A Marijuana Market Roundtable: What It Is, How Big Could It Be, and Top Stocks to Buy Now

A full transcript follows the video.

This video was recorded on Oct. 10, 2018.

Shannon Jones: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today is Wednesday, October the 10th. I'm your host, Shannon Jones. Ordinarily, Todd Campbell is joining me via Skype, but we've got a special treat today. We are actually joined in studio with Todd Campbell, live, in the flesh!

Todd Campbell: Hi, Shannon!

Jones: Hello, Todd! You're real! You're not a bot! [laughs]

Campbell: [laughs] That's right! I'm not artificial intelligence or a hologram.

Jones: Even more so, we've got two of what I consider our healthcare experts and even more so experts in the marijuana industry right now. We've got Mr. Keith Speights!

Keith Speights: Speights.

Jones: Speights?

Speights: Either way.

Jones: Keith is here, listeners! And then, Mr. Marijuana himself, Sean Williams. Guys, welcome to the show! So, so, so glad to have you here in the studio!

Speights: It's fun to be here!

Sean Williams: Thank you!

Jones: Listeners, you are in for a treat today. We're going to be talking about marijuana. This is one week before marijuana goes legal in Canada. We're going to be giving you a quick background and overview of what the industry is all about, but also, too, really excited to hear from the experts themselves, their topics, and also what are some of the risks and challenges that this industry is going to be facing.

Let's dive right in. I want to lay the groundwork here. Oftentimes here at The Fool, one of the most frequently asked questions that we get when it comes to the marijuana industry is, "Is this really legit? Is this a legit industry? Is this just the sketchy corner dispensary down the street? Are there really some legs to this industry?" What can you guys tell us about what the marijuana industry is all about, what it's made up of? What can you give the listeners?

Campbell: Anyone want to jump in? Keith?

Speights: I can jump in, and you guys can jump in after me. Yeah, it is legitimate. Obviously, there are some sketchy players out there. You have to be aware. But it's very legitimate. I think that thing everyone needs to realize, we're really talking about two different markets here. You've got the medical marijuana market, and you've got the recreational marijuana market. They're quite different. Obviously, medical marijuana has been legal in several countries already. It's been legal in Canada for a while, it's been legal in quite a few states. I think we're up to 30 states now, plus D.C. Then, on the recreational side, in the U.S., you've got nine states now that have legalized it. I think Michigan is voting in November.

Williams: Two states voting.

Speights: Two states voting. Michigan is one of the big ones. The latest I saw, the polls look like it's probably going to pass. So, we're going to have more states. Of course, the other thing to remember is that it's still illegal at the federal level in the U.S. 

The other aspect I think you have to look at is that there are different geographies involved. All the hype right now is Canada. Canada is a big market. You just mentioned, Shannon, the market for recreational marijuana opens up in just a few days. Everybody's anxious to see how that's going to turn out. But they've had medical marijuana legal for several years now. You've got Germany that legalized medical marijuana last year. That's a very big market. They're the largest population in the European Union, so that's an important market. 

We can't leave out the good ol' U.S.A. The U.S. currently, from the latest information I saw, accounts for 85% of total marijuana sales in the world. 

Right? Everybody's talking about Canada. The U.S. is where it's at, even though it's still illegal at the federal level. Obviously, Germany's going to grow, Europe's going to grow, Canada's going to grow, but even in a few years from now, the U.S. is still going to account for probably three-quarters of all marijuana sales. You have to look at all of this. When you see all the Canadian stocks getting all the hype, the bigger market is right here at home.

Campbell: And really, the Canadian market is pretty small fish in the big sea. Even with medical marijuana having been around in Canada available, you're still not talking about a ton in sales. Maybe a billion is what they're predicting for 2019. Totally combined, including recreational, maybe you get $5-7 billion or something like that. The global marijuana market is $150 billion if you include, of course, the black market. So, yeah, there's a major chance to disrupt. I agree with you, Keith. I think this is a real industry. There's a lot of disruption going on here. 

