Legal marijuana is among the fastest-growing industries in the world. Most research firms and industry insiders have the so-called "white" cannabis market expanding at a compound annual growth rate of over 35% in the next six years.
Perhaps even more impressively, top executives in the space, such as Canopy Growth (NYSE:CGC) co-CEO Bruce Linton and Tilray (NASDAQ:TLRY) CEO Brendan Kennedy, believe the industry can sustain its blistering growth rate for the entirety of the next decade, if not longer. The underlying reason is the growing belief that cannabis and cannabis-based products will eventually disrupt multiple high-dollar industries, such as alcoholic and non-alcoholic beverages, cosmetics, food, pharmaceuticals, and even tobacco.
With such an astonishingly high growth rate in mind, it's no wonder investors have bid up the prices of marijuana stocks to record highs over the past two years. If any of these companies simply matched the industry's projected growth rate over the next decade, an initial investment of $50,000 would translate into a return on capital of over $1,000,000. That kind of return on capital is unheard of for stocks that don't involve unacceptable amounts of risk, such as penny stocks trading on largely unregulated exchanges.
Marijuana investors, though, have a glaring problem right now. Alpha dogs in the industry such as Canopy and Tilray currently sport towering valuations that strongly imply that most, if not all, of this projected upside is already baked into their stock prices. On the flip side, most of the small- to mid-cap companies in this space are simply too risky to consider as long-term growth vehicles. The majority of these second-tier players don't have the economy of scale necessary to survive the industry's upcoming supply glut and corresponding margin compression.
What's the solution? The list of names that can arguably survive the flood of marijuana set to hit the market over the next two years and that don't already have multibillion-dollar market caps is exceedingly short, HEXO (NYSEMKT:HEXO) and OrganiGram Holdings (NASDAQOTH:OGRMF) appear to have what it takes. Here's why.
HEXO's unique value proposition
HEXO's management has said it expects a small handful of companies to control the vast majority (around 80%) of the cannabis market within the next few years -- an admission that few companies of its size have been willing to make for obvious reasons.
But HEXO has two solid reasons for being upfront with potential investors about this rather dire forecast. The company has built a solid competitive moat by way of a five-year supply contract with Quebec's Societe Quebecoise du Cannabis, which operates Quebec's cannabis stores, and it also has a partnership with Molson Coors to develop non-alcoholic cannabis-infused beverages. HEXO has thus secured a sustainable source of revenue worth up to $1 billion Canadian in the next five years, as well as a marquee partner that should guarantee a smooth entry into the high-value cannabis beverage market, once this ancillary commercial opportunity becomes available later this year.
What's the key takeaway? HEXO has differentiated itself from its closest competitors through these two key deals, paving the way for long-term growth. So even though HEXO's shares are currently trading at a hefty 8.9 times the company's projected 2020 revenue haul, this premium valuation is arguably warranted. If things go according to plan, after all, this second-tier cannabis player should be among the few names to survive the industry's upcoming bottleneck event.
The gold standard of cannabis production
Even though OrganiGram's shares have jumped by an astounding 998% over the past three years, this small-cap pot stock might still be deeply undervalued. The core reason is that OrganiGram's unique three-tiered growing system has allowed it to become one of the most efficient growers -- if not the most efficient -- in all of Canada. At peak production capacity, for instance, OrganiGram should end up rolling out approximately 113,000 kilograms of cannabis per year with only 490,000 square feet of growing space.
As a result, OrganiGram is on track to become a top-five cultivator in Canada later this year, despite its vastly smaller footprint than most top-cannabis producers. And with "all-in" production costs of less than $1 per gram, the company wins on the cost-efficiency front as well.
Nevertheless, OrganiGram's market cap of $778 million pales in comparison with upper-echelon cultivators such as Canopy and Tilray. The market, therefore, doesn't seem to fully appreciate OrganiGram's status as a leading and highly cost-effective cannabis cultivator -- at least not yet.
Obviously, though, it's not enough to just be a top producer of cannabis. A company, after all, has to have a market for its product to generate sales. But that's yet another area where OrganiGram excels against many of its peers. OrganiGram, for instance, already has supply agreements in place with every Canadian province except Quebec, setting it up for monstrous levels of revenue growth over the next few years. In fact, the company's shares are trading at only 4.3 times next year's projected sales, which is among the cheapest valuations in the entire industry right now.
All told, OrganiGram seems poised for years of industry-leading levels of growth, thanks to its outstanding cultivation platform and rock-solid business strategy.
George Budwell has no position in any of the stocks mentioned. The Motley Fool owns shares of Molson Coors Brewing. The Motley Fool recommends HEXO and OrganiGram Holdings. The Motley Fool has a disclosure policy.