Sometimes a first impression doesn't tell the full story. That's the case for my opinion of a small marijuana stock that perhaps hasn't caught the attention of most investors -- CannaRoyalty (NASDAQOTH:ORHOF).
You have probably read and heard a lot about the top marijuana stocks. For the most part, these are the stocks of Canadian marijuana growers like Canopy Growth (NYSE:CGC). But U.S.-based marijuana businesses don't get nearly as much attention. I'll be the first to admit that I haven't focused on some of these stocks of U.S. companies as much as I have on the Canadian stocks.
However, I did recently write about CannaRoyalty. And while I was generally positive about the company, I missed out on something very important about CannaRoyalty's business. The more I learned about this aspect of what CannaRoyalty is doing, the more impressed I became about the company's prospects. Here's what investors need to know about this under-the-radar marijuana stock.
What CannaRoyalty does
CannaRoyalty's name reflects what the company's primary focus used to be rather than its main focus now. The company started out financing other marijuana-related businesses in exchange for equity and a royalty stream from those businesses' sales. This business model is similar to that of Auxly Cannabis, formerly known as Cannabis Wheaton.
If you look at CannaRoyalty's website, you'll still see plenty of references to this royalty-streaming model. There's a lot of information about how the company carefully analyzes potential business partners before making investments in them.
However, CannaRoyalty now focuses much more heavily on its distribution operations. The company is the largest cannabis distributor in California, at least of the legal variety. CannaRoyalty buys cannabis products from manufacturers, warehouses those products, and distributes them to dispensaries throughout the state.
The company also owns several cannabis brands itself. These brands include FloraCal cannabis flowers, GreenRock Botanicals vapes, Simply vape pens, and Soul Sugar cannabis edibles.
CannaRoyalty hasn't totally abandoned its earlier business model. Earlier this year, the company provided financing to Canadian vaping products retailer 180 Smoke. But it's definitely switching gears. In the second quarter of 2018, CannaRoyalty's royalties made up only 4% of the company's total revenue compared to nearly 35% in the prior-year period.
Some of CannaRoyalty's previous investments under the royalty-streaming model have paid off quite nicely. For example, Aurora Cannabis (NYSE:ACB) recently acquired Anandia Laboratories for 115 million in Canadian dollars. CannaRoyalty initially invested around CA$4 million in Anandia in February 2017. The Aurora deal gave the company a quick return of roughly 315%.
Why it's largely flying under the radar
I think there are two main reasons CannaRoyalty hasn't generated the buzz that Canopy Growth, Aurora Cannabis, and other marijuana stocks have. First is the company's much smaller market cap of around $235 million compared to the multibillion-dollar market caps of several of the Canadian businesses. The reality is that microcap stocks don't get as much coverage in the press as stocks with higher market caps.
Of course, there's a bit of a catch-22 at work. Sometimes stocks enjoy higher market caps in large part because of the greater amount of publicity.
The second reason I think CannaRoyalty has gone unnoticed by many investors is its heavy focus on the U.S. market. CannaRoyalty is headquartered in Ottawa, Canada. Its stock is listed on Canada's New Stock Exchange (CNQ). But for all practical purposes, CannaRoyalty is a U.S. company. Most of its employees are located in California. Most of its revenue is made in the state as well.
U.S. marijuana stocks haven't gotten the love from the investment community that their Canadian peers have. This is largely because marijuana remains illegal at the federal level in the U.S. Canadian stocks like Canopy Growth have listed on U.S. stock exchanges and have attracted the attention of big institutional investors. However, there aren't any stocks of companies that primarily focus on the U.S. cannabis industry trading on the two major U.S. stock exchanges.
Canopy, Aurora, and the other leading Canadian marijuana stocks are listed on the Toronto Stock Exchange (TSX) -- some, like Canopy, with dual listings on the TSX and U.S. stock exchanges. However, the TSX prohibits its members from conducting significant operations in jurisdictions in which marijuana is illegal at the federal level. That means CannaRoyalty can't move up to the biggest stock exchange in Canada.
Why the stock is intriguing
There's a pretty good argument to be made that CannaRoyalty stock should trade at much higher levels than it does right now. The company generated revenue in its most recent quarter that was more than one-fifth that of Aurora Cannabis's revenue in its most recent quarter. If CannaRoyalty's market cap was one-fifth of Aurora's, its stock price would be five times higher than it currently is.
Investors, though, look more toward the future than the past. Aurora Cannabis, Canopy Growth, and their peers should soon see tremendous growth as the Canadian recreational marijuana market opens. While that's true, CannaRoyalty operates in California. The California cannabis market should total US$7.7 billion by 2022, according to projections from Arcview Market Research and BDS Analytics. As CannaRoyalty stated in an investor presentation, "Canada is big. California is huge."
I spoke recently with CannaRoyalty CEO Marc Lustig. He told me that the company plans to expand into neighboring Nevada. Arcview and BDS Analytics think that Nevada's marijuana market will top US$650 million within the next four years.
CannaRoyalty also benefits from the data it collects through its distribution business. The company has great visibility into which cannabis brands are performing well. Lustig said that CannaRoyalty could continue to scoop up brands that show great potential to add to its own lineup.
This stock isn't for every investor. There are significant risks associated with operating in the U.S. as long as marijuana is illegal at the federal level. Although CannaRoyalty was profitable in Q2 due to cashing in on earlier investments, the company still reported an operational loss.
However, CannaRoyalty is intriguing to me. For aggressive investors looking to jump into the largest cannabis market in the world (the U.S.), CannaRoyalty is the best under-the-radar marijuana stock I've seen so far.