If you are a listener that's new to the whole marijuana thing -- what the heck is this whole marijuana thing about? Just a little bit of background. We're talking about cannabis, cannabis sativa is the plant. You may be familiar with hemp, which is a type of cannabis sativa. Hemp has been used industrially for about 7,000 years. As a matter of fact, it was a major ingredient for things like rope and paper and everything back in the colonial times. As a matter of fact, you used to be able to pay your tax bill, Sean, you used to be able to pay it in cannabis seeds, which is cool. You could go into your local government and pay your taxes --

Speights: Didn't George Washington grow hemp?

Campbell: And Thomas Jefferson set aside some of the best land he had to grow hemp!

Williams: I'm going to see what my state says about that.

Campbell: [laughs] Yeah, today, probably not so much. Not so much. But, what we're talking about with marijuana is the female plant. We're talking about the bud of the female plant. That's the dried flower that people think of when they're talking about the commodity part of the marijuana business. I'm sure that we'll chat a little bit about the differences between commodities and not. You are going to have two very distinct markets. That's going to be the commodity -- I'm growing, say, tobacco, or, I'm growing wheat, or I'm growing whatever it is I'm growing. And then, you're going to have the finished good market, or the value-add market, however you want to refer to it. Those are going to be the things like cannabis oils, CBD, and those kinds of things. Then, to your point, Keith, you have this whole separate market, which could be, theoretically, very large, in the medical marijuana space. Most likely, we're talking about prescription medical marijuana.

Jones: Yeah, absolutely. We've established here, the industry itself is legit. There are different segments of the industry that are really building up and have been around for quite some time. Let's actually talk about what excites you most about the marijuana industry. I'm really curious to hear your thoughts. Sean?

Williams: Yeah, I'll kick this one off. There's a lot of marijuana stocks that have come out and given these huge pie-in-the-sky figures of how much they're going to grow. 700,000, 500,000 kilograms. But there's a lot more to marijuana than just growing it. What I'm really interested in seeing, beyond just the sales figures, beyond just the expected profitability, I want to see these companies differentiate themselves. That, I think, is going to be the most exciting part. 

Instead of seeing these companies grow traditional dried cannabis, what I'm looking forward to is the cannabis alternatives. By alternatives, I'm talking about vapes, I'm talking about cannabis oils, I'm talking about edibles, infused beverages -- which have been incredibly popular over the last couple of weeks. If you've watched any sort of market mover list, you've seen these companies at the top of the list regardless of their size, all the way from Tilray down to New Age Beverages Corporation. 

I'm really excited to see what they're going to be able to do, how they're going to differentiate themselves, once these new forms of consumption are available. 

What I will preface this with, and what I would remind investors at home, is that these new alternatives, you won't see most of these hitting the market come October 17th. Dried flower and cannabis oil have been given the thumbs up from the Canadian federal government. Every other form -- we're talking vapes, concentrates, edibles, infused beverages -- they're supposed to be discussed some time next year. But there's no timetable on that. It's simple promises and industry expectations at this point. 

Campbell: That's a great point, Sean! I think that not many people who are following the marijuana market recognize that you're talking about not having those things available until next year. We're really just talking about the dried flower at this point.

Speights: And I've seen some studies Sean, and you've probably seen the same ones, that showed it's the edibles and vapes and concentrates that are the most profitable segments of the industry.

Williams: Yeah, absolutely. I have seen those studies. I'm looking forward to seeing what they can do with it, but there's no guarantee that it's going to be a profitable venture right out the gate, or when it's even going to happen.

Campbell: It's a major market opportunity. If you think about your addressable market, your addressable market of people who are going to go out and buy dried cannabis are people who want to smoke it. Maybe you'll bake with it. But I think that when you have it in edibles, infused beverages, and you make it easier, a lot of consumers that maybe otherwise wouldn't have tried it will say, "Maybe I'll give this a shot, see what it's like." There's a lot of complexity, obviously, associated with that. But I agree. I think that's an exciting potential.

