Excitement has been budding for years in the legal cannabis space, and we've begun to see that translate into tangible results.
In the U.S., Oklahoma recently became the 30th state to legalize medical marijuana, while nine of these 30 states have also approved the use of recreational weed. To our south, Mexico legalized medical pot back in June 2017. And to our north, Canada stands ready to become the first industrialized country in the world to legalize adult-use cannabis. It's no wonder that cannabis research firm ArcView is predicting compound annual sales growth of 28% in North America through 2021.
Marijuana stocks couldn't catch a break in July
However, moving marijuana from an illicit channel to a legal one won't necessarily be without its headaches -- and that's certainly reflective in the underlying valuations of marijuana stocks. Even though the group as a whole has had one incredible run since the beginning of 2016, they collectively had a miserable July, which lent to the month's craziest statistic. After screening for the 25 largest and most influential direct and indirect pot stocks, just one finished the month higher. And, to be honest, you don't even need a single finger to tabulate its percentage gain.
The big winner for July, which also happened to be the top dog during the awful first quarter marijuana stocks suffered through, is California-based Kush Bottles (NASDAQOTH:KSHB). Kush Bottles ended July a whopping 0.7% higher than where it began the month.
There were two events in July that appear to have allowed Kush, which provides marketing, packaging, and branding services to more than 5,000 cultivators worldwide, to inch its way higher. First, there was the release of the company's third-quarter operating results. Sales wound up growing a hearty 173% to $12.9 million, which was somewhat aided by the acquisition of Summit Innovations. This buyout moves Kush into hydrocarbon gases and solvents, putting it smack-dab in the middle of the rapidly growing cannabis oils market, which uses hydrocarbon gases in the crafting of oils.
The second catalyst looks to be the announced launch of three new child-resistant packaging product lines (LocTin, Palm N Turn, and UV Glass Concentrate Container) for the cannabis industry. With Health Canada laying out some pretty rigid packaging and marketing restrictions for legal cannabis, Kush Bottles aims to become an indispensable middleman between growers and retailers.
Behind Kush Bottes, the next-best performers in July were posh dispensary MedMen Enterprises, down 0.3%, Aphria (NASDAQOTH:APHQF) down 2.2%, which was the best performance of all direct growers, and cannabinoid-drug developer GW Pharmaceuticals. GW Pharmaceuticals shed just 3.2% of its value in the month following the approval of its lead drug, Epidiolex, a cannabidiol-based oral solution designed to treat two rare types of childhood-onset epilepsy.
Three reasons marijuana stocks have had a rough go of things recently
Why no love for pot stocks with Canadian legalization just over two months and a week away? My belief is that it boils down to three factors.
1. There's a lot of supply-and-demand-based uncertainty
For starters, no one is entirely certain of what to expect when marijuana moves into legal channels. Since no country the size of Canada has ever given the green-light to adult-use weed before, it's all guesswork as to what demand and supply might look like in six months, a year, or three years from now.
If demand is strong and growers avoid oversupplying the market, margins should be robust and growers could be rolling in the green. Conversely, if cannabis growers flood the market with dried cannabis, and the product becomes commoditized, much in the same way as we've witnessed in Colorado, Washington, and Oregon in the U.S., then margins and profitability could be challenged, even with the benefits of economies of scale.
Building on this first point, there's also uncertainty as to whether or not Canada's low excise tax rate of 10%, which is notably lower than the excise tax on alcohol that can range between 50% and 80%, will be enough to lure consumers into legal channels. If the legal market can't unseat illicit growers and sales channels, then these lofty projections will soon be thrown out the window.
2. Fundamentals now matter
Consider this a bit of "buy the rumor, sell the news," but with the Cannabis Act now officially passed in Canada, as of June 19, attention is beginning to turn away from "what could be?" to "what have you done for me lately?"
Most marijuana stocks have spent a small fortune expanding their production capacity this year, and many aren't generating much in the way of profits as of yet. The aforementioned Aphria, the "top-performer" among growers in July, formed a joint venture with Double Diamond Farms, known as Aphria Diamond, acquired Broken Coast Cannabis, and announced its intent to construct an extraction center for cannabis concentrate production, just since the year began.
But these acquisitions, and Aphria's international expansion efforts, are hurting the company's bottom line. There's a real chance its positive EBITDA streak could come to a halt, and that Aphria delivers quarterly net losses despite rapidly rising revenue. This is a story that's playing out with a lot of pot stocks right now. Investors want to see results, but those results could be many quarters out still.
3. Share-based dilution
The last issue, which is something I've harped on relentlessly over the last six-plus months with marijuana stocks, is that they're diluting the heck out of shareholders.
You see, prior to the passage of the Cannabis Act in June, pot stocks didn't have access to basic banking services like a normal business. Financial institutions feared the potential for criminal and/or financial penalties if they offered basic banking services to weed-based companies. This meant capital raising was done primarily by bought-deal offerings. This involved the sale of common stock, convertible debentures, stock options, and/or warrants, to an investor or group of investors. Though these bought-deal offerings always seemed to do the trick when capital needed to be raised, they also substantially increased the outstanding share count of every pot stock that employed this tactic.
Royalty and streaming company Auxly Cannabis Group (NASDAQOTH:CBWTF), which primarily provides upfront capital to growers looking to expand their capacity, is the perfect case in point. Auxly needed to raise capital via common stock offerings to forge more than a dozen streaming deals, as well as acquire smaller grow farms. Despite its market cap actually rising since the beginning of the year, Auxly Cannabis Group's share price has plummeted more than 70% -- and it's entirely due to share-based dilution.
Though the legal cannabis industry as a whole has a bright future, marijuana stocks themselves may not generate the green that investors expect.