Interest in the marijuana industry is heating up among investors, and for good reason. Since the year began, the very first tradable cannabis exchange-traded fund, the Horizons Marijuana Life Sciences ETF, has practically tripled the returns of the broad-based S&P 500, which is having a stellar year of its own.
The legalization of recreational marijuana in Canada, the first industrialized country to have given adult-use cannabis the green light, has sparked a fire on Wall Street and led most folks to believe that the pot industry could grow at a double-digit pace for a long time to come. The only question is: What percentage of the tens of billions of dollars in revenue the global industry is expected to generate in the years to come will wind up being the result of the adult-consumer market and the longer-established medical marijuana market?
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Analyzing pot stocks' recreational-to-medical sales ratio
Generally speaking, the recreational side of the equation is a considerably larger opportunity. Having cannabis freed from the shackles of a physician's prescription allows adults to purchase an assortment of cannabis products, from dried flower to derivatives, any time they choose.
But the medical marijuana market is no slouch, either. According to the fourth-quarter National Cannabis Survey in Canada, medical pot patients use the product more frequently; make purchases much more often than adult-use consumers; and, most importantly, tend to buy higher-margin derivatives products, such as cannabis oils, more often than recreational weed users.
Both the recreational and medical side of the equation have value. What's interesting is to see how Canadian marijuana stocks have responded in the early going to these two separate markets. Let's take a closer look at the recreational-to-medical sales ratio breakdown of five of Canada's largest pot growers in their most recent quarter.
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Aurora Cannabis: 45.4% recreational, 54.6% medical
One of the more eye-popping statistics in the most recent round of quarterly reports for the marijuana industry was that of Aurora Cannabis (ACB -3.35%). It wasn't the 54.2 million Canadian dollars in net revenue, inclusive of net excise taxes, that was surprising, but rather that Aurora sold more to the medical community, despite this being the first that included recreational weed revenue.
The company's second-quarter operating report is where Aurora really solidified that the medical cannabis community is its future. Ultimately, this should be a smarter choice given the generally higher margins (albeit smaller consumer pool) associated with the medical cannabis community.
Aurora Cannabis has done an especially impressive job of pushing into international markets, which at the moment cater only to medical marijuana, with the exception of Uruguay. With a production and/or distribution presence in 24 countries worldwide, a number that's currently unmatched by its peers, Aurora looks to have multiple external outlets to move what could be an industry-leading annual output of 780,000 kilos by 2022.
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Canopy Growth: 79.4% recreational, 20.6% medical
On the other side of the coin, in spite of a substantial number of registered medical patients as of its fiscal third-quarter report, Canopy Growth (CGC -2.01%) appears fully content on focusing its attention on adult-use consumers. Pretty much $0.80 of every $1 spent in the most recent quarter went toward recreational pot sales.
This sales breakdown probably also provides a pretty good clue as to why Canopy Growth has earned the right to acquire vertically integrated dispensary operator Acreage Holdings for $3.4 billion if the U.S. legalizes marijuana at the federal level. The U.S., if legal, would almost certainly be the largest recreational cannabis market in the world. Having already earned a hemp production and processing license in New York, compounded with this contingent acquisition, Canopy Growth will have the infrastructure in place in the U.S. to succeed if and when the federal government ever changes its tune.
Canopy Growth is also no slouch on the production front, with more than 4.4 million square feet licensed by Health Canada of an estimated 5.6 million square feet. This likely places the company at more than 500,000 kilos annually at its peak, making it Aurora's only major rival in terms of production.
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Aphria: 40.4% recreational, 59.6% medical
Aphria (APHA), which will likely check in as Canada's third- or fourth-largest grower, with 255,000 kilos of peak annual yield at full capacity, looks as if it'll be more balanced than many of its peers. In the most recent quarter, about 40% of its total sales went to the recreational market, with 60% headed to medical cannabis patients.
Although the company is embroiled in issues surrounding a number of recent acquisitions, Aphria's management has traditionally placed great emphasis on generating positive EBITDA (earnings before interest, taxes, depreciation, and amortization). In order to do that, it's going to want a reasonably strong presence in the medical marijuana market.
Aphria's acquisition of Nuuvera in March 2018, coupled with a handful of organic overseas expansions, has given the company access to about a dozen countries, including Canada. These external sales channels, when combined with Aphria's renewed focus on high-margin extracts via an extraction center that's currently under construction, should provide a number of ways for Aphria to lessen its reliance on dried flower and the recreational market.
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HEXO: 91.2% recreational, 8.8% medical
Next to Aurora Cannabis selling more medical marijuana than adult-use pot, perhaps the biggest surprise was HEXO (HEXO) generating 91% of sales in its most recent quarter from the recreational market.
To some degree, a lean toward the adult-use side of the equation is expected. In April 2018, HEXO landed the biggest aggregate supply deal to date -- a five-year, 200,000-kilo supply agreement with its home province of Quebec, with an option for a sixth year. Prior to announcing its Newstrike Brands acquisition in March, this supply deal was slated to gobble up about 40% of HEXO's production through 2023, with Quebec using this output for adult-use sales. Even after the Newstrike deal brings HEXO up to 150,000 kilos of peak output annually, around 30% of its production through 2023 will wind up heading to Quebec's recreational market.
But make no mistake about it, HEXO's medical revenue should rise. That's because it and Molson Coors Brewing formed a joint venture last year to develop nonalcoholic cannabis-infused beverages. This partnership, known as Truss, will begin selling beverages in the fall, when a number of derivatives get the green light from Health Canada. Since these alternative cannabis options bear higher price points and are more likely to be purchased by medical patients, HEXO's reliance on the medical pot community would be expected to grow.
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OrganiGram Holdings: 90.8% recreational, 9.2% medical
Finally, you might be shocked to learn that one of the highest-yielding producers, in terms of cultivation space, also had nearly 91% of its revenue derived from the recreational market in its most recent quarter.
New Brunswick-based OrganiGram Holdings (OGI 1.05%) is set to produce 113,000 kilograms at its peak, with the full buildout of its Moncton campus expected to be complete by the end of this year. With just 490,000 square feet of growing space, OrganiGram's more than 230 grams per square foot doubles the industry average, in terms of yield.
While CEO Greg Engel does foresee roughly half of all medical cannabis sales being in the form of high-margin derivatives, the early data doesn't lie: OrganiGram is making its presence known in the recreational marketplace. Having signed a letter of intent with Quebec two months ago, OrganiGram became only the third grower to nab a supply deal with all of Canada's provinces. Since these supply deals are focused on the recreational market, it's no surprise that OrganiGram's revenue was so highly skewed toward adult-use. Like with HEXO, I'd expect an increase in derivatives, extracts, and maybe a brand-name beverage partnership to boost its medical revenue. But for the time being, OrganiGram looks to be a recreational-marijuana-focused grower.