Speights: I'll take a different angle on this. The healthcare guy in me will come out here. I'm excited about the medical potential for marijuana. We just had the first plant-based marijuana drug, Epidiolex, get approved. I love some of these names. They really roll off the tongue. But I think there's more potential than maybe people realize for different cannabinoids. Obviously, the focus now is on CBD. But there are dozens and dozens of other cannabinoids that have not been researched.

Campbell: Over 100!

Speights: Yeah, it's over 100. It's a lot. Who knows? In a way, marijuana has been under a stigma for so long, but here could be some real medical potential here. We see it with the rare forms of epilepsy now, but who knows? Schizophrenia, there are quite a few indications that this plant could yield some ingredients that really help patients down the road. That's what excites me.

Jones: Absolutely. I'm with you there, Keith. I think the potential on the medical side is huge. When you talk about movement disorders, neurological disorders, in terms of growth opportunities for CBD, medical marijuana, to really dive into that sector even more, and to really see how that plays out, not just for Epidiolex -- for listeners who have been following that particular story, to see that happen, that was a monumental moment. That was in May or June of this year.

Speights: June.

Jones: So, for Epidiolex to get the first FDA approval for CBD.

Williams: And even more than just the approval, the scheduling.

Jones: Yes, the scheduling, too.

Speights: Schedule five.

Williams: They got as good as you can get. GW Pharmaceuticals, who is marketing Epidiolex, that's really going to help them get that drug out.

Campbell: There's a human element, too. The initial indications are incredibly treatment-resistant. These people are suffering, I want to say up to 70 drop seizures a month. And in trials, it reduced those drop seizures by about 40%, depending on the study you're looking at, 40-50%. It's really moving the needle.

Jones: Truly remarkable! Multiple areas that are exciting for investors to be watching here. Now, the moment you all have been waiting for, I get the chance to pick the brains of our marijuana gurus and experts. I want to hear about your top picks. Sean, how about you kick us off?

Williams: Alright, why not? I'm weird. I like small-cap stocks. That's me! That's always been me!

Campbell: [laughs] Lean right into it.

Williams: I'm weird! [laughs] I have two companies, we'll call them a 1A and a 1B. I can't pick between which one I like more.

There are two. The first is OrganiGram Holdings. It's a pretty small company, under $1 billion market cap. The interesting thing about OrganiGram is, people forget about it. It's Atlantic-based. There are no Atlantic-based growers that are big. They're the small-time players. But here's OrganiGram, kicking out an expected hundred 113,000 kilograms a year. That's going to put it in the top 10, I believe. And everyone's forgetting about it. All the growers are in British Columbia, they're in Ontario, they're in Quebec. There are no Atlantic growers. That gives it a geographic advantage over everyone else. 

What I really like about OrganiGram, other than the fact that CEO Greg Engel was nice enough to give me an interview --

Speights: Good interview!

Williams: Good interview! Thank you, Greg Engel, if you're listening! It's the fact that they're really maximizing their grow space. They have a 480,000 square foot grow space up in Moncton, New Brunswick, I believe, across two facilities. Most growers have a million, maybe more than a million, square feet of growing space, and they're kicking out about 100,000 kilograms a year. OrganiGram is kicking out 113,000 kilograms on 480,000 square feet because they have a three-tier grow system. 

They're focused on those high-margin cannabis oils. They really have a good patient focus. They really want to move into the alternatives once they come out. It sounds like they're really excited about that. At least, that's the impression I got from Greg Engel. That's OrganiGram. I'm really excited about it. A little sketchy on the valuation because that's what all marijuana stocks are right now. But that's probably the 1A.

