The global marijuana market is worth $150 billion, and industry watchers think widespread legalization could result in legal marijuana sales that top $200 billion worldwide in 15 years.
The potential to profit from pot is significant, but investors' optimism has caused valuations to rocket higher. Although many marijuana stocks are trading near their 52-week highs, Aphria(NYSE: APHA), KushCo Holdings(NASDAQOTH: KSHB), and CannTrust Holdings(NYSE: CTST) have recently seen their share prices stumble. Should you buy these beaten-up pot stocks?
A marijuana leaf on top of a hundred dollar bill.
IMAGE SOURCE: GETTY IMAGES.
A rebound in sight?
The third largest Canadian cannabis company by sales, Aphria saw its shares falling off many investors' radars following allegations from short sellers that insider's inflated the value of acquisitions in Latin America. Aphria responded with an internal audit that determined its acquisition prices were within a reasonable range, albeit at the high end, and word that its longtime CEO was stepping down.
The leadership change and results from its internal investigation could make now a good time to add Aphria to portfolios. Its sales are surging following the opening of Canada's national recreational-use marketplace in October, and ramping up production suggests its revenue should continue growing significantly over the next 12 months.
In the quarter ended Nov. 30, Aphria sold 3,900 kilos of cannabis, resulting in net marijuana sales of CA$21.7 million, up 63% quarter over quarter.
Aphria's marijuana production capacity was an annualized 35,000 kilos in the quarter, but in March, the company received Health Canada approval for cultivation at expansions to its Aphria One greenhouse, adding 80,000 kilos of annual production capacity. The company's also awaiting approval to begin cultivation at Aphria Diamond, a second facility, and if regulators cooperate, Aphria's annualized production capacity could exit 2019 at around 255,000 kilos, entrenching its position as one of Canada's biggest growers.
On April 15, Aphria will unveil results for the three months ended Feb. 28, and the report could show another significant quarter-over-quarter increase in sales and provide insight into the ongoing C-suite transition and plans to enter new markets, including Germany, where Aphria recently launched cannabidiol oils.
Growing pains galore
The illegal marijuana black market is dominated by dried flower, and product packaging doesn't get any thought. That's not the case in legal, regulated markets, including Canada and U.S. states with pro-pot laws on the books. Legal marijuana markets are heavily regulated, packaging must meet requirements, and consumer purchases reach beyond dried flower to value-added products, such as vapes and edibles.
Less than five years ago, only four U.S. states had passed laws allowing recreational marijuana use, and only 20 states had allowances for medical marijuana. Today, 33 states have pro-pot laws on the books, including 10 states that have passed recreational adult-use laws. The rapid expansion of states allowing legal use of marijuana caused legal marijuana sales to soar to $8.4 billion last year, according to GreenWave Advisors Matt Karnes. That's great news for KushCo Holdings, one of the biggest vendors of marijuana packaging solutions.
KushCo's sales have soared because of growing demand, but it hasn't all been good news for the company. Yes, fiscal 2018 revenue jumped 177% to $52 million, but last quarter, management acknowledged it's struggling to keep up with customers' appetites. As a result, gross margin fell substantially because of steps that it's taken to keep customers happy, including expensive overnight shipping.
On top of that, KushCo said earlier this week its new CFO found an error in its previous accounting relating to a series of acquisitions in 2017 and early in 2018. The error requires restating fiscal 2018 financials to reflect a much larger loss than previously reported. Overall, KushCo's shares had declined 21% from their peak in January 2019 through the closing bell on April 11, before its most recent quarterly results.
There's reason for optimism, though. The accounting error doesn't affect previously reported revenue, gross profit, or cash flow, and it may be safe to assume the review was thorough enough to help the company come into compliance with Sarbanes-Oxley, an important step necessary to demonstrating that accounting controls are top notch.
KushCo's fiscal second-quarter results for the three months ended Feb. 28 show that sales jumped 240% year over year to $35 million, too. That prompted management to up its sales outlook for the full fiscal year by 27% to at least $140 million, from prior estimates of at least $110 million.
Unquestionably, the company has more work to do because it's still losing money, and its margins remain much lower than they were last year. Nevertheless, KushCo thinks margins can grow back to 30%, allowing it to return to profitability in 2020. If so, then buying shares now could be smart.
Marijuana growing in a greenhouse.
IMAGE SOURCE: GETTY IMAGES.
It may not be as bad as it seems
Marijuana grower CannTrust's shares have gotten hammered by about 30% since the company releases its fourth-quarter financial results in late March, and that could be presenting investors with an intriguing opportunity.
There was a lot to like in CannTrust's quarterly performance. Its active medical marijuana customer count grew to 67,000 patients, and recreational sales in nine provinces helped CannTrust's fourth-quarter sales jump 132% year over year to CA$16.2 million. It sold 3,407 kilos of cannabis and cannabis equivalents, such as oils, and it harvested 4,816 kilos of marijuana in the quarter, up 712% year over year.
So why were investors disappointed? It could be a big net loss and a drop in gross margin and average prices per gram for cannabis oils. Spending associated with expanding production caused gross margin, excluding fair value adjustments to inventory, to decline to 35% from 69% in the previous quarter. Average prices per gram of cannabis equivalent fell to CA$4.29 from CA$9.34 one year ago, and the company's net loss was CA$25.5 million.
Spending more money to establish a toehold in this market early on isn't necessarily a bad thing, though. Expansions at its Niagara facility and newly acquired acreage for outdoor growth next year should help margin bounce back. It also appears that some of the decline in average prices per gram for equivalent product, such as oils, might have stemmed from using more lower-grade marijuana than last year and the fact that recreational market prices were lower than medical market prices.
The company's annualized production is on track to reach 50,000 kilos now that new space in Niagara is coming online, and another expansion should increase production to 100,000 kilos there in the second half of 2020. The outdoor acreage could add 100,000 kilos to 200,000 kilos of very low-cost production per year next year. Management thinks its cost per gram for its outdoor acreage will be about $0.25, well below the current $0.83 per gram it's costing.
Assuming management is correct that profitability will recover, CannTrust could be one of the better bargains in the industry currently, making it a bargain worth buying, too.
Todd Campbell owns shares of CannTrust Holdings and KushCo Holdings. His clients may have positions in the companies mentioned. The Motley Fool recommends CannTrust Holdings and KushCo Holdings. The Motley Fool has a disclosure policy.
