This promises to be a year of big changes for the cannabis industry. Aside from the fact that 29 states have legalized marijuana in some capacity since 1996 in the U.S., the biggest thing since sliced bread in the cannabis industry is the expected legalization of recreational weed in Canada by this summer.
Bill C-45, or the Cannabis Act, as it's better known, would allow adults over the age of 18 to purchase marijuana legally in Canada. Should the Senate vote on June 7 in favor of the measure -- which seems very likely to happen -- the Cannabis Act would swiftly work its way through the legislative process, being signed into law shortly thereafter. The current timeline suggests that adults could be legally purchasing cannabis by sometime in August or September, adding what could be $5 billion or more in annual sales on top of the revenue currently being generated from medical weed sales and exports to medically legal foreign countries.
Image source: Getty Images.
In anticipation of this expected waving of the green flag in the months to come, Canadian growers have been expanding their growing capacity at a blistering pace. The thesis here is that growers with a lot of inventory and production will be able to secure lucrative long-term supply deals with retailers and/or provinces, leading to predictable annual cash flow.
Why Canopy Growth Corp. is king
Yet, of the more than 90 cultivation and/or sales licenses handed out by Health Canada, no company stands taller from a market cap perspective than Canopy Growth Corp. (CGC -10.51%). As of this past weekend, Canopy Growth commanded a $4.35 billion valuation, which is far and away the highest among pure-play pot stocks.
Why is Canopy Growth deserving of marijuana's highest market cap? There are essentially five reasons.
Image source: Getty Images.
1. Few growers can rival Canopy's peak annual production potential
To begin with, production does matter, and few growers have what it takes to rival Canopy Growth in terms of annual production. Last month, the company announced it had 2.4 million square feet of licensed growing space, which was more than three times higher than where it began the year. More importantly, Canopy is on its way to an expected 5.7 million square feet of cultivating space.
The interesting thing about this company is that it hasn't exactly been forthcoming with an annual production estimate or a timeline of when all of its British Columbia-based greenhouses will be complete. However, with 5.7 million square feet being the goal, it's not out of the question that 450,000 kilograms to 500,000 kilograms of dried cannabis production per year is the end result.
The only grower that even remotely comes close is Aurora Cannabis (ACB -4.85%). Last month, Aurora Cannabis announced the acquisition of 71 acres in Medicine Hat, Alberta, that'll house the 1.2 million-square-foot Aurora Sun facility. When complete, Aurora Sun, along with Aurora Nordic in Denmark and its previous flagship facility Aurora Sky, should help the company produce approximately 430,000 kilograms of dried cannabis a year. No other grower appears to be above a fully funded annual capacity of 230,000 kilograms per year.
Image source: Getty Images.
2. The company's distribution channel is unparalleled
Next, Canopy Growth's distribution channels are simply unmatched.
For a number of growers, being able to sell some of their supply to Canadian provinces, as well as having a foreign country or two for export purposes, would signify a relatively successful distribution channel. Canopy Growth, in addition to signing provincial long-term supply deals, has numerous foreign markets where it can export dried cannabis, as well as both an online and privately owned physical store presence where it can build its brand and market cannabis.
Finding a home for 500,000 kilograms of cannabis may sound like a challenge, but Canopy Growth has laid the groundwork better than any of its rivals to quickly find sales channels for its product.
Image source: Getty Images.
3. Key partnerships allow Canopy Growth to stand out
In addition to its superior distribution channels, Canopy maintains its dominance by partnering with big-name companies.
In January, it became the very first marijuana stock to procure equity financing assistance from one of Canada's five major banks, the Bank of Montreal. The size of Canopy's business, coupled with the expected legalization of recreational weed by this summer, allowed Bank of Montreal to feel comfortable enough to co-lead a nearly $136 million equity financing.
Late last year, Canopy wound up selling a 9.9% stake for about $190 million to spirits giant Constellation Brands. The maker of Corona and other spirits viewed its acquisition of a minority stake in Canopy as the perfect opportunity for future collaboration. Though Constellation Brands was crystal clear that it doesn't intend to operate in markets where governments don't view cannabis as legal, it does bring plenty of marketing and branding expertise to the table in countries that do allow medical or recreational weed to be sold.
Image source: Getty Images.
4. Its branding and margin focus should pay dividends
Canopy Growth has also done a superior job of building up its brands and focusing on the products that matter.
What I failed to mention in the section on distribution channels above is that the company's subsidiary, Tweed, is arguably the most recognized cannabis brand throughout all of Canada. While it could be difficult for growers to forge emotional attachments with consumers given packaging, marketing, and logo restrictions, as outlined by Health Canada, Canopy already has a head start over its peers.
Furthermore, the company's third-quarter operating results showed a decisive shift toward higher cannabis oil production. Oils are a niche product with a considerably higher price point and superior margin relative to dried marijuana. During the third quarter, Canopy sold 2,132 liters of cannabis oil, which equates to an 84% increase from the prior-year period. More importantly, these oils, which include its line of softgel capsules, increased to 23% of total sales in the third quarter from just 13% of total sales in the prior-year quarter. In other words, as long as oil sales remain on the rise, Canopy's margins have the potential to show significant improvement.
Image source: Getty Images.
5. Financing isn't an issue
Lastly, the company is well financed to handle greenhouse construction, marketing, research and development, and new product launches. At the end of the third quarter, Canopy had more than $320 million in cash and cash equivalents at its disposal. Assuming marijuana is legalized via the Cannabis Act in a few months, banks would be free to offer their services to pot companies, paving the way for even easier access to financing in the future.
However, what investors should note is that at no point have I suggested that Canopy Growth deserves a $4.35 billion market cap. I've merely listed the reasons it deserves to be the biggest pot stock by market cap among its peers. It's going to take time before we have a clear picture on supply and demand within Canada and global medical cannabis markets. Until we gain clarity on how much supply there will actually be once Canadian growers are fully ramped up, as well as how much demand there will be from foreign markets, betting on a higher share price for a cannabis kingpin like Canopy Growth is a risky bet.