If there's a 1B, it's CannTrust, based in Ontario. The interesting thing about CannTrust, they're growing through hydroponics. Rather than growing plants in soil, they're growing them in a nutrient-rich water solvent. Along with their containerized bench system, which is supposed to help with harvesting, they should have less lumpy harvesting. Normally, you'd plant the crop, X amount of time later, you harvest the crop. This will be a lot faster, a lot more continuous, and hopefully should help with long-term supply deals. It doesn't hurt that they've been profitable, too.

Campbell: Very interesting. One of the things I was thinking matter when we were asked to pick out names, you could say, "Tilray! Aurora!" Don't. So, I think it's kind of cool to hear about something that's under the radar like that. I think it's something that's valuable to our listeners to recognize, there are other companies out there. Of course, those companies also present some pretty extreme risks, too, that everybody should be thinking about. 

When I was trying to settle in on what I would pick, I decided that I wanted to try and see if I could focus on finding a company that maybe was getting a little bit forgotten but wasn't quite a small. I settled on Aphria. I think Aphria is going to be the third biggest player in Canada. They're on pace for about 255,000 kilograms of production early next year. 

What's really interesting to me about them is that 250,000 kilograms of their production is being done in greenhouses. The reason that that's important is that greenhouse production is cheaper than indoor production by a lot. That gives them a competitive advantage where maybe, maybe, if you're going out and it becomes an issue of, most marijuana demand ends up being for ingredient rather than dried flower, then the low-cost provider could have a valuable edge over some of these other companies. I think that's something that really attracted me to it.

I also like that they're not, I'm not going to say promotional, but they haven't been as aggressive, they haven't been as out in front of everybody, as these other companies. It makes me feel like maybe they're just putting their head down getting their work done and establishing themselves in this business. So, I kind of like that. One of the reasons that I like that is because its valuation, I don't think, is nearly as stretched as some of these other ones. I looked earlier today, I think we're about $3 billion market cap. For comparison, Canopy (CGC +0.00%) is still over $10 billion, and Aurora is much larger. Now, they're bigger companies. Canopy is going to crank out, what, 500,000 kilograms, Sean?

Williams: Something around there.

Campbell: And Aurora is aiming for 550,000.

Williams: 570,000, but that doesn't even count ICC Labs.

Campbell: Yeah. So, it's not going to be as big as they are, but it may have an edge in pricing and profitability. If you look at, over the last 12 months, their ability to translate more money down after all their expenses, it's pretty impressive. 

It's really hard right now when we try and talk valuation with marijuana stocks, because they don't make money, and there are so many one-off expenses that are screwing up the net income for these companies. You've got stock-based compensation, all these other things. So, I'm looking at gross margin right now when I look at these companies. And by far, of all the biggies, Aphria has the highest gross margin. If you're comparing Aphria to Canopy, it's by a lot. So, I think that would be the name that, if I was a new investor coming in and considering these, maybe I would look at Aphria as one of the first ones I would consider.

Speights: I would actually agree with both of you guys. I like both of the picks that you've mentioned. I'm going to throw in a real twist: Liberty Health Sciences. It's even smaller than OrganiGram. What I like about Liberty, they're actually based in Canada, but their operations are nearly exclusively in Florida. Now, you might not realize, Florida is projected to be the third-biggest marijuana market in the U.S. By 2022, the projections I've seen, I've seen on the low end, $1.7 billion, upwards of $1.8 billion. And it's only medical marijuana legalized in that state. They will rank only behind, of course, California No. 1, Colorado No. 2. Florida is projected to be the third biggest marijuana state in the U.S. So, that's a big market. 

Here's the cool thing. The state has very limited licenses for production. They've only awarded 14 licenses. Liberty has one of those. The licensing they give gives the company the ability not only to grow, but to have up to 30 retail dispensaries. Liberty Health Sciences is positioned in the Florida market. They're rapidly cranking out more retail locations. They also do home delivery throughout the state, medical marijuana. 

