Shifting marijuana sales out of the shadows to legal marijuana dispensaries is a multibillion-dollar opportunity, so cannabis companies are spending big money to win market share early on. The flurry of spending means the marijuana industry is losing money right now, but some companies offer better gross margin than others, making them top pot stocks worth buying.
How big is the marijuana opportunity?
A lot is made of the market opportunity associated with marijuana for good reason. Globally, spending on marijuana totals about $150 billion per year, including $50 billion in the United States.
However, most of that spending is still done behind closed doors. Uruguay and Canada are the only two countries to have legalized recreational marijuana use nationwide, and those countries only represent a sliver of the total market worldwide. Uruguay's marijuana market is tiny, and Canada's market is only worth about $5 billion per year, or roughly 3% of total global spending. In Q4, only 20% of Canada's marijuana sales were made legally.
In the U.S., individual states are embracing pro-pot laws, but marijuana remains illegal at the federal level. Currently, 33 states have OK'd medical marijuana use, and 10 states have approved recreational use markets. Regardless, legal marijuana sales in the U.S. were only $8.4 billion in 2018, according to Matt Karnes of GreenWave Advisors, which is only about 17% of total U.S. spending on the herb.
Who are the biggest publicly traded marijuana growers?
The U.S. marijuana industry is fragmented because of marijuana's federal status. U.S. growers face obstacles to accessing banking services and onerous tax policies, plus they can't list on major market exchanges, including the New York Stock Exchange, because marijuana's still a schedule 1 prohibited drug. Instead, U.S. cannabis companies are listed on the over-the-counter exchange, a Wild West-style exchange that's at greater risk of fraud.
Because of Canada's national pro-pot laws and decisions by Canada's biggest growers to avoid the U.S. marijuana market, they've been able to secure adequate financing and, in many cases, listings on the NYSE and NASDAQ. Thus, they've become the biggest publicly traded marijuana growers.
Canada's cannabis growers can be broken into two tiers based on sales and marijuana production capacity. Canopy Growth (CGC -1.80%) and Aurora Cannabis (ACB -2.40%) are in the top tier with over $200 million Canadian dollars in annualized sales and production forecasts exceeding 500,000 kilos per year. Second-tier cannabis companies include Aphria (APHA), CannTrust Holdings (CNTTQ), Cronos Group (CRON -3.75%), HEXO Corp. (HEXO -2.04%), OrganiGram (OGI -3.79%), and Tilray (TLRY). They offer peak production potential of up to 300,000 kilos per year, and each could reach nine figures in annualized sales soon.
Who has the best gross margin?
Gross margin offers insight into which companies could be the most profitable someday. It shows how much revenue is left over after subtracting cost of goods sold, or the expenses directly related to producing products, such as materials and direct labor costs. As such, gross margin helps investors determine what company is producing marijuana at the lowest cost, or is selling the most profitable marijuana products.
To ensure an apples-to-apples comparison of gross margin at Canadian marijuana growers, investors should focus on gross margin excluding fair-value changes to inventory, a metric demanded by international accounting regulators that can be volatile.
Excluding those fair-value changes, OrganiGram's gross margin of 60% during its most recent quarter ranks best, while Aphria's 18% gross margin ranks worst.
Recently, Aphria acquired two international drug distributors that accounted for $56 million of its $74 million in revenue last quarter. Because those distributors boast gross margin below 15%, and they don't make their money by selling marijuana (yet), gross margin isn't as good of a measure of Aphria's marijuana production costs as it is for OrganiGram's.
OrganiGram owes much of its margin advantage to a 3-tier grow system that maximizes pot production per square foot at its indoor grow rooms. To take full advantage of that approach, it's expanding its Moncton facility by 92 grow rooms this year, which should triple production capacity to 113,000 kilos per year.
In addition to OrganiGram, Aurora Cannabis and HEXO deserve kudos for boasting gross margins above 50%, too. Aurora Cannabis' gross margin is helped by ramping production at existing greenhouses incorporating automation, while product mix is a big driver of HEXO's success. Dried flower commands lower retail prices than marijuana-derivative products, such as oils, so growers that get a larger percentage of sales from oils see tailwinds to their gross margin. Oils accounted for 23% of HEXO's sales in its most recent quarter, up from 19% in the prior quarter.
|Marijuana Stock||Sales (MRQ) in Canadian Dollars||Gross Margin (MRQ)|
What to watch next
Gross margin could improve for these companies as expansion plans come online and scale up to full production. That's particularly true at Aurora Cannabis, where marijuana production jumped to 150,000 kilos per year in Q1 2019 following a major expansion to its Aurora Sky greenhouse. Gross margin at companies relying heavily on wholesale marijuana supply, including Tilray, could face margin headwinds until supply finally catches up to recreational market demand in Canada, making them potentially less attractive in the short term.
Overall, I suspect we'll see some shifting in this ranking over the next year, but OrganiGram's execution so far suggests it may be positioned best to turn marijuana revenue into earnings from here.