A huge change could be coming to the U.S. marijuana market.
President Trump stated last week that he will likely support a bipartisan bill that would keep the federal government out of the way of states that have legalized marijuana. This statement echoed an announcement made by Sen. Cory Gardner (R.-Colo.) in April that the president had agreed to support a legislative solution to the chasm between federal and state marijuana laws.
Even before Trump's latest comments, the U.S. marijuana market was projected to grow to $22 billion by 2022 -- more than triple its size last year. I've written in the past that probably the best company positioned to ride this wave is Scotts Miracle-Gro. However, there is another top U.S. marijuana stock that could also be a big winner. Is now the time to think about buying Kush Bottles (NASDAQOTH:KSHB)?
A cush spot for Kush
Kush Bottles finds itself in a unique position. It definitely falls into the category of marijuana stock, since the company's core business is selling packaging and supplies to marijuana dispensaries and growers. But because Kush Bottles doesn't actually deal with marijuana itself, the company has access to capital that most industry players don't.
Established in 2010, Kush has been able to grow rapidly as more states have legalized marijuana. The company now has more than 5,000 customers, up from around 4,000 in 2017. And sales are soaring. During each of the last three quarters, Kush reported year-over-year revenue increases of at least 249%.
The great news for Kush is that expansion of the U.S. marijuana industry is still only in its early stages. Kush is moving into states that have new recreational markets such as Nevada and Massachusetts. Legal recreational marijuana in the company's home state of California should have a significant growth trajectory ahead.
Even more states are looking to legalize recreational marijuana. Michigan votes on a measure to allow the legal use of recreational marijuana later this year. New Jersey and New York could follow suit in the not-too-distant future.
Kush Bottles is looking to capitalize on the trends in several ways. The company is moving into adjacent ancillary businesses supporting the marijuana industry. Kush acquired Summit Innovations in May. Summit distributes hydrocarbon gases used to convert cannabis plants into oils.
Kush is also looking north to Canada. Although medical marijuana has been legal in Canada for several years, the restrictions in this market didn't present a big opportunity for Kush's products. However, anticipated national legalization of adult use of recreational marijuana could change the dynamics for Kush.
In addition, the company has its eyes on expanding beyond the marijuana space. Kush recently launched a new division that offers packaging solutions to the pharmaceutical and veterinary industries.
Good news or bad news?
This move into more traditional packaging solutions could be a smart move for Kush Bottles. The prospects of changes in U.S. marijuana laws that would prevent the federal government from intervening in states that have legalized marijuana is good news for the industry, but ironically, it could ultimately be bad news for Kush.
Kush Bottles' key advantage right now is that the U.S. marijuana industry is still something of a pariah to many established businesses. Kush has stepped in when many others wouldn't, and that has worked out very nicely for the company so far.
However, a change in federal marijuana laws could de-stigmatize the marijuana industry. If and when that happens, there could be a flood of well-funded competitors entering the market that Kush Bottles largely has to itself right now.
Building a sustainable moat in manufacturing packaging solutions isn't easy to do. Kush Bottles CEO Nick Kovacevich stated last week that the company has "about a dozen provisional patents" filed for products that haven't been launched yet. Establishing intellectual property rights could help Kush defend its turf, but there's no way to prevent others from coming up with their own solutions that might be just as good.
Still, though, Kush Bottles enjoys a first-mover advantage. The company has forged solid relationships with dispensaries and marijuana growers. It is jumping into new markets as they open up. Kush could build up enough of a head start that it is in position to thrive in an expanded U.S. marijuana market, even with greater competition.
Should investors buy Kush Bottles stock? There are several things to consider first.
Kush Bottles stock has been a big winner over the last year, the shares soaring more than 150%. However, it's been a highly volatile ride. Most recently, Kush stock plunged nearly 20% after the company announced a $36 million stock offering, a move that dilutes the value of existing shares.
Its rapid rise has also made Kush Bottles stock very pricey. Shares currently trade at 11 times sales. You have to throw earnings-based valuation metrics out the window for Kush, because the company posted a $920,000 loss in its second quarter that wiped out all of its profits from the previous three quarters.
Kush appears to be in pretty good financial shape, though. That Q2 loss stemmed primarily from non-cash stock compensation and depreciation expenses. The company reported more than $7 million in cash as of Feb. 28, 2018, with only around $1.2 million in debt. And if Kush Bottles' revenue continues to skyrocket as it has been, it won't take long for the company's valuation to improve significantly, even with the stock continuing to rise.
I agree with my colleague Sean Williams that the ancillary cannabis industry is one for investors to closely watch. I also agree with Sean that Kush Bottles is one of the top stocks to keep on your radar in this ancillary market. However, I'm hesitant to call the stock a buy right now. My view is that there are other stocks that provide a better risk-reward proposition than Kush Bottles.
Editor's note: A previous version of this article stated that Kush Bottle's Q2 loss was $920 million. The actual loss was $920,000. The Fool regrets the error.