I talked to their CEO, George Scorsis, a couple of weeks ago. He said their estimate right now is, they have about a 15% market share in Florida. But by early next year, they're going to be the biggest producer, because like a lot of the Canadian companies, they're really ramping up their capacity. He thinks there's going to be a lot of product shortages very soon in the state. As they ramp up that production capacity, he really projects they're going to have a 25% market share. So, I thought, "Well, that's the CEO. He's going to really play this up."

Campbell: He's probably not going to say that it's ...

Speights: Yeah. But if you do the math -- think about this. Let's say $1.8 billion. That seems to be a consensus-type projection for Florida. $1.8 billion. Even if they don't increase their market share, even if they only have 15% -- I won't do the math in my head here -- the market cap is only around $360 million right now. This company has some real room to run. Let's say 20%. That's $360 million a year at 20% of the market. 

Liberty Health Sciences is a company that really has some real opportunity. We talk about some of these absolutely outrageous valuations -- Tilray.

Williams: [laughs] No name-dropping.

Speights: I mean, honestly, I look at a Liberty Health Sciences flying under the radar -- kind of like OrganiGram, flying under the radar -- but it's a legitimate business and has some really great business prospects. So, I like the stock right now.

Campbell: It's so hard, right, Shannon, with some of these U.S. marijuana plays. We hear all of these people who say, "You have to be worried about marijuana in the U.S.," because we don't necessarily have an administration in Washington right now that's a big fan. The change because of Epidiolex, that did not do anything to marijuana. It's still a schedule one drug. There's all sorts of banking restrictions. There's these things, and maybe, Keith, that's why.

Speights: I'm sure. That's exactly why. The companies that operate primarily in the U.S., they're still under that dark cloud of marijuana being illegal at the federal level. We could place bets on whether or not the bill that's being pushed through right now might pass, that at least the federal laws could change where the government will not get in the way of states. But I don't think we're going to see a crackdown. That's my opinion.

Jones: Interesting stuff. We've talked about the huge growth opportunities, how the market is so tremendous for the marijuana industry. With that, this is still an industry that has many challenges to go. You alluded to that just now. If there was one thing that kept you up at night when it comes to investing in this space, what is that?

Williams: I'll kick us off again. It would be that marijuana is seen as the next big thing right now, and every single next big thing that we've seen over the last 25 years has ended in a bubble bursting. We saw it with the internet, internet business-to-business commerce, genomics, 3D printing, cryptocurrency/ Blockchain. And I believe we're seeing it with marijuana now. There's that worry that history will repeat itself. 

There's also the worry that even though we haven't seen a lot of precedents of countries legalizing recreational marijuana, we can look south of the border into the U.S. from Canada, and we can see some of that precedents in Colorado, Washington, Oregon. In all three of those states, after a short period of euphoria and demand and consumers just jubilant and ready to buy marijuana, the price per gram of that dried flower -- which is mostly what we're going to see in the early going, until Parliament in Canada decides to do something about it -- there's a good chance that the price per gram is going to drop. 

The good thing for these marijuana companies is that scale will help them reduce their cost. But there is nothing built into that scale that's going to prevent the price from dropping 20-40%. It will hurt. There's a very real chance that these companies, between their high initial spending, and if the price of cannabis starts dropping, they may not make anywhere near as much profit as anyone expects.

I believe that's the biggest worry, somewhere between history and the price per gram of cannabis falling.

Campbell: Right. You can have a disruption in an industry, and it can be a real disruption, it can be a real market-moving event. That doesn't necessarily mean that you're going to have runaway stock prices forever.

Williams: Correct.

Speights: I would second that. Valuation. The valuations are absolutely ridiculous, especially with some of the more well-known Canadian stocks.

Williams: [coughs] Tilray.

