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The World's Largest Marijuana Stock Has Investors Seeing Green, Despite a Second-Quarter Loss

By Sean Williams - Nov 16, 2017 at 9:07AM

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With 2.4 million square feet of indoor and greenhouse production under development, this pot stock has a clear competitive advantage.

In case you haven't noticed, marijuana stocks are on fire -- and with good reason. According to cannabis research firm ArcView, sales in North America for legal weed grew by 34% in 2016 to $6.9 billion, and they're expected to grow at a compound annual rate of 26% through 2021. If this prediction comes true, we're talking about a nearly $22 billion North American opportunity for investors by 2021.

While the greatest long-term growth potential lies with the U.S. market, over the near and intermediate term it's Canada that offers the most potential. Prime Minister Justin Trudeau introduced legislation in April designed to legalize recreational marijuana by July 1, 2018. Though there have been concerns about making Canada the first developed country to legalize adult-use weed, such as ease of adolescent access, it appears as if Trudeau's measure is on track to become law sometime next year. That could open the door to billions in added annual revenue, and also create an instant surge in demand.

A jar of cannabis buds lying atop a small pile of cash.

Image source: Getty Images.

The world's largest marijuana stock loses money in Q2 but still delivers

Not surprisingly, Canadian pot stocks have been the top performers of late, with Canopy Growth Corp. ( CGC -3.62% ), the now-largest marijuana stock in the world by market cap, leading the charge. On Tuesday morning, Nov. 14, Canopy wowed investors once again by reporting its second-quarter operating results for fiscal 2018. And while the company did report a net loss of $0.01 per share, reversing a year-ago profit of $0.05 per share, it more than made up for it in a number of other respects. 

For the quarter, Canopy Growth Corp. reported a 107% increase in Q2 sales to $13.8 million, keeping alive a streak of triple-digit sales growth from the prior-year period. It wound up selling 2,020 kilogram and kilogram-equivalents (e.g., cannabis oils) during the quarter, representing a 73% year-on-year increase, and a 10% sequential increase from the first quarter of 2018.

Breaking down sales a bit further led to more excitement for investors. It turns out that cannabis oil sales, which includes its Softgel capsules, increased to 18% of total sales in Q2 2018 from 14% of total sales in the year-ago quarter. Cannabis oils have a higher price point and margin than dried cannabis, so this trend is a positive that signals the potential for margin expansion if it continues.

A cannabis joint being held in front of Canada's red maple leaf.

Image source: Getty Images.

In terms of efficiency, the weighted average cost per gram before shipping and fulfillment was $0.98 per gram, down nearly 2% from the sequential quarter, and 26% lower than the year-ago quarter. Inclusive of higher-margin cannabis oils, the weighted cost per gram to the point of harvest was just $0.57 per gram. Meanwhile, the year-to-date selling price per gram has averaged $6.27, up 13% from this point last year.

The company also ended the quarter with plenty of capital on hand. It was sporting $85 million in cash and cash equivalents, which doesn't include the $192 million investment for 9.9% of all outstanding shares from spirits giant Constellation Brands ( STZ -0.11% ) that closed earlier this month.

Canopy's expansion efforts dwarf its competitors

But there were even more positives for bulls to cling to.

Canopy Growth notes that it currently has more than 2.4 million square feet of indoor and greenhouse production under development throughout Canada. This includes an October-announced joint venture agreement for 1.3 million square feet of greenhouse growing capacity in British Columbia, with the option to add another 1.7 million square feet, along with a September-announced 212,000-square-foot facility that's under construction. This latter facility will be neighbors with a 450,000-square-foot facility Canopy Growth recently acquired, which should push Tweed farms' production capacity over 1 million square feet, when complete. Tweed is easily Canada's most recognizable pot brand.

An indoor commercial cannabis grow farm.

Image source: Getty Images.

This expansion in production capacity is needed for a variety of reasons. According to Health Canada in May, the number of eligible medical patients has been growing by 10% a month, meaning demand from the medical side of the equation is rapidly expanding. Add to this the real possibility of adult-use legalization in Canada during the summer of 2018, and the fact that Canopy Growth has overseas partnerships allowing it to export its dried cannabis, and there's potentially more than enough demand to handle this production expansion.

In fact, Canopy Growth is looking like a giant next to its peers. Aphria (NASDAQOTH: APHQF), which is working on a phase 4 expansion project that'll cost in excess of $100 million, might be able to produce around 100,000 kilograms of dried cannabis annually across 1 million square feet of growing capacity. The project, according to the company's fiscal first-quarter report, should be complete by January 2019. 

Similarly, Aurora Cannabis' ( ACB -6.16% ) highly automated Aurora Sky project, an 800,000-square-foot project, is expected to yield more than 100,000 kilograms of dried cannabis annually and be completed by mid-2018.  Even combined, these two large pot players don't have the capacity under the development that Canopy Growth does. That's a first-mover advantage that could pay handsome rewards to the company's shareholders.

A street sign that reads, risk ahead.

Image source: Getty Images.

Two reasons investors should be concerned

In other words, the company lost money in the second quarter because it's making what it believes are prudent investments in its future. On paper that sounds great, but it doesn't mean Canopy Growth is a perfect stock by any means.

To begin with, even though it was able to secure a very welcome $192 million from Constellation Brands, the primary funding mechanism for Canopy Growth has been bought-deal offerings. This is a fancy term describing a share sale to an underwriter before the release of a prospectus. In short, Canopy Growth is selling stock to boost its capital on hand. Since Dec. 31, 2014, its outstanding share count in Canada has grown from 39.86 million to 167.23 million.  Though it's giving the company ample opportunities to expand its marijuana footprint, it's also diluting existing shareholders in a big way.

The other concern at this point is whether it can stand up to its lofty valuation. The company is currently lugging around a $3 billion market cap, yet it hasn't been able to generate a full-year profit on account of its capital expenditures. Even in the quarters where it has been profitable, it's only been negligible. Though it does have clear competitive advantages, the stock appears priced for perfection without knowing all the details of what might happen in Canada come next summer.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Canopy Growth Stock Quote
Canopy Growth
CGC
$9.98 (-3.62%) $0.38
Constellation Brands, Inc. Stock Quote
Constellation Brands, Inc.
STZ
$225.02 (-0.11%) $0.24
Aurora Cannabis Stock Quote
Aurora Cannabis
ACB
$5.76 (-6.16%) $0.38

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