The marijuana industry is among the fastest growing in North America, and it's certainly turning heads among investors. Most marijuana stocks with a market cap in excess of $200 million have seen their share prices rise by at least 100% over the trailing year on account of optimism surrounding the green rush.
But what investors have to realize is that no two pot stocks are exactly the same. Assuming the industry is allowed to bud, certain cannabis stocks should outperform others over time. The challenge for investors is locating marijuana stocks that are expected to sport the highest operating margins. Higher operating margins would mean the ability for a company to generate more profit from the same amount of revenue than its peers. That's the type of company marijuana-stock investors should consider looking into.
The marijuana stock with the highest projected operating margin comes with an asterisk
So, which pure-play marijuana stock is expected to have the highest operating margin? The answer really depends on what you consider a pure-play marijuana stock to be. If we're focused on the entire pot industry, then the answer seems pretty straightforward.
Chances are, the highest operating margin will derive from cannabinoid-based drug developer GW Pharmaceuticals (GWPH). Drugmakers have exorbitant up-front costs tied to developing medicines, but they command exceptional pricing power if they can bring a product to market. GW Pharmaceuticals' experimental drug Epidiolex easily found the mark in numerous pivotal-stage clinical trials involving two rare types of childhood-onset epilepsy, known as Dravet syndrome and Lennox-Gastaut syndrome. Specifically, Epidiolex reduced seizure frequency by 39% in patients with Dravet syndrome, which was three times the reduction observed in the placebo group.
If approved, Epidiolex could generate in the neighborhood of $500 million in peak annual sales, moving GW Pharmaceuticals healthfully into the black and giving it the highest operating margin of all pot stocks by the end of the decade.
Close but no cigar
Then again, some investors might not consider GW Pharmaceuticals a pure-play pot stock considering that it's utilizing cannabinoids from the cannabis plant and not growing or selling cannabis like a traditional marijuana company. Figuring out which true pure-play pot stock (i.e., grower, distributor, or retailer) is going to deliver the best operating margin isn't such an easy task.
On the surface, you'd think an industry giant with incredible scale and a knack for acquiring other companies would have the edge. Canopy Growth Corp. (CGC -4.82%) currently has the highest growing capacity in Canada, a market where the number of medical cannabis patients has been expanding by 10% a month, according to Health Canada. As of its most recent quarterly report, Canopy Growth had over 2.4 million square feet in growing capacity being developed in preparation for a possible legalization of recreational weed in Canada and the ongoing expansion of medical cannabis markets domestically and overseas. Canopy is one of a handful of companies authorized to export dried cannabis to countries that have legalized medical cannabis.
But Canopy may not have an operating margin edge, despite its market share advantages, as a result of its acquisition-related expenses and possible integrational challenges.
Other investors might point to Aurora Cannabis (ACB -2.42%) or Aphria (NASDAQOTH: APHQF), both of which are predominantly growing on an organic basis. Aurora Cannabis' key project is Aurora Sky, which when completed in mid-2018 will be capable of yielding around 100,000 kilograms of dried cannabis annually across 800,000 square feet of capacity. Aurora Cannabis has touted its project as the most technologically advanced grow facility in the world, which would signify the expectation of low growing costs.
As for Aphria, its phase 4 project will expand its growing capacity to 1 million square feet and yield a similar 100,000 kilograms of dried cannabis annually. The more than $100 million project is expected to be completed in January 2019.
Being able to internalize these organic expansion costs and not deal with acquisition-related expenses does bode well for Aurora Cannabis and Aphria. Nevertheless, they too aren't likely to boast the highest operating margin among pot stocks.
The pure-play pot stock with the best operating margin might surprise you
While there's absolutely some guesswork at play here given the fact that recreational marijuana is still illegal in all but one country worldwide, my belief is that MedReleaf (NASDAQOTH: MEDFF) will eventually generate the best operating margin of all pure-play marijuana stocks.
MedReleaf offers a lot of the same growth tactics as its peers. It's a Canadian cannabis grower that's built up its eligible medical patient base, raised cash for expansion (albeit in its case it did so through an initial public offering, rather than through multiple bought-deal offerings), and worked to grow its capacity.
But MedReleaf has two advantages up its sleeve. First, it tends to hit a more affluent medical cannabis clientele, which could translate into bigger bucks if Canada approves adult-use weed by July 2018. More expensive cannabis strains generally mean higher margins.
Yet in the grand scheme of things, dried cannabis margins tend to underwhelm compared to other pot products. In particular, cannabis oils tend to have the best margins in the industry due to their considerably higher price point than dried cannabis. As of the end of 2016, MedReleaf controlled nearly 45% of Canada's cannabis oils market. This focus on consumers who want a higher-quality product should pay off in the form of the best operating margin, in my opinion.
If you're looking to add a marijuana stock to your watchlist, MedReleaf might be the name to consider.