Speights: Yeah, Tilray. These stocks have gotten disconnected from the legitimate business prospects. Now, don't get me wrong. Tilray has legitimate business prospects. Their sales are going to grow phenomenally. There's no doubt. But their stock more than reflects those growth prospects, way more than reflects them. If I had bought Tilray, I would be running like the wind right now. But it's not just Tilray. A lot of the stocks are overvalued. Yeah, we're seeing a bubble, for sure. But, again, it's a legitimate industry. Over the long run, there are going to be some big winners.

Campbell: Yeah. You guys both made great points, it made me think of something. One of the things that I'm a little bit worried about is that, we are talking about how exciting medicinal marijuana could be. And in that excitement, maybe we're forgetting that, along the way, we've already had GW Pharmaceuticals. They've already had readouts from trials in indications that we thought would be home run indications, and easily done. And those trials have failed. Pain being the best one that jumps to mind. They ran a bunch of pain cancer trials, and those failed to beat the placebo. That was a disappointing setback. So, ratcheting back some of the enthusiasm that you're hearing on today's show is Todd Campbell. I'm just saying, OK, yeah, there's going to be fits and starts along the way.

The other thing that keeps me up at night is the potential risks of the unknown, the unintended consequence of this surge in marijuana use. When we were talking about edibles, I'm not necessarily as concerned. But there's a part of me, and I don't know if it's because I grew up in the 80s or not... hmm, Regan times... there's a part of me that says, if you're smoking some smoke, into your lungs, maybe there's an unintended health consequence that evolves later on. And studies that have been done so far have not been able to draw a concrete link. That's because a lot of people who smoke marijuana also smoke cigarettes, so they've not been able to separate the two and figure out what's doing what. Now, marijuana does show some anti-cancer properties. So, there's some argument there that maybe we won't see those kinds of things.

Again, we're just speculating things that could keep you up at night. One of those things that keeps me up at night is, is there an unforeseen or unknown consequence that we just don't fully understand yet? 

Jones: Yeah. I think all of those points are so valid. If you had a brand-new investor to this space, just to close us out, what would be the one thing you would want them to take away from this conversation?

Speights: I would say, remember we're still talking about businesses. Don't focus on the stock, focus on the business. Just as you wouldn't spend $1 million to go buy a neighbor's lemonade stand, look at the realistic business prospects, and make sure that you're paying a price that, over the long run, you'll get a good return.

Jones: Excellent!

Williams: I would emphasize, and build on Keith's point, businesses take time to mature. Whereas we've seen all those other businesses I described -- the internet. There are plenty of successful internet companies. There could be an Amazon of this group. But it's going to take time. It's not just going to launch out of the gate and be off to the races and that's that. If the market worked like that, I think we'd all be retired by now. [laughs] 

Campbell: Sean, you don't mean that every single one of these is going to be the next Amazon?

Williams: [laughs] Wouldn't that be great?

Campbell: Will some of these fail?!

Williams: I think so!

Campbell: Yeah. I think that's definitely a great point. That's why -- Shannon, guess what I'm going to say! -- diversify!

Jones: [laughs] How did I know that, Todd?

Campbell: I might say that every once in a while on the show. You're probably sick of me saying it. But, yeah, diversify! Create a little basket, if you're really interested and you want to be involved marijuana stocks, to have some in your portfolio. We talked in the past, when you talk about truly disruptive things, it doesn't move in a straight line. You may lose a lot of money in certain periods of time. But if you believe that the $150 billion market is being disrupted by legalization globally, and that some of these companies that are at the forefront right now are going to be around in 15-20 years to benefit from it, then diversify. Own a few.

Jones: No wiser words from Todd Campbell. Diversify! [laughs] You heard it here first!

I just want to say to all three of you, thank you so much for being on the show! Definitely one of my highlights of this entire past year that I've been with the fool.com team. Thank you so much! And to our listeners, thank you so much for tuning in! That's it for this week's Industry Focus: Healthcare episode. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Todd Campbell, Keith Speights, Sean Williams, I'm Shannon Jones. Thanks for listening and Fool on!