Ready or not, recreational legalization is just around the corner for our neighbor to the north. In 40 days, licensed retail dispensaries will be able to sell adult-use cannabis to those aged 18 or 19 and older, depending on the province.
Aside from Canada making history by becoming the first industrialized nation to give the green light to recreational weed, legalization also means big bucks for Canadian marijuana stocks. Though estimates vary wildly -- as we'd expect to see from an industry that really has no precedence -- the expectation is that legal cannabis in Canada could generate in the neighborhood of $5 billion in added annual sales. Remember, Canadian pot companies were generating a couple hundred million dollars annually from the sale of medical marijuana domestically, and via exports to foreign countries where medical pot is legal, prior to the passage of the Cannabis Act.
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When can we expect profits from pot stocks?
The all-important question, though, is this: When will marijuana stocks begin turning a profit on a recurring basis?
Unfortunately, there is no one-size-fits-all answer.
The two wildcards that will more or less determine when a marijuana stock has an opportunity to become profitable on a recurring basis are (1) capacity expansion and (2) business reinvestment.
Ongoing capacity expansion will constrain profitability
Although the Cannabis Act was passed on June 19 by Parliament, it didn't look like a sure thing to pass until late last year. Though marijuana is clearly a big-money business, growers weren't going to spend hundreds of millions of dollars on capacity expansion until they knew for certain that passage was likely. This is why Wall Street and investors have witnessed a mad scramble to expand capacity, forge partnerships, and make acquisitions during the first half of this year.
However, the pace at which growers are expanding their capacity varies from one pot stock to the next. For example, Aurora Cannabis (ACBFF 3.13%) expects to slide in as the top weed producer throughout Canada, with 570,000 kilograms of annual yield when at full capacity. But Aurora only recently announced its intent to build the 1.2-million-square foot Aurora Sun facility in Medicine Hat, Alberta, and it's still in the process of retrofitting existing greenhouses that had previously been used for growing vegetables via its strategic partnership with Alfred Petersen & Son in Denmark. Long story short, Aurora Cannabis still has a lot of up-front costs to contend with in the interim that'll likely keep it from producing a profit.
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Business reinvestment could eat up some, or all, profits
The other factor at play here is business reinvestment. The next logical step in the evolution of the marijuana industry beyond capacity expansion is for sales, marketing infrastructure, and branding to be built from the ground up. For instance, a number of top-tier growers have chosen to partner with software-as-a-service giant Shopify (SHOP 1.09%). Shopify's e-commerce platform is set to act like a middleman for cannabis orders. It'll be responsible for executing orders, as well as anticipating customers' needs. Shopify has already snagged a partnership with the Ontario Liquor Control Board, as well as Aurora Cannabis, among other growers.
Back to actual growers, the largest pot stock by market cap, Canopy Growth Corp. (CGC 3.13%), is unlikely to be profitable anytime soon since it'll be reinvesting most of its operating cash flow back into building its sales channels and product development in foreign countries. Following the announcement that Modelo and Corona beer maker Constellation Brands will be making a $3.8 billion equity investment in Canopy Growth, pending regulatory approval, Canopy has in excess of $4 billion to deploy on its international infrastructure and brand-building strategy.
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Ancillary pot stocks are the best bet for early profits
While it's very difficult to say when most marijuana stocks will be profitable on a recurring basis, it does look as if ancillary pot stocks -- i.e., companies that don't directly touch the cannabis plant, but nevertheless play a crucial role in the weed industry -- have the best shot of "delivering the green."
One ancillary weed stock that's already profitable, and that could see its earnings per share rise even more in the year to come, is real estate investment trust (REIT) Innovative Industries Properties (IIPR +1.40%).
The idea behind a REIT is that it buys real estate or buildings that are focused within a specific industry, then aims to lease those properties for an extended period of time. Many years down the road, it can choose to sell the property for a profit. Innovative Industrial Properties acquires medical cannabis grow farms in the U.S. and leases them out for between 15 and 20 years, with annual rental increases and management fees tacked on that ensure it stays ahead of the inflationary curve. The company has been profitable for numerous quarters now, and given its relatively fixed-cost structure and predictable cash flow from its long-term leases, Innovative Industrial Properties should remain quite profitable in the years to come.
In my opinion, it's possible we could begin to see recurring profitability by as early as late 2019 for growers, but with the supply-and-demand outlook being a complete unknown, ancillary marijuana stocks look to be your best bet for early profits.
