Marijuana stocks are on fire, and they likely have the rapidly changing public perception of the drug to thank for those gains.
Gallup, the national pollster that's been conducting surveys on the public's opinion toward marijuana since the 1960s, found that 60% of respondents wanted to see the drug legalized nationally as of 2016. Comparatively, only 25% approved of legalizing it nationwide back in 1995, the year before California became the first state to legalize medical marijuana for compassionate use.
As the public's stance on marijuana has both softened and brightened, individual states have taken advantage by passing recreational and/or medical cannabis legislation. North American sales of legal pot totaled $6.9 billion in 2016 according to cannabis research firm ArcView Market Research, while investment firm Cowen & Co. anticipates legal sales growth of more than 23% per year through 2026. All of this data means one thing: a possible once-in-a-lifetime opportunity for investors looking to capitalize on this growth by investing in marijuana stocks.
Only there's one pretty major catch: Most marijuana stocks are a fundamental train wreck.
Marijuana stocks are fundamental mess
If there's one thing that nearly all marijuana stocks share in common, it's that they're losing money. Remember, there is no precedence for the cannabis industry, so many of these companies are learning as they go. The result is that all but one pot stock trading above a $200 million market value is losing money over the trailing-12-month period (we'll get to that company a bit later).
Marijuana businesses also face two major disadvantages that weigh on their ability to grow and expand. For starters, traditional cannabis businesses are unable to access basic banking services, which includes something as simple as a checking account. Since financial institutions answer to the federal government, and the latter currently lists cannabis as a Schedule 1 substance, and ergo illicit, dealing with weed businesses could be construed as money laundering. This forces marijuana businesses to deal in cash, which is a major security concern and a clear inhibitor of their growth.
Marijuana companies also face disadvantages when it comes to paying their corporate income taxes. Internal Revenue Service tax code 280E disallows businesses that sell federally illegal substances from taking normal business deductions. This effectively dooms pot companies to pay tax on their gross profits (should they have any) instead of their net profits.
And how can we forget that nearly all marijuana stocks trade on the over-the-counter (OTC) exchanges. To be clear, the OTC exchanges have made significant strides in reporting standards over the past couple of years, but they're still nowhere near what you'd find in a company listed on the NYSE or Nasdaq. The end result is that it can be tough at times to get accurate and up-to-date financial information on OTC-listed marijuana stocks. Not to mention that most marijuana stocks also happen to be penny stocks, and that's a path we'd rather not travel due to their volatility and the high probability of losses.
These two pot stocks are generating positive EBITDA
However, amid the minefield of money-losing marijuana stocks sit two cannabis companies that have actually generated positive EBITDA (earnings before interest, taxes, depreciation, and amortization) over the last 12 months.
EBITDA is an important measure for investors because it focuses on the operating performance of a company and the decisions made by management. It deemphasizes a number of one-time costs and expenses, such as tax payments, depreciation, and amortization, in order to give investors a better look at the operational success or failure of a company.
As noted, just two marijuana stocks with a market valuation of $200 million or greater are generating positive EBITDA: Canopy Growth Corp. (CGC 0.53%) and Aphria (NASDAQOTH: APHQF).
Insys Therapeutics (INSY), which is also known as a "marijuana stock," is generating positive EBITDA on a trailing-12-month basis, too. However, because almost all of its revenue comes from its sublingual pain medication Subsys, it's a bit of a misnomer to lump Insys in with pot stocks.
1. Canopy Growth Corp.
Canopy Growth Corp., a Canadian-based e-commerce retailer of dry cannabis and oil products that currently boasts a $1.2 billion valuation, generated $5.85 million in EBITDA over the trailing-12-month period, although it lost nearly $500,000 when analyzing its bottom line over the same time frame. However, through the first nine months of its current fiscal year, Canopy Growth has generated $0.04 per share in profit, or $4.5 million, meaning it may become the second profitable pot stock (on an annual basis) soon enough.
As a retailer of cannabis products, Canopy Growth could benefit greatly if Canadian Prime Minister Justin Trudeau moves forward with his pledge to legalize pot. This would nicely complement the company's impressive year-over-year registered patient growth from approximately 8,000 patients in the third quarter of the previous year to more than 29,000 in Q3 this fiscal year.
Additionally, Canopy Growth has been a busy bee on the acquisition front. Its most important business development was its buyout of Mettrum Health, which was completed at the end of January. This acquisition significantly boosted the company's growth production capacity.
Canopy Growth is also counting on its brand-name products to drive sales. Its best-known brand is Tweed, but it also entered a partnership with well-known rapper Snoop Dogg in October 2016. The Leafs by Snoop strains are already being sold by Tweed.
To be clear, Canopy Growth is valued at roughly 36 times its extrapolated 12-month sales and about 205 times its 12-month trailing EBITDA, so it's not cheap by any means. But it's a rare example of a thus-far modestly successful marijuana stock in a sea of otherwise bad bets.
Perhaps it's only befitting, then, that the only other marijuana stock that's generating a profit over the trailing-12-month period is Aphria, which happens to be Canopy Growth's prime competitor. Like Canopy Growth, Aphria is a medical marijuana-focused business that sells dried flower and cannabis oils in Canada through its e-commerce store as well as by telephone. Over the trailing-12-month period, Aphria has generated almost $2.1 million in positive EBITDA.
Considering that the two companies have a similar business model, Aphria is also looking to benefit from Canada's more lax stance on marijuana. Trudeau has previously pledged to lift restrictions on pot, but it remains to be seen if Canada can legalize the drug throughout the country.
Through the first half of its current fiscal year, Aphria has already generated more than $2.2 million in EBITDA. An 880-basis-point improvement in adjusted gross margin between Q2 2016 and Q2 2017 is a big reason for that difference.
What's more, it's well capitalized with $98.6 million in cash and cash equivalents on hand after a $37.2 million bought deal during the second quarter, and it's commencing on part 3 of its growing space expansion, which will add another 200,000 square feet of space. Though Canopy Growth has the larger operation, the smaller Aphria may prove even more attractive.
Personally, I think investors should keep their distance from marijuana stocks, but these are two names to put at the top of their radar for now.
Marijuana's market opportunity is big, but few marijuana stocks are worth investors' consideration.