Unless you've been living under a rock since the beginning of 2016, you've likely noticed the increased fervor surrounding the legal cannabis industry. That excitement has only intensified of late, following the passage of the Cannabis Act in Canada, which makes recreational marijuana legal for adults to purchase as of Oct. 17, 2018.
Waving the green flag on adult-use cannabis is a big deal for the legal weed industry as it could lead to an estimated influx of approximately $5 billion in added annual sales. This will come atop what the Canadian pot industry is already generating from the sale of medical cannabis in the domestic market, and via the export of cannabis and cannabis-related products to foreign markets where medical weed is legal.
As you might expect, with Canadian pot sales expected to soar from a few hundred million dollars annually into the billions each year, companies with direct involvement in the growth, processing, distribution, and sale of the plant have been expanding their reach as quickly as possible. Likewise, these companies typically represent the most front-and-center investment opportunities for marijuana stock investors.
But don't think for a moment that there isn't a massive ancillary market waiting in the wings to capitalize on the ongoing expansion of the legal cannabis industry. This ancillary market is filled with companies that don't directly come in contact with the cannabis plant, but nonetheless play a vital role behind the scenes in making the industry tick.
Opportunities are budding for this behind-the-scenes pot stock
One such ancillary marijuana stock reported its third-quarter operating results after the closing bell on Thursday, July 12. And while the results were a bit rough around the edges, they speak to a lot of growth to come for the ancillary cannabis market.
On Thursday, California-based Kush Bottles (NASDAQOTH:KSHB), a company focused on marketing, packaging, branding, vaporizers, cartridges, and other solutions for the medical and recreational marijuana industry, announced that its sales grew by 173% on a year-over-year basis to $12.9 million, up from $4.7 million in the third quarter of 2017. This included organic growth across its existing segments, especially its vaporizer and cartridge product segments, as well as inorganic growth derived from its acquisition of Summit Innovations, which closed on May 3.
Beyond just Kush Bottles' top-line results, there were a number of things for optimists to be excited about. As noted, the closing of the Summit Innovations acquisition for $3.2 million in cash and 1.28 million shares of Kush Bottles' stock moved Kush into the hydrocarbon gas and solvent market. Hydrocarbon gases are used when converting cannabis plants into oils. Considering that dried cannabis has shown to be commoditized over time, the push to diversify into oils and other alternative cannabis products is growing. Ergo, this could be an especially smart acquisition for Kush Bottles.
The company also recently bolstered its cash position. Having ended the quarter with $3.6 million in cash, a registered direct offering in June led to $32.9 million in net proceeds. This extra cash takes away any near-term cash concerns, as well as gives Kush the ability to go on a shopping spree, should it choose. As CEO Nick Kovacevich commented in his company's press release:
[O]ur recently completed capital raise providing net proceeds of almost $33 million will provide the financial foundation for continued expansion in support of our growth strategy. All of these activities place us in a unique position to identify market demands, develop innovative products and bring them to market. As we head toward the end of our fiscal year, we look forward to driving continued organic and acquisitive growth.
The company also stands to be a major beneficiary of Canada's legalization. Regulatory agency Health Canada laid out a laundry list of packaging requirements that'll have to be adhered to by growers and retailers. That should put Kush Bottles in the enviable position of providing that marketing, packaging, and branding solutions that allows these potentially hundreds of Canadian cannabis brands to stand out. Just think, once edibles and cannabis-infused beverages enter the market, which could happen within a year or two, Kush's position as an integral behind-the-scenes player may be cemented.
Still a bit rough around the edges
However, Kush Bottles' third-quarter report wasn't perfect. In particular, the company wound up reporting an adjusted net loss of $2.17 million ($0.03 per share), which reversed a negligible year-ago profit of $6,119. Although only one Wall Street analyst is covering the company, the $0.03 per share loss was wider than expected. Selling, general, and administrative costs ballooned to $4.99 million from $1.38 million in the year-ago quarter, while stock-based compensation nearly doubled to $495,897. The point being that as long as Kush Bottles remains in rapid expansion mode, turning a profit may prove difficult.
Another consideration to be made here is that, at least until edibles and infused beverages are approved by parliament, margins could prove challenging for Kush Bottles. The company specifically noted a 720-point reduction in gross margin from the prior-year period, which it blamed mostly on increased business in its lower-margin vaporizer and cartridge segments. Just as profitability should blossom for growers once the industry matures a bit, the same can probably be said for an ancillary player like Kush Bottles.
Lastly, like practically every other marijuana stock, Kush Bottles isn't generating enough positive cash flow to organically and inorganically grow its business. It, too, has turned to selling shares of its common stock to raise capital. While it's had absolutely no issue raising cash when needed, these share offerings will ultimately increase the number of shares outstanding, diluting existing shareholders and making it that much tougher for the company to record a meaningful per-share profit.
Don't get me wrong -- Kush Bottles finds itself in a wonderful niche despite not being in direct contact with the cannabis plant. But even behind-the-scenes cannabis stocks like Kush Bottles will likely need time for the industry to mature before they become worthy of investment consideration.