Few industries have had investors seeing green more over the past couple of years than legal marijuana. Cannabis research firm ArcView reports that North American legal pot sales jumped 34% in 2016 to $6.9 billion, while investment firm Cowen & Co. is estimating that U.S. sales alone could reach $50 billion by 2026. It's certainly not hard to see why investors are so gung ho on marijuana stocks.
But it's also important to realize that not all marijuana stocks are created equal. Quite a few are losing money and may continue to do so for years to come, even with the industry rapidly expanding. Likewise, certain countries aren't very conducive to growth at the moment. For example, in the U.S., the legal weed industry is growing sales by a double-digit percentage. However, because of U.S. tax code 280E, which disallows businesses that sell federally illegal substances from taking normal corporate income tax deductions, U.S. pot businesses often pay an effective tax rate upwards of 70% to 90%. That's not great news for investors.
Instead, the greatest growth can currently be found with our neighbor to the north, Canada.
Canada: Land of opportunity and serious marijuana growth
Canada has two things working in its favor. First, it legalized medical cannabis all the way back in 2001. Health Canada has overseen the expansion of the country's medical pot industry on a grander scale, with some of the largest companies already producing profits solely because of medical cannabis patient demand.
The second factor working in its favor is the expected legalization of recreational cannabis by July 2018. Prime Minister Justin Trudeau introduced legislation to legalize adult-use cannabis in April 2017, and with progressives maintaining a majority of seats in parliament, it seems more likely than not that adult-use pot will be a thing come the summer. Approving this bill would eventually add between $3.7 billion and $5 billion in sales a year.
Therefore, it probably comes as little surprise that the fastest growing marijuana stocks can almost always be found in Canada.
But even Canada has a hierarchy of growth. To be clear, nearly every public company I can find in Canada is expected to deliver some sort of growth over the next two fiscal years. But one company in particular stands head and shoulders above the rest.
The fastest-growing marijuana stocks over the next two years
The company with the quickest growth prospects in the entire marijuana industry at the moment is Aurora Cannabis (NYSE:ACB), which is expected to grow its annual sales by 307% in 2018 and another 268% in 2019, for an aggregate increase of nearly 1,400% in a two-year span. Canopy Growth Corp. comes somewhat close, but Aurora benefits from the fact that its sales are growing on a year-over-year basis from a smaller base.
Aurora's current growing capacity is actually quite small (less than 100,000 square feet), but that's about to change in a big way, which will be critical to ballooning sales for the company. Its Aurora Sky project -- an 800,000-square-foot facility that's expected to be highly automated -- is set for completion in mid-2018, and it should be able to produce in the neighborhood of 100,000 kilograms a year. You'll note that its completion date corresponds almost perfectly with the expected legalization of recreational weed.
Aurora Cannabis has also benefited from being able to send its dried cannabis products to overseas markets where medical cannabis has been legalized. The company's German subsidiary Pedanios stands to benefit from a nascent German market that has little domestic growing capacity at the moment.
Furthermore, Aurora Cannabis is looking to grow by acquisition. It recently made an unsolicited bid to acquire CanniMed Therapeutics (OTC:CMMDF) for up to $425 million. The combined company would be capable of around 130,000 kilograms in annual dried cannabis production, per estimates, and synergies from the combination would potentially improve margins. This isn't being factored into Aurora's growth estimates on Wall Street at the moment, but if what's currently a hostile bid for CanniMed comes to fruition, Wall Street may revise its expectations even higher.
A warning for Aurora Cannabis investors
Despite this exceptional growth rate, prospective investors in Aurora Cannabis do need to be aware of two things.
For starters, Aurora is wholly focused on reinvesting a good portion of its cash flow and cash on hand in expansion projects at the moment. That certainly seems like a prudent move with Canada on the verge of legalizing adult-use weed, but it also means that profits are going to be marginal despite nearly 1,400% aggregate sales growth between 2017 and 2019. There's a really good chance that Aurora is valued at more than 100 times its 2019 EPS, which is a rich price to pay.
Perhaps the more concerning issue is what the company is doing to raise capital for its expansion efforts. Since the business isn't generating much in regard to cash flow, Aurora has been leaning on bought-deal offerings to do the heavy lifting. A bought-deal offering (which is a common capital-raising option in Canada) involves an institutional investor buying shares in a company prior to the release of a prospectus. While bought-deal offerings have ensured a steady stream of capital on demand for Aurora, it's also diluting the heck out of existing shareholders. As of Nov. 8, 2017, the company had over 375 million shares outstanding, which is up from only 16.1 million outstanding in mid-2014. Even though shareholders who've held have made money, this dilution has a real chance to adversely impact investors in the future.
Thus, while Aurora is running away from its peers with regard to sales growth, the latter might offer the better investment opportunity.