Money and marijuana: two green substances that investors seemingly can't get enough of right now.
Since the year began, the Horizons Marijuana Life Sciences ETF, which holds an assortment of roughly four dozen pot stocks of various weightings, has nearly tripled the performance of the broad-based S&P 500 (which is also having its best start to a year in decades). With global weed sales hitting $12.2 billion in 2018, and slated to grow 38% in 2019, according to the duo of Arcview Market Research and BDS Analytics, it's not surprising that investors have continued to pile into pot stocks.
Consolidation is the new norm
But following the first stage of growth in 2018 -- capacity expansion -- it's time for the cannabis industry to turn its attention to the next phase of its maturation, namely consolidation. We've already witnessed a plethora of deals in recent months among vertically integrated dispensary operators in the United States. Here's a quick rundown, in no particular order:
- Harvest Health & Recreation is acquiring privately held Verano for $850 million in stock;
- Cresco Labs is buying Origin House for an estimated $823 million in stock;
- MedMen Enterprises is buying privately held PharmaCann for $682 million in stock;
- iAnthus Capital Holdings purchased MPX Bioceutical for around $600 million; and
- Canopy Growth is buying Acreage Holdings for $3.4 billion in a cash-and-stock deal, contingent on the U.S. legalizing cannabis at the federal level.
However, the time has come for real consolidation to occur among Canadian pot growers. While I have no crystal ball, the following three marijuana stocks look to be the surest bets, in my view, to be acquired over the next couple of years.
Even though it's gone on the aggressive by acquiring Newstrike Brands for what amounts to $197 million, HEXO (NYSE:HEXO) looks to have a pretty good chance of being purchased, in my opinion.
The first advantage HEXO offers a potential bidder is added capacity. Already on track for 108,000 kilos at peak capacity with its existing 1.3 million square feet of growing space, HEXO will add at least 42,000 more kilos with its purchase of Newstrike. At 150,000 kilos annually, HEXO should check in as roughly the sixth-largest producer in Canada. This production should be ready to roll by 2020, meaning HEXO could quickly boost capacity for a larger peers, especially if demand picks up.
Secondly, HEXO has one of the most de-risked portfolios among Canadian growers. If you think Canopy Growth's 70,000 kilos of annual provincial supply deals is impressive (between 13% and 14% of peak annual output), then you must not have seen the deal HEXO landed with its home province of Quebec in April 2018. The supply deal calls for at least 200,000 kilos, in aggregate, over a five-year period, with an option for a sixth year. Furthermore, the amount supplied increases annually. Since HEXO's production won't be up to full speed in 2019, this deal could represent approximately 30% of its output through 2023.
Third, HEXO has a brand-name partner in Molson Coors Brewing (NYSE:TAP). The 57.5%-42.5% joint venture known as Truss (Molson Coors has the majority ownership stake) was forged in early August, with the duo expected to develop, manufacture, and distribute nonalcoholic cannabis-infused beverages by this coming fall. Molson Coors has been contending with a precipitous decline in beer market share in Canada and is hoping this deal will turn the tide.
Lastly, HEXO's own CEO, Sebastien St. Louis, noted that HEXO was for sale for the right price in an interview with the Montreal Gazette last year. Said St. Louis, "In five years there may be four global cannabis companies and whether HEXO is a buyer or a seller on that journey, what matters to us is for our shareholders to participate in that to become one of the four... It's certain that if someone comes and offers a 150 percent premium tomorrow, we are for sale."
Although my personal suspicion is that Atlantic-based OrganiGram Holdings (NASDAQ:OGI) and CEO Greg Engel would prefer to remain independent, the company offers far too many competitive advantages for its larger peers to pass up. That makes it a logical buyout candidate.
What you might note first about OrganiGram is that it offers geographic diversity. It's the only major grower in Canada's Eastern provinces and territories, with 113,000 kilos of peak forecasted annual capacity at its Moncton, New Brunswick, campus. Though the Atlantic provinces aren't nearly as populated as, say, Ontario or British Columbia, the fourth-quarter National Cannabis Survey showed that adult-use cannabis rates are higher in New Brunswick, Prince Edward Island, Nova Scotia, and Newfoundland and Labrador. That's great news for OrganiGram and any potential suitor.
Additionally, few growers can match OrganiGram when it comes to yield. Whereas most growers would need somewhere around 1 million to 1.5 million square feet of cultivation space to produce 113,000 kilos of marijuana a year, OrganiGram is able to do so with just 490,000 square feet. This is because the Moncton campus employs three tiers of growing, thereby maximizing cultivation space. As a result, OrganiGram is yielding over 230 grams per square foot, which is more than double the industry average of about 100 grams per square foot.
OrganiGram is also after higher-margin derivative products. In its recently released second-quarter operating results, it was noted that the company has begun refurbishing 56,000 square feet at Moncton for, among other things, added extract capacity and edibles development. What's more, OrganiGram believes it may have developed a faster-onset beverage formulation for infused-cannabis drinks and is actively seeking an experienced beverage partner.
With nothing going on outside of Moncton, NB, OrganiGram's end goal is probably an acquisition at a hefty premium.
A third company that I don't expect to remain independent for too much longer is small-cap Flowr (OTC:FLWPF), which is the midst of a major ramp-up of its Kelowna campus in British Columbia.
Whereas most marijuana growers will struggle to stand out from the crowd, Flowr should have no issue at all -- and it has nothing to do with the company's peak production potential. In fact, at 60,000 kilos of peak output by 2021, Flowr may struggle to stay in Canada's top 15 largest growers. Rather, Flowr will be able to differentiate itself by the quality of cannabis it produces, and the level of yield it generates per plant.
Flowr is focusing on ultra-premium cannabis. If you took top-tier geneticists and told them to grow extremely high-quality cannabis strains, you have what Flowr is producing. Ultra-premium cannabis has a much higher price point than traditional or discount weed, and it's also much less susceptible to supply and pricing pressures, namely because so few other growers are focused on the ultra-premium space. Since Flowr's customer tends to be a more affluent user, they're also less likely to alter their buying habits if the Canadian or global economy weakens.
Also, remember above how I mentioned that "few growers can match OrganiGram when it comes to yield"? Well, Flowr is the only one that can. In fact, it blows OrganaiGram and the rest of the industry out of the water with 300 grams to 450 grams per square foot of yield.
Like OrganiGram, Flowr is solely focused on its Kelowna campus, which means its size will be limited. But in terms of cannabis quality and production efficiency, Flowr is unmatched. That makes it a pretty good bet to be acquired by an opportunistic grower in the future.