansion, expected to yield 100,000 kilograms annually, is not slated for completion until January 2019. Being a few months late to the party could mean losing out on long-term supply deals if Canada passes the Cannabis Act in June.

Aphria's pricey $670 million cash-and-stock acquisition of Nuuvera that'll help it expand into numerous foreign markets is also a bit worrisome. The expansion is great news, as it gives Aphria new places to export its product, but recent bought-deal offerings and share issuances are diluting existing investors.

Once we have a better bead on domestic supply, Aphria could be worth a nibble.

This article originally appeared on The Motley Fool.

 

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