"Going green" has taken on an entirely new meaning in 2018. In just nine days, on Oct. 17, 2018, Canada will be lifting the curtain on more than nine decades of cannabis prohibition. Beginning next Wednesday, adults aged 18 or 19 (depending on the province) will be free to purchase recreational marijuana in licensed dispensaries or online. It'll also make Canada the first industrialized country in the world, and only second overall behind Uruguay, to legalize recreational weed.
When legal, adult-use weed is expected to be a big-money business. Initial estimates from Wall Street suggest it could generate in the neighborhood of $5 billion in added annual sales, atop what the industry is already bringing in via medical marijuana sales and exports. Given the expectation of strong consumer demand and lofty sales projections, it's no wonder that marijuana stock valuations have been pushed into the stratosphere.
Five pot stocks with genuine long-term potential
Whereas some investors can justify ignoring traditional fundamental metrics like the price-to-earnings ratio when triple-digit sales growth is involved, other investors, like myself, struggle to do so. Feel free to call me a skeptic, but I've seen bubble-like scenarios play out with "the next big thing" plenty of times before, and there's a good chance marijuana stocks will be no different.
Though I'm not exactly champing at the bit to buy marijuana stocks, and have suggested that the wait-and-see approach is best suited for investors in the meantime, there are five pot stocks that do have my full and undivided attention.
1. OrganiGram Holdings
OrganiGram Holdings (NASDAQ:OGI) is a company I've dubbed my favorite pot stock, so it shouldn't be a huge surprise that it's among the marijuana companies I believe could do well over the longer term. OrganiGram is genuinely separating itself from a crowded field of growers and should benefit over the long run from its cost-saving practices.
OrganiGram is growing all of its cannabis at its Moncton, New Brunswick, facility. Rather than expanding into a new location, the company can minimize costs by centralizing its grow site, as well as using its three-tiered growing system to maximize space. Despite just 480,000 square feet of capacity, management expects 113,000 kilograms per year at peak production. That should place OrganiGram among the top 10 growers in Canada by yield.
CEO Greg Engel also isn't losing focus on the high-margin medical marijuana market. By targeting at least 50% oil sales for medical marijuana consumers, OrganiGram should be able to boost its margins above many of its peers. Tack on the fact that OrganiGram is an Atlantic-based grower that's probably being overlooked by Wall Street, and you have what I believe is a strong case for long-term outperformance.
2. CannTrust Holdings
Although CannTrust Holdings (NYSE:CTST) has been (legally) using fair value adjustments on its crop to turn a healthy per-share profit in recent quarters, it's the company's focus on hydroponics and its perpetual harvest system that's really got my attention.
Hydroponics involves growing plants in a nutrient-rich water solvent as opposed to soil. When combined with moving containerized benches that allow for consistent harvesting of cannabis, as opposed to lumpy harvesting every couple of weeks or months, CannTrust may have a better chance of progressively ramping up production and securing long-term supply deals that many of its peers. When complete, the company's Niagara Greenhouse facility should be capable of more than 100,000 kilograms of annual yield. Like OrganiGram, this should place it among the top 10 producers.
Additionally, it's the company's commitment to cannabis oils that has my attention. Alternative cannabis products are going to really allow marijuana growers to be differentiated. In CannTrust's case, I'm expecting it to result in higher margins and successively better earnings per share, even without the assistance of fair-value crop adjustments.
3. KushCo Holdings
Beyond just growers, I really like what KushCo Holdings (NASDAQOTH:KSHB) is doing in the ancillary cannabis business. Behind-the-scenes players that operate in niche businesses could be surprisingly profitable for investors over the long run.
KushCo is probably best known for the role it plays in providing packaging materials for more than 5,000 marijuana businesses around the world. When Health Canada announced its stringent regulations that growers would need to follow in order to get their products on dispensary shelves, it turned into an opportunity for KushCo. The company will be responsible for developing the tamper- and child-resistant packaging and branding that'll help growers and their brands stand out, while also remaining compliant.
KushCo also made waves when it acquired Summit Innovations. Summit is involved in hydrocarbon gas and solvent production. Hydrocarbon gas is a critical component of the process to make cannabis oil, while solvents are used in the production of concentrates, which won't be legal come Oct. 17, but are expected to be legalized along with other consumption options like edibles, vapes, and cannabis-infused beverages next year. Put simply, KushCo is in the perfect place at the right time.
Speaking of pot stocks with an incredible niche, say hello to CannaRoyalty (NASDAQOTH:ORHOF). Although it's a company that began its existence by making investments in other marijuana-based businesses, it's transformed recently to become what could be California's most intriguing pot stock (even though it's based in Canada).
What makes CannaRoyalty stand out is its focus on becoming a key cannabis distributor in California. You see, California's marijuana market, once mature, could outpace sales throughout all of Canada. There'll be thousands of products on the shelves in hundreds of dispensaries throughout the state. Yet, there are only a very small number of approved distributors allowed to move cannabis from point A to B. CannaRoyalty has been busy acquiring businesses in this distribution space in an effort to increase its share of the growing distribution pie. With little competition, this should be a predictable moneymaker for the company.
And, as noted, California is nowhere near a peak for its marijuana industry. Early snafus with regard to dispensary licensing and cannabis oversupply should be resolved within the next couple of quarters, opening the door for CannaRoyalty to really thrive.
5. Innovative Industrial Properties
Lastly, this marijuana skeptic likes Innovative Industrial Properties (NYSE:IIPR), a U.S.-based real estate investment trust (REIT).
The beauty of the REIT model is that it tends to produce predictable cash flow at roughly fixed costs. A REIT will acquire land and buildings within a specific industry of focus, then look to lease these assets out for a long period of time. Later, these assets can be disposed of for a profit, should the REIT choose.
In the case of Innovative Industrial Properties, it owns nine medical marijuana-growing properties across seven states that are leased for between 15 and 20 years. Each of its leases comes with clauses allowing for healthy annual rent increases, as well as a 1.5% management fee. In effect, the company has ensured that it'll continue to grow its annual cash flow faster than the rate of inflation.
There's also a sense of security in this model as long as cannabis remains illegal at the federal level in the United States. Since marijuana can't cross state lines, there should be pretty consistent demand for grow farms in legalized states. And in case you haven't noticed, more states continue to legalize. Make no mistake about it, Innovative Industrial Properties is the slowest-growth model of the five stocks mentioned here, but it should be pretty consistent.