When it comes fast-growing industries, you'd struggle to find one with more consistent annual growth potential than legal marijuana -- and marijuana stock investors know it! Depending on your source, the marijuana industry is set to grow by between 23% and 27% annually over the next 5 to 10 years, with investment firm Cowen & Co. offering the most bullish prediction, with a call for $50 billion in legal U.S. sales by 2026.
Since more than an estimated $46 billion in North American pot sales were conducted under the table in 2016, according to ArcView Market Research, marijuana stock investors view the potential to transfer these illegal sales to legal channels as a massive growth opportunity.
The result for many pot stocks has been substantial year-over-year share-price appreciation. Most weed stocks with market valuations in excess of $200 million have doubled, tripled, or in rarer cases, increased even more over the trailing year. For private cannabis businesses on the outside looking in, this could be an opportunity that's simply too enticing to pass up.
Investors witness yet another "marijuana first"
In April, investors were privy to the very first marijuana stock ETF, which debuted on the Toronto Stock Exchange with slightly more than a dozen holdings. This represented the very first time a basket fund was created for investors to easily diversify their pot-stock holdings. Considering how risky investing in marijuana stocks can be, the Horizons Medical Marijuana Life Sciences ETF (TSX:HMMJ) offers a way to somewhat spread out investor risk.
And last week, investors witnessed another marijuana first: the largest North American marijuana stock IPO of all-time.
On Tuesday, May 30, Ontario-based MedReleaf (TSX:LEAF), a licensed Canadian medical-marijuana producer and retailer, raised $75 million -- $60 million in sales coming from its treasury and $15 million from existing shareholders -- by pricing an initial public offering at roughly $7.03 a share (or $9.50 Canadian). The IPO values MedReleaf at approximately $636 million, making it the largest North American marijuana stock IPO of all time.
The pricing also placed MedReleaf, which began trading on June 7th, ahead of peers Aurora Cannabis (NASDAQOTH:ACBFF) and Aphria (NASDAQOTH:APHQF), in terms of market cap, to become the second most valuable Canadian-based pot stock behind only Canopy Growth Corp. (NASDAQOTH:TWMJF). Investor interest in MedReleaf is based on a rapidly growing base of medical marijuana users -- medical pot has been legal in Canada since 2001 -- as well as the hope that Canada's government will legalize recreational weed by the summer of 2018. Should this happen, MedReleaf and its peers would be expected to see a surge in demand.
Based on investors' growing appetite for marijuana stocks, this could be the beginning of a rush for legal weed IPOs.
MedReleaf is not guaranteed to succeed
However, cannabis stock investors could be in for a surprise if they expect to make money off of investing in MedReleaf. Like other pot stocks, MedReleaf's valuation is astronomically high, even if it's been showing signs of operational improvement.
According to the company's prospectus, sales have reached nearly $30 million through the first nine months of the current fiscal year, which is a nice improvement from the $12.4 million in sales recorded in the nine months over the prior-year period. Profits have also more than quintupled.
Nonetheless, the company is on pace to earn perhaps $10 million to $12 million for the full year, yet it'll be valued initially at $636 million. Even in a utopian scenario, we're talking about well over 50 times its profit potential, which is quite frothy for a business that sells a substance that's illegal on an adult-use level in Canada, the United States, and Mexico.
MedReleaf is also set to face pretty sizable competition from the aforementioned three producers, as well as medical cannabis suppliers Canopy Growth, Aurora Cannabis, and Aphria. Canopy Growth recently acquired 472,000 square feet of property, which includes its headquarters, and also purchased Mettrum Health, boosting its medical cannabis market share and its grow capacity.
Meanwhile, Aurora Cannabis is constructing the 800,000 square foot Aurora Sky project, which will dramatically boost its capacity, and Aphria is working on its Phase IV expansion that'll boost its grow capacity to 1 million square feet. Both Aurora and Aphria are expected to have their facilities operational prior to the possible launch of legal recreational cannabis in July 2018. MedReleaf will have no cakewalk with this sort of competition.
Additionally, there are no guarantees that Canada chooses to legalize recreational weed, which would take the wind right out of the sails of these four Canadian marijuana stocks. Concerns over children gaining access to adult-use cannabis, as well as ensuring that users don't drive while impaired, are issues that Canada and the U.S. are struggling to find resolutions for.
In general, marijuana stocks, including MedReleaf, are far more trouble than they're worth at the present. If we do see meaningful change from Canada's parliament, it may be worth revisiting these companies, but speculating based on the whims of politicians usually isn't a smart investing strategy.