Later this week, Canada's Senate is scheduled to render its vote on bill C-45, which, if passed, would push the Cannabis Act (as bill C-45 is better known) one step closer to becoming law. At some point this month, recreational marijuana may officially be legal in Canada, making it the first developed country in the world to have passed such legislation.
With sales of the drug expected to commence in either August or September, cannabis growers have been ramping up their growing capacity as quickly as their wallets will allow. Legalizing recreational weed could add upwards of $5 billion in annual sales to an already-burgeoning industry. Unfortunately, investors are fully aware of this fact, and they've pushed pot stock valuations into the stratosphere.
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For example, Aphria is a company I'd previously leaned on as being attractively valued in the cannabis space. However, after acquiring Nuuvera in one of the priciest pot deals of all time, and following the diluting effects of a handful of bought-deal offerings, Aphria is now valued at a nosebleed forward price-to-earnings ratio of 84.
Aurora Cannabis, which recently announced its intention to acquire Ontario-based MedReleaf for $2.5 billion, has an even loftier valuation. The effect of going from just over 16 million shares outstanding at the completion of fiscal 2014, to almost 565 million shares as of its latest quarter, combined with the added costs of expansion and acquisitions, has pushed its forward price-to-earnings ratio above 200.
The world's cheapest pot stocks
From a fundamental perspective, finding value in the cannabis space isn't easy. However, it's not impossible, if you're willing to do a little digging. At the moment, there are three pot stocks that are sporting a forward price-to-earnings ratio of less than 30, which when accompanied with the industry's fast-paced growth, looks like a bargain.
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1. OrganiGram Holdings: Forward P/E of 28
While OrganiGram Holdings (OGI 2.63%) isn't the only grower on this list, it is unique. Unlike other cannabis growers that are expected to yield in excess of 100,000 kilograms per year when at full capacity, OrganiGram is the only one with a single grow site. The company's Moncton, New Brunswick, location is expected to be completed by April 2020 and yield 113,000 kilograms of cannabis a year at full capacity. The advantage of operating a single grow site is that it helps centralize the company's costs, ultimately improving its margins.
OrganiGram's management team also understands how important it is to branch out beyond just dried cannabis. In the company's most recently reported quarter, it sold 552,000 milliliters of cannabis oil, a 297% increase from the prior-year quarter. Even though oils are a niche product, they command a significantly higher price point and, in this instance, a much juicier margin than dried cannabis as well.
Though OrganiGram does run the risk of losing out on some long-term supply deals given that its expansion won't be complete until 2020, its focus on oils and its central location will allow it to do more with each dollar of revenue than its peers. The end result is a pot stock valued at just 28 times Wall Street's 2019 profit projections, which in my view appears inexpensive.
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2. Innovative Industrial Properties: Forward P/E of 20
An ancillary weed industry play that just might be the cheapest pot stock of them all is small-cap real estate investment trust (REIT) Innovative Industrial Properties (IIPR 2.21%).
As with any REIT, the idea is simple: buy land and/or buildings, and lease them out to a specific industry for an extended period of time. Innovative Industrial Properties acquires medical marijuana greenhouses in the U.S., and leases these facilities out for 15-year periods, with two additional five-year extensions allowed per lease. In creating such long-term leases, Innovative Industrial ensures that it generates predictable cash flow each and every quarter, which is sort of important to the relatively fixed-cost REIT model.
Also, as a REIT, the company is responsible for returning a majority of its net operating income back to shareholders in the form of a dividend. Maintaining this structure allows Innovative Industrial Properties to circumvent normal corporate income tax rates. For investors, the end result is a $0.25-per-quarter dividend, which is good enough for a yield of almost 3% per year.
Though there are obvious risks to owning properties that grow a substance that is entirely illegal in the United States, the federal government does appear content for the moment in allowing states to regulate their own cannabis industries. Assuming more states legalize in the future, Innovative Industrial Properties and its forward P/E of just 20 could be quite the bargain.
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3. CannTrust Holdings: Forward P/E of 24
Among marijuana growers, there's arguably none cheaper than Ontario-based CannTrust Holdings (CNTTQ). Based on forward P/E, CannTrust edges OrganiGram ever so slightly (24 versus 28).
What makes CannTrust so profitable is the company's focus on oils and extracts. In the company's most recently reported quarter, more than half of its total sales were derived from cannabis oils. Given the significant margin difference in oils versus dried cannabis, it simply means that CannTrust is able to do more with each dollar in revenue it receives than its peers.
CannTrust is also using product innovation to its advantage. In April, it introduced vegan hard-shell oil capsules, as well as announced a partnership with Grey Wolf Animal Health to examine potential uses of cannabis or cannabis oils in pets. Few growers have a more diverse lineup of oils and extracts than CannTrust.
When the company's Niagara Greenhouse facility is complete, it should have approximately 1 million square feet in growing capacity. Though that's well below what many of its peers will be sporting, it's more than enough for a company with a significant focus placed on higher-margin products. Based solely on the basis of forward P/E, you'd struggle to find a more fundamentally attractive marijuana grower than CannTrust.
