Marijuana legalization is spreading, and that's got investors wondering what marijuana stocks are worth buying. Many companies are vying for a slice of this $150 billion global market, but the biggest vertically integrated marijuana stocks come from Canada, including OrganiGram (OGI -5.35%) and Aphria (APHA). Are both stocks worth buying, or is one a better buy than the other?
A marijuana green rush
Canada's national medical marijuana market generates about 600 million Canadian dollars in sales per year, but that's only a fraction of the opportunity in Canada and a sliver of the global marijuana market opportunity. About CA$5 billion is spent on marijuana illegally in Canada every year, and that should change following the opening of the country's adult recreational use market last October.
Globally, the opportunity to profit from pot is truly massive. Only two countries have legalized marijuana nationally so far, but there are signs that more countries could embrace pro-pot laws. For example, in the U.S., where $50 billion is spent on marijuana annually, 33 states have passed pro-marijuana laws in one form or another, including 10 states that allow adults to legally use marijuana. Overseas, momentum to legalize cannabis is also growing. For instance, Germany established a national medical marijuana market mandating insurance coverage in 2017, setting the stage for more European countries to follow suit.
Overall, industry watchers think legal marijuana revenue worldwide could reach $200 billion in 15 years if more countries legalize it.
Cashing in on Canada's cannabis market
Recently, OrganiGram and Aphria reported financial results for their most recent quarter. The results show each is investing significantly to ramp up their marijuana revenue to take advantage of adult-use sales in Canada, but OrganiGram is executing better.
OrganiGram net marijuana revenue in the three months ending February totaled $26.9 million, excluding excise taxes, up 692% year over year. Recreational-use sales accounted $24.5 million of the total, while medical marijuana revenue contributed $2.4 million.
That performance is a stark contrast to Aphria's results. Aphria's consistently ranked as the third-largest marijuana company by sales, but operational setbacks and a decision to hold back sales to fuel future growth caused its recreational marijuana sales to fall to CA$7.2 million last quarter from CA$11 million in the previous quarter. Its medical marijuana sales fell 2% quarter over quarter to CA$10.6 million, too, so total net marijuana revenue was only $17.8 million in the period. The disappointing results were somewhat masked by the acquisition of two international drug distributors -- CC Pharma and ABP S.A. -- which added CA$56 million in noncannabis revenue to Aphria's income statement.
A path to profitability?
When you look at mature recreational markets in the U.S., one thing that stands out is that wholesale marijuana prices have fallen substantially once legal markets reached cruising altitude. Canada's recreational market is currently absorbing all the marijuana the industry has to offer, but that's unlikely to continue forever because most cannabis companies are investing in new marijuana production.
A risk of falling marijuana prices in the future suggests the companies likely to profit most from pot over time will be those embracing low-cost production methods. One way to figure out what company's executing on costs better is to consider gross margin, or the profit that's left over after subtracting cost of goods sold. Currently, OrganiGram has an edge here as well.
OrganiGram uses a novel, three-tier grow system that makes its indoor facility highly competitive to traditionally lower-cost greenhouses. Last quarter, its all-in cannabis cultivation costs were just $0.65 per gram, a downright tiny figure when compared to Aphria's all-in cost per gram of $3.76.
Unsurprisingly, OrganiGram's lower production costs translated into gross profit of $16 million, or gross margin of 60%, excluding changes in the fair value of its inventory. Despite delivering more in top-line revenue, Aphria's gross profit was only $13 million because gross margins at its new distribution companies are below 15%. Since Aphria's revenue mix was so heavily tilted toward its drug distributors last quarter, its gross margin collapsed to 18% from 47% during the previous quarter.
Dropping further down the income statement, OrganiGram's general and administrative expenses were CA$2.6 million and its sales and marketing expenses were CA$3.1 million last quarter, up from CA$1.7 billion and 934 million one year ago, respectively. At Aphria, general and administrative expenses increased to CA$22.4 million and selling, marketing, and promotion costs were CA$6.95 million, up from CA$2.8 million and CA$3 million one year ago, respectively.
On the surface, it seems Aphria's margins are dismal. However, the decline could be a short-term phenomenon because costs included a doubling in its packaging costs and as production increases (more on that in a minute) and packaging expenses fall, margins should improve. Nevertheless, OrganiGram's profitability is better.
Plans for future production
Revenue and margin only offer limited insight into the future performance of these companies because it's arguably very early innings in capturing this market opportunity.
As construction projects boosting production come on line, more of the CA$5 billion spent illegally in Canada on recreational-use marijuana should shift to these companies. Therefore, evaluating production capacity is an important way to compare them.
Last quarter, OrganiGram and Aphria annualized marijuana production capacity was similar at 36,000 and 35,000 kilos, respectively. OrganiGram's on track to reach a 62,000-kilo annual pace in April and a 89,000-kilo pace in September. It expects to reach a run rate of 113,000 kilos in December.
Aphria's peak production capacity is bigger.
It recently secured Health Canada approval to begin cultivation at a major expansion to its Aphria One greenhouse, increasing production capacity to 115,000 kilos. A second, massive greenhouse, Aphria Diamond, is awaiting regulatory approval that could increase Aphria's peak production to 255,000 kilos per year.
And the winner is...
OrganiGram and Aphria have an opportunity to generate hundreds of millions of dollars in marijuana sales over the coming 12 to 24 months, but so far, OrganiGram's managing its growth and expenses better. Ultimately, Aphria may have more upside because of its capacity plans, but OrganiGram's execution makes it the pot stock to buy now.